Government Panel Suggests A Cash Flow-Based Financing Model For MSMEs

A government panel suggested that small businesses should be allowed to borrow money based on their expected future cash flows at a time delayed payments from clients are affecting their operations.

The inter-ministerial committee, headed by former Economic Affairs Secretary Subhash Chandra Garg, recommended that the Reserve Bank of India should develop a cash-flow based financing model—loans extended by lenders for working capital, using the expected cash flows of a borrower as a collateral—for micro, small and medium enterprises.

The panel also suggested to establish an invoice infrastructure to increase financing to MSMEs. The e-invoice infrastructure, validated by the trade receivables discounting system and goods and services tax network, may form the basis of the cash-flow based lending by banks and non-bank financing companies to MSMEs, according to the panel’s report.

Small businesses have limited financial history and may not have detailed documentation of credit history, which makes disbursement of loans by banks challenging, it said in a report. Some fintech firms have business models that cater to this unserved section and have the potential to meet the needs of small and medium enterprises based on innovative methods of credit scoring, risk assessment and disbursement, the report said.

“Peer-to-peer lending and crowd funding have the potential to improve access to finance to small and medium enterprises who are otherwise declined credit from banks due to their risk portfolio,” it said.

The panel, however, cautioned that the cash flow-based lending will need superior fintech-based systems for providing early warning signals to track the borrower as there is no collateral backup.

The committee—which also had the secretary financial services, electronics and information technology secretary and RBI deputy governor, among others, as its representatives—was formed after the announcement made by former Finance Minister Arun Jaitley during budget 2018-19. Its task was to review various issues related to the development of fintech space in India and suggest ways to make fintech-related regulations more flexible and generate enhanced entrepreneurship.

The “use of fintech in financing space will help in the growth of MSMEs. A group in the Ministry of Finance is examining the policy and institutional development measures needed for creating the right environment for fintech companies to grow in India”, Jaitley had then said.

Regulatory Barriers In Fintech

The National Payments Corporation of India should provide non-discriminatory access to fintech and other financial firms that are not currently shareholders of the umbrella body of digital transactions.

This would enhance competition and innovation, and provide level-playing field among banks and non-bank lenders, the panel said in the report.

Better Regulation

The financial sector regulator could explore options for setting up fintech advisory groups as the segment is constantly evolving due to technological developments, the panel said.

The groups will have participation from industry and academic experts to identify ways to modernise the regulatory architecture, it said.

Other Recommendations

• Encouraging fintech firms, that specialise in cybersecurity to protect from financial frauds, to set up their business in India.
• Review of prepaid instruments system to liberalise its use.
• MSME Ministry should work with the Department of Financial Services and RBI to test blockchain solutions in trade finance for MSMEs.
• Insurance companies to use drones to assess discrepancies in self-reported cropping patterns.