Will the Stock Market end in tears

However, despite several measures by the Government of India and the RBI for improving financial access to the MSME sector, the supply of credit from formal financial institutions continues to fall short of demand. Total credit supply has increased from Rs. 7.0 trillion to Rs. 10.9 trillion between 2010 and 2017, thus leaving a credit gap of Rs. 25.8 trillion.

Over the last few years, the government of India has taken up a wide array of policy measures to improve access to finance for MSMEs. The MSME Act 2006 has been major enabling legislation around which several regulatory and institutional facilitation of MSMEs has become possible. At the last count, the website of the Ministry of MSMEs listed 28 direct government support schemes for the sector. The RBI has been trying to increase the supply of credit to the sector through several measures such as the classification of MSME loans under the category of priority sector lending, the introduction of TReDS (Trade Receivables Discounting System) platforms, strengthening the reach of Credit Information Companies and launching the Credit Line Guarantee Scheme for the MSMEs. The MUDRA (Micro Units Development and Refinance Agency) loan scheme has tried to address the credit needs of the micro and small spectrum of the MSME sector. Streamlining the debt recovery mechanism through various amendments in the IBC (Insolvency and Bankruptcy Code) 2016, the creation of CRESAI (Central Registry of Securitisation Asset Reconstruction and Security Interest of India) are steps to increase the confidence level of banks and NBFCs while lending to potentially highrisk MSME businesses.

Some of these schemes have been well received by the MSME sector. For example, the Udyam Portal has registrations from 8.4 million MSME units. This promises to be one of the largest sources of data on MSMEs in the times to come. The MUDRA loan scheme has extended cumulative support of Rs. 15.52 trillion to 295.5 million loan accounts over 6 years of operation. Through TReDS platforms in FY 2021-22 MSMEs were able to discount invoices worth Rs. 360 billion at a borrowing cost of 4-9% as against the cost of 12-15% they would have usually paid to the banks. While the numbers are impressive, a lot more needs to be done. The total credit to Micro and Small enterprises has steadily declined from 13% of total nonfood credit in January 2016 to 11.78% in January 2022. In the case of TReDS, only 36% of the identified buyers have so far registered on the platform since 2017 despite persistent efforts from the government.

Stagnation in Credit-flow to the Micro and Small Enterprises Source: RBI Monthly Bulletin

Most of these policy initiatives require MSMEs to be familiar with the filing of applications, compliance reports, and other procedures in online mode. The Fintech firms are leading the spurt in designing innovative financial products, outreach to customers, appraisal methods, and quick and low-cost processing of applications. However, not all MSMEs, especially in the micro and small segment are equipped to and comfortable with the digital mode of operation. The language of these digital access platforms being predominantly English also poses a challenge to the

MSME promoters. There is an urgent need to make these digital interfaces available in all the major regional languages in the country. While technology can help in reducing transaction costs and speed up the processes, it can also act as a barrier in many ways. An RBI Working Group study on digital lending puts the total lending through digital channels at a mere 6.04% of the total number of loans and 2.07% of the amount disbursed for Scheduled Commercial Banks (SCBs). NBFCs have done better on this front by disbursing 10.87% of amount using digital channels to 53.05% of loan accounts. However, the share of NBFCs in total loans to the MSME sector is a mere 10%.

The second issue that hampers access of MSMEs to formal sources of finance is the information asymmetry that persists in the credit market for MSMEs. MSMEs often function in hyper-local geographies, information about which is either not available or costly to acquire. Governance mechanisms in MSMEs and reporting and compliance standards are often found wanting. Promoters are often first-time entrepreneurs and do not have any track record of past businesses. Shortage of capital would also mean that an asset-light model of operation is preferred. All these factors make appraisal and lending to MSME projects a challenge. Banks, NBFCs, and especially the Fintech companies in their pursuit of speed, volumes, and reduction in transaction costs have been following some innovative methods of appraising project viability and credit worthiness of promoters: 1. Apart from traditional analysis of financial statements, lenders are using bank statements, POS devices, and data from other digital modes of payment to understand the profitability of enterprises. Thanks to the evolving digital payments eco-system lenders can have more reliable and high-frequency information on the business to structure cash-flow-based lending products. 2. Personality traits of promoters can be used as indicators of their ability to make business profits and willingness to pay. Psychometric tests of promoters are being used for assessing these aspects as part of the appraisal process. 3. Some fintech companies are combining the social media footprint of the promoter with data analytics to understand the character of the promoter. 4. Appraisal can also include an analysis of the social network of the promoter such as family members, friends, neighbours, and their businesses. Lenders also get feedback from customers and suppliers of the business to get information on the dealings of the promoter. 5. Traditional lenders such as banks and NBFCs need to explore new distribution channels. Fintech companies and informal money lenders have a deeper reach and are more flexible in terms of the structuring of the products, documentation, and compliance requirements relying more on social pressures for the recovery of loans. Such channels can be formally used by the banking sector. Some structures analogous to the SHG-Bank Linkage Program can be explored especially for meeting the credit requirements of the micro and small sector.

However, while doing this, it is important to heed the warning given by an article by William Magnuson that the next crisis may not originate from the Wall Street but from the Fintech firms in the Silicon Valley. The report of the RBI Working Group on Digital Lending notes that currently the fintech companies are being governed under the existing laws and rules such as the Banking Regulation Act (1949), RBI Act (1934), Companies Act (2013), Chit Funds Act (1932) and a host of state-level acts for money lending. The report stresses the need to strengthen the legal and regulato-

regulatory framework keeping in mind the specific nature of the Fintech business such as enforceability of supervision, the risk to financial stability on account of the Fintech sector, and its need for continuous innovation, both in technology and ways of doing business. The report also emphasises the need for looking into issues such as technology standards, consumer protection, data privacy and security, and the extent of transparency in the algorithms used by the Fintech companies without affecting their competitive advantage.

The challenges faced by the MSMEs are multidimensional. Lack of access to finance is an important factor. Diversity among the MSMEs is seen not just in terms of size but also in the sectors, product lines, geographical areas, and structure of businesses. The interstices of the economy in which MSMEs operate are spaces replete with contextual richness. If formal financial institutions are to make themselves more accessible to MSMEs, they will have to look beyond standard financial products and traditional delivery mechanisms. A judicious mix of flexibility and speed, with innovative ways of keeping a check on the quality of assets being created, will be the key to success. The financial sector, while retaining its prudence, will have to get as ‘jugadu’ as the MSMEs they hope to target.

1.The Indian Express, February 8, 2022 2.Hsieh, C. T., & Klenow, P. J. (2014). The life cycle of plants in India and Mexico. The Quarterly Journal of Economics, 129(3), 1035-1084. 3.Ayyagari, M., Demirguc-Kunt, A., & Maksimovic, V. (2017). SME finance (No. 8241). The World Bank. 4.International Bank for Reconstruction and Development. (2021). Program Appraisal Document on a Proposed Loan in the Amount of US$500 million to India for a Raising and Accelerating Micro, Small and Medium Enterprise Performance (Report No. PAD4243). The World Bank 5.International Finance Corporation (2018) Financing India’s MSMEs: Estimation of Debt Requirement of MSMEs in India. The World Bank

8.The Financial Express, May 4, 2022 9.RBI (2021). Report of the Working Group on Digital Lending Including Lending Through Online Platforms and Mobile Apps 10.RBI (2019). Report of the Expert Committee on Micro, Small, and Medium Enterprises 11.International Finance Corporation (2018) Financing India’s MSMEs: Estimation of Debt Requirement of MSMEs in India. The World Bank

12.The Economic Times, September 19, 2017