Evolution of MSME Lending

The Micro, Small and Medium Enterprises (MSME) sector has consistently grown at a quicker pace than India’s GDP, but has not been supported by adequate formal financing opportunities. This is largely because many of these businesses are in the informal segment, and lack proper documentation and liquid collateral, making underwriting difficult for banks.

Traditionally, banks perceive lending to small businesses a relatively risky proposition,and have adopted conservative policies to minimize both credit risk and cost of delivery. They have taken far greater comfort in financing formal and medium enterprises, leaving a gap in the market. Over the years, India has witnessed the evolution of various models to try and fill this gap and meet the credit needs of the unorganised sector. Non-banking finance companies (NBFCs) with localised presence and domain knowledge have started to look at small business finance market as an opportunity. Presently, the small business finance market comprises of NBFC-MFIs, large and old NBFCs along with new NBFCs. The aggregate AUM of NBFCs focussing on small business financing is estimated at INR 33,000-35,000 crores. Within this segment, large NBFCs dominate the market, catering to borrowers in both the formal sector, who are able to produce documented proofs of income, and the informal sector.Large NBFCs including Sundaram, Chola, Bajaj and Shriram, dominate the market with over 90% of the aggregate AUM. Other players include NBFCs, a number of whom have partnered with IFMR Capital, to focus on mortgage loans or secured and unsecured loans to small businesses. Semi formal and informal sectors remain largely under-served; this is especially true when the loan requirement falls below INR 5 lakhs. NBFCs catering to the informal segment rely on their ability to assess the clients’ income, develop templates to understand the margins and cash flows of local businesses, and have a strong in-house process of credit and security verification. The number of originators in this market and their assets under management is very small in proportion to the demand – presently, they collectively manage less than INR 4000 Crore.

A) Microfinance emerged as a step forward in addressing the continued challenge of financial inclusion. Some MFIs such as Grameen Financial, Grama Vidiyal and Ujjivan have started offering Individual Loans to customers with long standing relationships, while others like Swadhaar, Arohanand Utkarsh have created a small customer base of individual run micro enterprises.Many other players are also experimenting with this product for their ‘graduated’ group-loan clients as well as non-clients who are entrepreneurs, on pilot basis before they scale up the product to small businesses.

B) Non-banking financial companies (NBFCs) with a sectoral focus on MSME finance like Intec Capital, Electronica Finance, MAS Financial Services and Five Star have steadily developed their business for over two decades. Their unique model of underwriting and credit delivery has helped them scale-up financing to small businesses while maintaining strong portfolio quality.The loans offered facilitate occupational needs including, equipment purchase, business expansion, technology upgradation and working capital requirements.

C) Over the past 5-7 years, newer NBFCs sensing opportunity have made a foray into SME lending with innovative business models. These NBFCs analyse informal records that banks generally do not accept, and conduct background checks on potential customers through an exhaustive evaluation process. They have built unique credit methodologies to undertake cash-flow based assessment of MSME financials, even in the absence of conventional income documents, by assessing customers’ economic activity. Several new players have entered the market. These new entrants are a mix of new entities and offshoots of existing financial institutions. New NBFCs such as Vistaar Finance, Kinara Capital and Intelle grow have commenced business with a focus on micro enterprise lending, while others like Shriram City, Bajaj Finance, Religare Finvest, and Au Financiers have leveraged upon an existing branch network and customer base.* Large NBFCs including Sundaram Finance and Cholamandalam have increased their portfolios in mortgage and home equity loans especially to small enterprises.

FY 2013-14 has witnessed the emergence of new NBFCs such as Aye Finance, Capital Float and NeoGrowth. These originators have leveraged their technological expertise to facilitate credit assessment and maximized process efficiencies to build a competitive advantage.A number of private equity firms have expressed an interest in these originators at their early stages of growth. Furthermore, it is interesting to note that a number of originators have developed their own niche of operations to meet specific gaps – working capital needs of corporates, equipment financing for larger MSMEs, ongoing business requirements for smaller businesses etc. Others have focused on developing their networks in specific geographies. These new lending institutions have developed innovative processes to expand target clientele – referral systems integrated with the supply chain, systematic cluster-based approaches, direct marketing, and strategic relationships with other institutions which work with the same target clientele, to name a few. A handful of organizations, including IFMR Rural Channels and Janalakshmi Financial Services, are promoting a more holistic, livelihood-based approach to lending, and have begun offering enterprise loans in their operational area.

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