Alternative Lending can help bridge the credit gap in the MSME sector, which was reckoned by the RBI to be in the range of INR 20 to 25 trillion.
Key Highlights
- Alternative lending uses non-traditional sources of data to provide credit products tailored to the unique needs of SMEs.
- Combined with traditional sources of data, alternative lending can help the burgeoning credit gap in the MSME sector.
- Alternative lending can lead to better underwriting models, in turn leading to lower costs of borrowing.
Despite playing a dominant role in the GDP and exports of India, the MSME sector is plagued with the problem of a credit gap, with many SMEs unable to get financing options from traditional lenders due to stringent stipulations.
Banks and NBFCs attribute a higher risk profile to SMEs as compared to large businesses/corporates due to limited sources of revenue and lack of enough assets to be provided as collateral.
In addition, many SMEs do not possess documentary proof of their revenues, which results in banks undermining their repaying capacity.
This often leads to higher interest rates being offered to SMEs, often as an unsecured business loan.
On the other hand, Small and Medium-sized Enterprises (SMEs) frequently require financing to meet their working capital requirements.
In addition, a lot of SMEs in India are New-to-Credit (NTC) borrowers, with no credit history and hence unable to navigate through the debt products being offered.
Timely access to credit then becomes a necessity for the MSME sector.
This predicament has led to the growth of Alternative Lending, a part of Alternative Financing.
What is Alternative Lending?
According to a Morgan Stanley report, Alternative Lending is described as credit products being made available to borrowers beyond a traditional bank loan, often through the usage of alternative sources of data.
Alternative Lending is gaining currency in India with the rise of digitalisation and the concomitant financial revolution supported by the launch of UPI, open networks like OCEN and ONDC, new-age financial entities like the Account Aggregators, and other digital public goods being offered by the India Stack.
Alternative data like revenues, payments for utility bills, and geo-tagged properties, collected from Digital Public Infrastructure like the GST Network (GSTN), Bharat Bill Payments System (BBPS), etc. are often used along with traditional sources of data like the Credit Score from Credit Bureaus for Alternative Credit Decisioning (ACD).
Alternative lending usually facilitated using this data often takes the form of revenue-based financing, Invoice Discounting, GST-based loans, etc.
How Alternative Lending can help SMEs
As businesses increasingly digitalise their operations, new avenues of credible data can help lenders in optimising their underwriting models. It leads to lower costs of borrowing as credible financial data about the borrowers is available to the lenders.
In addition, the usage of Artificial Intelligence (AI) on such data sets can provide projections on the future revenues of the firms and help in better risk profiling.
Incidentally, a recent survey by Moody’s Analytics found that Banks and Fintech are the leading industries in the adoption of AI for business operations.
Already, banks have GST Surrogate Programmes and Banking Surrogate Programmes that use such alternative data to provide hassle-free business loans with quick approvals.
The usage of alternative data, combined with open networks like the OCEN and ONDC can democratise digital lending.
As one such indication towards this model, ONDC recently started providing GST-based loans among other financial services on the network to help businesses transacting through the digital commerce network.
Alternative lending can also potentially lead to tailor-made credit offerings for businesses, and increase the penetration of credit products like Purchase Order (PO) Financing, and Sales Bill Discounting, in turn helping SMEs with access to credit aligned to their business models.
Given its potential to serve underserved borrowers, it’s gaining traction in India with the sector projected to record a CAGR growth of 20.5% during 2023-2027 to reach the market valuation of US$ 18.61 billion by 2027.
