The promise of digital finance to Small Businesses – Surabhi Nigam


New Delhi, November 20, 2016: There are ~60 mn small businesses in India contributing to ~37% to India’s GDP. Most of these borrow for business needs at usurious rates of 3-4% per month from informal sources. By some estimates, the total demand of finance for small businesses is estimated to be ~USD 300 bn. Among the top reasons behind this high cost borrowing is lack of financial literacy and financial readiness of this segment.

Financial literacy – Most small businesses are unaware that availing formal credit for business needs in a sustainable manner is a much surer way to business growth and profitability than resorting to informal finance. It is surer because a) it provides capital at a much lower cost and hence keeps cost of running a business under control thus aiding profitability and b) availing formal credit helps builds a good credit history of the business which opens up the business’ access to all-vital affordable credit as growth kicks in over a period of time. This lack of awareness towards the long-term sustainable benefits of availing formal finance is unknowingly exacerbated by understatement of income in income tax returns and financial statements. Lured by the proposition of saving tax on their hard-earned income, small businesses often get trapped and under-report their revenue and profit in their financial statements.

While they are able to save some tax in the short run, they end up ‘dwarfing’ their business and in the process naively depress the quantum of formal credit they can avail, if at all.

Financial readiness – most of the small businesses are so much caught up in their daily routine that they never bother to get the adequate business documentation in place. The fact that there is no formal deterrent for lack of business documentation abets these phenomena. Plus the hassle of obtaining the mandatory business documentation further plays devil. Ultimately, when it is time to avail credit for business, more often than not it is such an urgent need that the borrower find borrowing from informal sources at high interest rates a much better option than getting the documentation in order and approach a formal lender. Since the absolute amount of credit is not very large, the incremental effect of high interest cost is a marginal pain as long as credit is made available quickly with minimum hassle.

From a formal lender’s perspective, lack of documentation, credibility of available documentation (given the huge under-reporting of income), and high cost of due diligence when compared to the low ticket size of loans to this segment makes lending to a small business an unattractive proposition. Further the fact that these small businesses often may not have any collateral to offer for the most common working capital or term loan requirement further increases the discomfort of the lender.

Macro policy support – However, over the last couple of years certain macro developments in government policy formulation focusing on financial inclusion of small businesses and developments in digital technologies have propped up promising alternatives to solving this problem of enabling formal finance to small businesses.

The central government has launched credit schemes to assist small entrepreneurs like Mudra Scheme (collateral free business loan up to INR 10 lakhs), Stand up India scheme (business loans for women entrepreneurs and entrepreneurs from weaker sections of society), Make in India scheme etc. Infusion of additional capital in the system coupled with push from the government is likely to increase the flow of same to small business community.

Solution in the form of Digital India – Under the Digital India programme and Open API policy, Government of India (GoI) aims to make all Government services digitally accessible to citizens through multiple channels, such as web, mobile and common service delivery outlets. This can open a world of opportunities for both the small businesses and the lenders. As the Digital India and Open API policy takes roots, we can expect interoperability between systems developed by multiple agencies thereby making available hitherto unavailable information in a secure and authenticated manner. For example, lenders may get access to a prospective borrower’s bank account transaction data and income tax return data after getting a borrower’s digital consent thus enabling a seamless and fast underwriting. This would not only mean reliable underwriting based on authenticated financial data of borrower but also reduce the cost of due diligence, reduced paper in the process and much shorter application-to- sanction turnaround time.

At the heart of this Digital India programme is the India Stack programme that is an open API platform of useful services and leverages the Aadhaar system, Digi Locker, IMPS, UPI, digital consent to name a few. Among other things India Stack promises to deliver services like eKYC, eSign and digital consent by customers that can potentially make the business loan lifecycle completely digital and pain-free for both the parties. As per a McKinsey on digital finance, digitally enabled financial services can boost India’s GDP by US$ 700 bn (~12%) and new credit up to US$ 689 bn by 2025. Multiple technology startups focusing on solving one or more aspects of the lending value chain like credit scoring, credit enhancement, capacity building, digital inspection, digital disbursement and repayments, digital loan monitoring and repayment reminders to name a few have already seen significant success and the ecosystem is poised to benefit exponentially with time. Formal lenders especially the public sector ones on the other hand have a lot of catch up to do and move beyond checking credit score and PAN authentication. While some startups are going by the book by using available digital data from formal sources others are taking a leap of faith and using surrogates like mobile recharges, call-history, geo-tags to find innovative ways to credit-score individuals and businesses where no historical financial data exists.

The writing is on the wall. Lenders, startups, intermediaries, anybody connected with credit facilitation to individuals or small businesses must get innovative and leverage digital tools and technologies to up their game and benefit from the cascading effect of enabling digital finance or risk being left out…

Surabhi Nigam,
Surabhi is founder of UdyogCredit, a credit enabling platform for small businesses.

Corporate Comm India(CCI Newswire)