Closing MSME Credit Gap: Traditional & FinTech Collaboration for Financial Sustainability

Contributing about 33 percent of India’s total gross domestic product (GDP), the domestic MSME sector comprises over 63 million MSMEs that provide nearly 120 million jobs and account for 45 percent of the country’s overall manufacturing output. With India harboring ambitions of transitioning to a developed economy by 2047, the country’s MSME sector will have to undergo massive transformation and expansion over the next two decades. While the Indian government has been extending credit schemes and promoting MSMEs to participate in India’s increasing international trade, the vast credit gap that exists today continues to be the MSME sector’s biggest hindrance to growth. According to a recent thought paper on MSME lending, there is an unfulfilled credit gap amounting to US$530 billion in the Indian MSME sector, with the overall demand for debt-based finance tallying to US$1.5 trillion. To make matters worse, 47 percent of this debt demand comes from small-scale entrepreneurs who do not meet the eligibility criteria of traditional financial institutions, highlighting the need for technological innovations that can drive greater financial inclusion and address the funding needs of India’s MSME sector. 

How technology is helping drive greater financial inclusion

To cater to the unbanked segment of India’s MSME sector, financial institutions will have to go beyond traditional credit gauging metrics. FinTech service providers are doing this by studying behavioral, psychometric, and social media references to assess the financial capabilities of those who have never accessed formal credit. In turn, these FinTech firms can enable non-banking financial companies (NBFCs) to customise credit products that are well-suited to micro, small, and medium enterprises. Moreover, with an increasing digital footprint and online transactions now becoming commonplace even in the remotest locations of our country, online lending platforms are emerging as a viable option to meet the short-term credit needs of India’s burgeoning MSME sector.

Undoubtedly, the use of new-age technologies and digital tools such as artificial intelligence (AI), machine learning (ML), and advanced cloud-based data analytics will remain key to helping this high-potential and high-value space grow and drive greater financial inclusion across the country.

Alternative financing tools such as peer-to-peer (P2P) lending, invoice discounting, and equity financing are notable examples of new financing models that are helping bridge the current credit gap that exists within the MSME sector. However, it is important that traditional financial institutions like public and private sector banks embrace innovation in their underwriting process, supported by new technologies developed by India’s rapidly expanding FinTech space. This collaboration will prove more effective in bridging the US$1.2 trillion credit gap that exists in the MSME sector today and help more entrepreneurs tap into global markets to market their products and services.

Embracing digital payment solutions and emerging technologies to empower MSMEs

While the Unified Payments Interface (UPI) has transformed the Indian digital payment landscape, it can play an even greater role in empowering MSMEs with easier access to capital and better cash flow management. By facilitating real-time customer payment options through innovative credit products like Buy Now Pay Later (BNPL), MSMEs can realise payments instantly and even convert their receivables into liquid funds by listing them on Invoice discounting platforms. This incessant innovation has been made possible by FinTech firms that are leveraging India’s digital payment revolution to build a more equitable and inclusive financial landscape across our nation. 

With India now piloting its own Central Bank Digital Currency (CBDC) across both retail and wholesale segments for call money settlement, emerging technologies like Blockchain will unlock new opportunities to enhance security, increase payment processing efficiencies, and remove hurdles that are limiting traditional banks in catering to the credit demand of India’s MSME sector. As digital payment solutions empower underserved businesses and FinTech firms ramp up the pace of innovation by integrating new-age technological solutions, a greater collaborative effort between them and traditional banking institutions will remain critical to straddle the credit gap that is stifling India’s MSME sector.

Authored By- Vivekanand Ramachandran, Chief Financial Officer, Electronica Finance Limited