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.
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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