No doubt that it is a sizeable part of the banking business. Loans to micro, small and medium enterprises make up about 20% of overall credit given out to industry. In fact, SME lending, if done well, can be a relatively higher margin business because lending to such enterprises tends to entail taking on higher risk and is sometimes unsecured. But it’s equally a tedious business—small loans to a large number of borrowers in a segment that is most exposed to economic swings and has limited buffers to withstand bad times.
That’s the reason why banks have done little more than the bare minimum to address this segment. It shows in the data. Only 4% of the 57.7 million small businesses have access to formal finance from the banking sector, according to a 2013 report of the National Sample Survey Office. Enter the SME lending startups—targeting what they see as a clear gap in the financing market. The idea isn’t unique to India. In fact, domestic startups appear to be drawing inspiration from a few global success stories in SME lending.
Among these is Kabbage, Inc., which since its inception in 2009, has provided nearly $1 billion in finance to small businesses, says its website. The USP of Kabbage (and others in the space) is the ability to process loans for small companies quickly by analysing their credit worthiness using proprietary technology which draws on available customer data. Based on this data, a credit decision is made within minutes, an interest rate is set and a loan is disbursed. Apart from lending directly, a company like Kabbage also ties up with banks that use its credit appraisal methods.
Another success story has been OnDeck. Started in 2007, the company has given out $3 billion to more than 7.8 million customers, according to its website, which adds that it uses a proprietary model to assess more than 2000 data points that can help assess a small business’s credit worthiness and deliver funds within a day. Similar models have cropped up in India but whether they will enjoy similar success remains a question mark.
CapitalFloat, a Reserve Bank of India-registered non-banking financial company (NBFC), which started in 2013, is among them. The company says it is trying to solve the ‘missing middle’ problem that plagues India where finance to mid-sized enterprises is sparse. According to Sashank Rishyasringa, co-founder of the company, it has disbursed 200 crore since it started and the business is gaining traction. “The pickup has really come in the past year where business has grown two times month-on-month," said Rishyasringa, adding that while initially a lot of the business came from e-commerce-linked vendors, this proportion has now reduced.
But building scale of any significance won’t be easy and expansion in the Indian lending market will present its own unique problems. First, the ability to expand the lending book significantly will depend on being able to raise large amounts of funds to lend. As an NBFC, you will have to raise money at cost effective rates from the market to be able to lend out at rates that compete with what banks can offer. The fact that a new set of small finance banks have been licensed, who can raise deposits, and target the very same SME lending market as these startups, only complicates the task.
There are other more complex problems. One such problem is many small businesses rely on cash for day-to-day activities. This reliance makes it tougher to map a small company’s finances and hence its credit-worthiness. The lack of adequate legal backstops to recover your money in the case of a default is also something that needs to be considered.
“Some SMEs have started to modernise and move towards more electronic payments. The older SMEs were very dependent on cash," said Pralay Mondal, senior group president-retail and business banking at Yes Bank. “The SME business is tough because you have to understand the company’s cash flow. That’s the starting point. You also have to keep doing annual inspections to ensure the money you lend is being put to right use," said Mondal, adding that he would not dismiss any of the new business models since disruption can come from anywhere. If some of these startups are able to bring in technology-driven models that ease the credit assessment process, banks and NBFCs may find value in tying up with them.
LendingKart.com, for example, is a startup that is basically focussing on building a platform that collects information about SMEs and enables credit decisions through an in-house analytics model. It also has an NBFC but its focus is on the platform business, said Harshvardhan Lunia, its chief executive officer and founder. He said the idea is to collect data from online sources and also cash flow data and to automate it all to enable lending decisions. He sees the business largely as a fee generating one, where they would provide these credit assessment techniques, among other services, to lenders.
“The segment which is least served is the 50,000 to 10-15 lakh segment. The ‘Small’ of SME. The reason banks stay away is because information asymmetry is high," said Lunia, explaining the basis of their business model, which draws on banks’ reluctance to go through the tedious process of evaluating and lending to SMEs.
It is possible to see banks finding such services useful, although, it is equally possible that banks will eventually start to develop such technologies in-house if they see enough merit.
Ira Dugal is assistant managing editor, Mint.