According to the Economic Times, the MSME industry is the backbone of the Indian economy, accounting for 30% of the nation’s GDP, 48% of total exports, and 40% of the country’s employment. Currently, the MSME sector in India has an estimated 60 million individuals or 6 crores.
The Ministry of MSME reports that as of 2022, there are 12,201,448 registered MSMEs, with micro-enterprises accounting for 11,735,117, followed by small enterprises at 426,864, and mid-sized enterprises at 39,467. Even with these numbers, the sector has very low access to formal credit. They still struggle in that matter.
But, despite the above challenge they face, the MSME sector has undergone significant changes in recent times and still continues to drive the Indian economy forward and contribute significantly to the country’s growth. The industry has also witnessed a surge of innovations, particularly in digitalization and technology. As we planned to conduct our February 2023 webinar on this topic, we have collaborated with many industry experts who have raised several pertinent questions to be asked in this session. Some of the most common questions include
- how to underwrite customers without relying on credit scores,
- what non-conventional methods can be employed for customer underwriting,
- how to onboard MSME customers in a digital mode, and
- what POS-based lending and cash flow-based lending are all about.
These are just a few of the many questions that have piqued people’s curiosity, and the industry is keenly awaiting answers to the broader question – “what innovations are happening in MSME credit?”
This article will delve into these topics and more, providing insightful answers and shedding light on the latest innovations in the MSME credit sector. And we had a renowned MSME expert and CEO of Prest Loans, Mr. Ashok Mittal, and our very own Co-Founder & CEO of CloudBankin and a digital sensation for #manispeaksmoney on Linkedin, Mr. Mani Parthasarathy, provide those insightful answers. So, let’s get right into it!
Mani – Can you start by defining MSME?
Ashok – The definition of MSME encompasses entrepreneurs, self-employed individuals, and anyone trying to establish and grow their business, irrespective of whether they are engaged in trading, manufacturing, or providing services to B2B, B2C, or D2C customers. Although the government has provided guidelines for defining MSMEs, anyone can apply for a Udyam Certificate to be recognized as an MSME.
Mani – What’s the percentage structure of the MSME business segment? (Individual, Partnerships, LLP, Private limited companies)
Ashok – Regarding organizational structure, micro businesses are typically owned and run as proprietorship firms. On the other hand, small businesses are predominantly partnerships, with some also operating as Limited Liability Partnerships (LLPs). Medium businesses, meanwhile, are mostly registered as LLPs or private limited companies.
In recent years, many SME platforms have emerged to get listed on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), with around 500-600 companies currently listed. These platforms provide an avenue for SMEs to raise funds and expand their operations, contributing to their growth and the overall development of the economy.
Mani – For NBFCs, Banks & Fintechs to lend to the MSME businesses, what’s the onboarding process currently?
Ashok – The onboarding process for MSME loans typically involves several steps.
- Firstly, the borrower’s identity is verified using their proof of identity (POI) and proof of address (POA) documents, often by validating them through Aadhar. Many platforms like CloudBankin have integrated with the CKYC portal for digital KYC verification.
- Next, the borrower’s financial details, such as bank statements and GST returns, are validated to assess their creditworthiness. Personal information such as social media and geolocation may also be validated. If the loan application is accepted, an agreement is prepared and signed between the borrower and lender. The loan is disbursed, and the borrower is successfully onboarded.
It’s important to note that not all MSME borrowers are tech-savvy, and hence, it’s crucial to have differentonboarding journeys to cater to different types of borrowers. This includes a completely digital onboarding journey for those who are comfortable with technology, a phygital journey for those who are comfortable with integrating technology into their traditional journey, an assisted journey where a loan officer helps the borrower through the digital onboarding process, and a traditional journey for those who prefer a more traditional approach. By offering different onboarding options, lenders can cater to a wide range of borrowers and make the loan application process more accessible and convenient.
Mani – What is the Customer Acquisition Cost (CAC) rate for onboarding an MSME business borrower?
Ashok – The customer acquisition cost for a loan depends on several factors, such as the location of the customer and the type of loan being offered. For secured loans backed by collateral, it may not be feasible for tech-enabled NBFCs or fintech companies to complete the onboarding process entirely through digital means. However, for loans that are not backed by collateral, digital onboarding is possible and cost-effective. Using digital methods such as PAN or Aadhar verification can significantly reduce costs compared to physical onboarding. Overall, the CAC rate for an average loan is approximately 0.5-0.6% of the loan amount. For instance, for an average loan of three lakh rupees, the cost would be around 1500-2000 rupees for everything put together.
Mani – What is the process for underwriting customers in MSME Credit?
Ashok – Let me describe the process through my company’s underwriting method. Our method, Prest Score, runs on an algorithm we developed. Like any other financial institution, we verify a borrower’s ability to pay by examining their financial documents, such as bank statements, GST, etc., as well as their intention to pay through reference checks and verifications, such as seller, buyer, and neighbourhood references. However, this process can take time to validate.
To overcome this challenge, we evaluate the entire profile of the customer using over 200 parameters, collecting both financial and non-financial information. This helps us make more accurate decisions regarding loan approvals and reduces the risk of default for our company and customers.
Mani – What data sources do you look for completing the underwriting process?
Ashok – As mentioned earlier, Prest Loans’ underwriting method, Prest Score, evaluates over 200 parameters to assess a borrower’s complete profile. The process begins with the borrower’s personal, family, and social information and then moves on to their financial documents, such as bank statements, GST returns, and collateral details (if applicable).
Regarding non-financial parameters, we consider a wide range of factors to determine the borrower’s creditworthiness. For instance, we evaluate whether the borrower owns their home or business premises or if they are rented, as well as the duration of the borrower’s business experience and the education levels of both the borrower and their spouse. Even the education of the borrower’s children is taken into account. We also consider the credit manager’s experience while visiting the customer and the small details such as customer behaviour and geographic location.
Regarding financial parameters, we evaluate bank statements to assess the borrower’s financial behaviour and also look into their GST returns for more information. By considering these 200+ parameters, we create a complete profile of the borrower to better assess their ability and intention to pay.
Mani – What about the weightage given to the parameters mentioned above?
Ashok – Once all the parameters have been combined, we will provide a Prest Score of the customer in 1000s, which is similar to credit bureau scores. Prest Loans offer loans with varied interest rates depending on the customer’s score and entire profile. Customers with high scores are eligible for lower interest rates, while those with lower scores (just cutting off the level) are eligible for higher interest rates for their loans. The Prest Score serves as a deciding factor in loan approval. If a customer’s score is below a certain level, they will be rejected, while a score above a certain level will be accepted. The interest rate is determined by the customer’s Prest Score and profile, which is unique to every customer.
Mani – Can you give a few examples of Prest Loans Customer Profiles?
Ashok – Prest Loans has a unique approach to providing loans to its customers, particularly new-to-credit borrowers or customers with no credit history. This makes up about 28% of all Prest Loans customers. The company takes a hands-on approach to understand the businesses of these individuals before providing them with loans.
The first individual, located in the Old Delhi area, runs a humble tea stall. Typically, providing a loan to a tea stall owner would be challenging, as there are no formal financial parameters to assess their creditworthiness. Nevertheless, we spent a few hours with this owner, studying his sales and profit margins, and inquired about his desire for a loan. He expressed his aspiration to move his stall from the roadside to a small commercial area where he could better sell and make his tea. We granted him a loan, and within just one and a half to two years, he not only repaid the loan, but also flourished in his business.
Similarly, another individual in South Delhi also runs a tea stall and sells pakodas. Despite the obstacles in assessing his financial viability, we were able to determine his cash flow by analyzing his business operations and spending time getting to know him. Consequently, he received a loan from us and expanded his business with remarkable success.
In Jaipur, we encountered another tea stall owner who sold “patties” as snacks. This particular snack costs Rs. 5, and he sells it for Rs. 8. He gets a profit of Rs. 3. But when he heats up the patties and adds a layer of onions with masala, it allows him to charge a higher price of Rs. 12 and increase his profits by Rs. 7 on the same snack item. Thus by understanding his unique value proposition and spending time studying his business operations, we were able to provide him with the necessary loan to grow his business further.
Another was a man who made unique ornaments for women’s clothing. He employed 100 women from rural areas and paid them a fair wage. Although he has no formal banking or GST filings, we took the time to comprehend his business model and were fascinated by his incredible profit margins. His cost of manufacturing is only Rs. 3, but he sells each item to wholesalers for Rs. 6, enjoying a 100% margin. Without a doubt, understanding his business was essential in granting him the necessary loan to help him continue to flourish.
We believe that there are many high-margin businesses in India that are done by micro-segments of the population and that by understanding how these entrepreneurs run their businesses, we can provide financing to those who need it most.
Mani – If you are not able to get digital data of these profiles, how long does it take to underwrite them?
Ashok – As soon as these clients have shared their information, you have already sifted through and analyzed a wealth of details. All that remains is to decipher their unique customer profiles. As a loan officer or underwriter, you personally pay them a visit, understand their trade, establish their profiles, evaluate their creditworthiness, and make lightning-quick credit decisions within 30 to 50 minutes. Micro-segmented business owners are typically not fussed about the ticking clock and are primarily concerned with obtaining a confirmation about the outcome of their loan applications. Hence, if it takes you no more than 3 days to grant them an answer (and certainly not longer), they would be more than content. I deem 72 hours to be an ideal timeline for borrowers to receive a decision unless properties or collateral are implicated. It is all about effective communication. By conveying that “yes, your loan has been approved, but it will take this much time,” they will be fully satisfied. The quandary crops up only when you are unable to confirm or communicate the status of their loan applications.
From hereon, we handed over the session to our audiences for AMA with the speaker. Take a glimpse of the discussion below.
1. How are Prest Loans acquiring MSME customers? What is their growth rate?
Prestloans acquires most of its customers through its team and network in various branches and also engages with them via social media and other digital channels. Additionally, some of their customers are obtained through DSA partners. Over the past 18 months, the company has experienced a remarkable 10x growth rate in customer acquisition. Looking ahead, the growth rate in 2023 is expected to increase by an additional 6x compared to 2022. These impressive numbers demonstrate the strong demand for MSME lending and the success of Prestloans' customer acquisition strategies.
2. How much are the revenues or turnovers of the MSMEs?
40 Lakhs to 2 Crores approx.
3. How much are the IRR and turnaround of the MSMEs?
Prestloans offers unsecured loans ranging from INR 50,000 to INR 10 lakhs, with a tenure of 3 months to 3 years. The average ticket size for unsecured loans is INR 3 lakhs, with an average tenure of 27 months. For secured loans, the ticket size ranges from INR 3 lakhs to INR 20 lakhs, with a tenure of 5 to 10 years. The average ticket size for secured loans is INR 6 lakhs, with an average tenure of 7 years. The interest rate for unsecured loans ranges from 12% to 30%, depending on the customer profile. However, there is no fixed rate for IRR. This ensures that the interest rate is tailored to the borrower's risk profile and creditworthiness, making it easier for them to access credit that suits their needs.
4. How do Prest Loans avoid a biased underwriting process for a human-based decision to give loans or not?
In the underwriting process of Prestloans, there are two ways in which the credit officer's influence is minimized. Firstly, the sequence of questions asked by the credit officer keeps changing, and they are not aware of when the sequence might change. Therefore, they do not have any influence on the Prest score given to customers. Secondly, credit officers rotate across different areas, and there is no fixed credit officer for a specific area. This reduces the chance of any credit officer having an undue influence on the decision-making process during underwriting. These measures are in place to ensure that the underwriting process at Prestloans remains objective and unbiased and decisions are based solely on the creditworthiness of the applicant.
5. How did the pandemic affect Prest Loans in giving loans to their customers?
Over the past 15 months, Prest Loans has shifted its lending strategy in response to the Covid-19 pandemic. Prior to the outbreak, the company predominantly provided unsecured loans to metropolitan areas. However, as the pandemic disrupted business operations and impacted loan repayment capabilities, the company reduced its provision of unsecured loans and began offering more secured loans to both metropolitan cities and Tier 2 and Tier 3 cities. Consequently, the proportion of secured loans has significantly increased at present. The transition was relatively seamless, and the company continues to adapt to changing market conditions in order to serve its customers best.
6. What are the ways to reach out to the MSME business owner for giving loans since the segment is very wide, scattered and fragmented?
When lending to the MSME sector, it's recommended that lenders not focus solely on a particular Ideal Customer Profile (ICP) but rather lend to those who deserve it. The loan ticket size, lending interest rate, and loan tenure may vary depending on the individual borrower. Lenders also suggest that MSME business owners maintain good reporting by always filing their GST. It's also important to have a strong digital presence on the internet by creating websites and having pages on social media platforms like Facebook, Instagram, and LinkedIn, among others. These measures can help MSME business owners reach wider lenders and increase their chances of getting approved for loans.
7. What kinds of lending products can we give to the customers of MSME segments today?
Working capital finance or business loans mainly. Sometimes personal loans. Some kinds of channel financing or dealer financing. Invoice discounting When companies like Bharatpay or Paytm assess the sales pattern of an MSME business owner, they design a credit offer and extend that to the MSME business owner.
8. For cash flow forecasting and projections for lending in the MSME segment, what are the key things to be kept in mind?
Two key factors must be considered. Firstly, it is essential to obtain accurate and reliable data about the customer's business, taking into account factors such as revenue, expenses, and growth potential. Secondly, this data should be evaluated against industry-standard margins to determine whether the customer's business is performing well or not.
9. What are the challenges financial institutions like NBFCs face in MSME credit?
Lenders and borrowers face different challenges while dealing with loans. The lenders have to deal with internal challenges like complying with regulations, managing teams and maintaining proper records. On the other hand, borrowers face challenges in understanding how their loan applications are sourced. If a loan application is bought through a DSA partner, it passes through multiple lenders before landing at the right door. In contrast, if it is bought directly or through a network, it is important to ask questions and verify the source. It is also important to consider when the loan application is sourced as well as when the visitation with the customer takes place. The customer's behaviour may vary depending on the date and time of the visitation. Additionally, borrowers face property-related risks, especially in cases of securitization where the legality and consent of family members may be a concern.
10. What is the role of Co-Lending in MSME Credit?
With the support of the regulatory body RBI, the partnership between NBFCs has resulted in a booming product in the market for loans to the MSME segment. However, the execution of loans for borrowers in a Bank-NBFC partnership takes a longer time, which may cause problems for MSME business owners in urgent need of a loan. Despite this, the scope for NBFC-NBFC partnerships continues to run successfully and provide much-needed financial assistance to MSME enterprises.
11. Is balance sheet lending encouraged for MSME credit?
For unsecured loans, there are certain criteria that a borrower needs to meet in order to be eligible. Proper filing of GST, regular banking activities, and a good cash flow for the business are some of the key factors. In such cases, there is no need for balance sheet lending. However, for secured loans, balance sheet lending is encouraged as many aspects need to be considered, such as ITR, GST filings, notes of accounts, property papers (in cases of securitization), and the overall banking and business profile of the customer. It is essential to evaluate all these aspects to mitigate the risks associated with secured loans.
Ashok – The demand for MSME lending is on the rise in India as there is a significant increase in the number of entrepreneurs who are looking to start their own businesses. This trend is not limited to urban areas, as even people in remote locations are eager to start their ventures. As a result, the MSME lending industry is thriving, and it is expected to grow even further in the coming years. The industry’s growth is driven by the improvement in the way business is being conducted in India and the availability of loans to finance startups. This trend is set to continue for the next decade, creating a disruptive effect in the finance industry. Regardless of the business type or industry, the MSME lending sector is poised for significant expansion and is here to stay.
We conduct webinars related to Fintechs & Digital Lending on a monthly basis at CloudBankin, so keep an eye out for that! Also, don’t forget to stay tuned for more upcoming blogs!
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