A Brief Insight into Digital Lending in MSME

Soniya Khanna

06 Jul, 2023

In recent years or so, the emergence of fintech and especially digital lending has revolutionized the Micro, Small and Medium Enterprises (MSMEs). Digital Lending in MSME has accounted for significant growth in the MSME sector. For a better understanding, let’s look at some of the meanings.

What is Digital Lending?

In simple words, Digital lending is the process of granting loans to borrowers using the digital medium. All process related to lending is conducted electronically. It involves the use of online technology to originate and renew loans in favor of a customer. Digital lending helps in quicker decision making and faster process of loan disbursal.

What is MSME?

MSME stands for Micro, Small and Medium Enterprises. The Ministry of MSME is a branch of the government of India, which is the highest body for the administration of the rules and laws relating to MSMEs in the country.

The enterprises are classified under two divisions:

• Manufacturing enterprises that are engaged in the manufacturing or production of goods in any industry; and
• Service enterprises that are engaged in providing or rendering services.

Digital Lending in MSME: Overview

Owing to some positive regulatory environment and progressive initiatives of the government, SMEs have witnessed significant growth accounting for nearly 17% Y-o-Y growth in the previous year.

Various studies have revealed that the growth of 15x in digital lending to MSME could be expected by 2023. This level of growth is due to rapid digitalization and access to easier and cheaper credit facilitated by digital lending companies.

Indian financial market faced a huge setback last year with ILFS (Infrastructure Leasing and Financial Services) crisis. It wiped off more than $116 billion investor wealth. ILFS is a significant infrastructure player, and the ILFS crisis could have triggered a substantial financial crisis, but owing to a quick reaction on the part of the government and the regulatory bodies thwarted the financial crisis.

Why is Digital Lending increasingly preferred among the MSMEs?

Given the ease of access and a seamless process of securing loans, Digital lending is preferred more among the MSMEs as compared to the traditional sources of lending. Leading digital companies use the help of data of business performance and financial health to assess loan eligibility.

Loan applications were assessed traditionally on the basis of various financial information and documentation like tax returns, credit report, payment history, etc. With the transformation of this data, digital lenders can quickly determine the loan and the interest rate for which the borrower is eligible.

Instead of formal sources of data like bank statements, ID cards, and GST filings, alternate data gets the knowledge of the financial history of a person through digital evaluation of the person’s habits. Few of such sources include Social media, locations, debit card details, etc. Moreover, with the use of Artificial Intelligence, digital lenders can verify the data more efficiently. It provides MSMEs with greater avenues of securing business, thereby enabling their growth.

What are the contributing factors for digital lending in MSME?

Some of the contributing factors that have echoed the use of digital lending are mentioned below:

• MSMEs are digitizing their operations and credit acquisition rapidly;
• The credit value chain is digitizing; therefore, MSMEs can have access to funding within a day’s time;
• 75% of MSMEs are comfortably sharing data digitally; and
• 47% of MSMEs have made use of digital tools for accounting, payment, or sales.

What are the advantages of using digital lending in MSMEs?

Digital lending in MSME provides the following advantages:

• Quick Loan Approval

Digital lending will help in quicker decision making thereby leading to quick loan approval speed.

• Credit underwriting Insight

Digital lending shall provide a deep insight into credit underwriting, which shall help in assessing the creditworthiness or risk of the potential borrower.

• Operating cost-efficiency

Digital lending will allow a reduction in operation costs and will lead to efficient operational cost. Digital lending models have a cost advantage of 20% for collections and 30-40% for acquisition. 

• Introduction of formal banking and reduced credit gap

It is one of the significant benefits where digital lending shall bring in the formal banking system to MSMEs, and it shall also reduce the credit gap. As per a study, Digital lending can expand by 15x to 6-7 lakh crore rupees by 2023.

What are the factors that are helping the MSME sector in the purview of digital lending?

The factors that are helping the MSME sector by causing a cycle of formalization are as follows:

• The regulations of the government and supply chain pressure leading to automation;
• Growing digital trails of MSMEs through online filings;
• Credit providers leveraging digital trails in order to provide cheaper loans; and
• More MSMEs operating digitally with a view to getting cheaper credit.

Digital Lending in MSME: Road ahead

Technology shall remain at the forefront of digital lending, considering a majority of users are borrowing business loans with little or no credit history. It will then be imperative to innovate continuously and deliver products that empower the larger MSME community.

Digital lending Companies are increasingly using new-age technologies to improve and address repayment and delays. The use of these technologies in the lending business shall reduce a lot of operational costs and save a lot of time, thereby increasing the profit of the MSME sectors.

Conclusion

Also, read: How MSMEs benefited from RBI’s loan restructuring: An Insight Story