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The rising tide of cash flow-based loans

A KPMG report says that the contribution of MSME sector to GDP in some of the global economies is 25-60%, but it is just 8% in India. If lending to this sector is unlocked via cash flow-based lending, it could unleash many entrepreneurs and create many more jobs. Photo: Saisen/MintPremium
A KPMG report says that the contribution of MSME sector to GDP in some of the global economies is 25-60%, but it is just 8% in India. If lending to this sector is unlocked via cash flow-based lending, it could unleash many entrepreneurs and create many more jobs. Photo: Saisen/Mint

Many small and medium enterprises do not opt for asset-backed loans, the mainstay of Indian banking. They prefer cash flow-based loans to grow their business

In the dusty bylanes of Bengaluru, a quiet transformation is happening that has been missed by banks on the main street. In a rapidly urbanizing city, villages have found themselves encircled by urban sprawl. Houses are tightly packed next to each other. The roads are so narrow that two cars approaching from opposite sides of the road come to a screeching halt and gently inch past each other after much signalling back and forth. A bus entering these lanes looms large as a monster and chokes traffic for 15 minutes.

In these dusty lanes, we met three different entrepreneurs from three different sectors who had one thing in common: they had never taken a loan in their lives, either from a money lender or from a bank, until recently. The tipping point came when Paytm and Payworld approached these individuals and offered them collateral-free instant loans from Capital Float, a non-banking financial company (NBFC) set up to provide unsecured business loans to small and medium enterprises (SMEs). The three entrepreneurs decided to try out this instant loan offer. Using an app, they submitted their Aadhaar eKYC (electronic know your customer) and permanent account numbers (PANs) and received a loan offer on the app itself. Using Aadhaar eSign, they accepted the loan agreement. After acceptance, the loan amount was credited to their account within a day. For all three entrepreneurs, this was the first time they had taken a business loan, and this illustrates the growing trend of cash flow-based loans, as compared to asset-backed loans that have been the mainstay of the Indian banking, financial services and insurance (BFSI) sector.

The first entrepreneur that we visited ran a remittance service that helped individuals send money to the bank accounts of their families in other parts of India. In a tiny little shop with a black iron grill that separates the cashier from the customers, this business attracts 100 customers a day who remit an average of Rs2,000 through a service called Payworld. The charges range from Rs10 for remitting up to Rs500, going up to Rs300 for remitting up to Rs49,999. The entrepreneur has to keep a balance with Payworld, and the remittances are deducted from this account. The robust cash flows of this entrepreneur’s Payworld-affiliated business helped Capital Float with the decision to provide a loan. The entrepreneur was able to use the loan amount to increase his limit with Payworld, and do more business.

A year ago, he had taken the first loan of Rs1 lakh with a tenure of two weeks. So far, he has taken around 17 tranches of such loans, which are credited directly into his Payworld account. These loans helped him double his volumes, until demonetization slowed business down.

This particular segment attracts the highest interest rate of 27% but the entrepreneur, a very tech savvy, 10th-standard pass gentleman, seemed unfazed by the interest rate. In fact, he pushed us to help him increase his credit limit to Rs2 lakh as that would help him do more business.

The second entrepreneur we visited had a thriving business selling vegetables in another crowded inside lane of Bengaluru. His well-stocked corner shop opens at 5.30am and shuts at 10.30pm, and has been in existence for 10 years. He sells around Rs40,000 worth of veggies every day at the shop and also supplies Rs50,000 of vegetables daily to 14 restaurants in the vicinity. He was fairly content growing his business without any loan, until Paytm approached him.

At first, he did not believe that he could get a loan without extensive documentation, but he took a chance and applied for the loan a month ago. He was surprised at the speed with which his application for an Unsecured Business Loan (UBL) for Rs2 lakh, with a tenure of six months, and an interest rate of 24%, was disbursed into his account. While he had taken a car loan in the past, this is the first time that he has taken a business loan. He plans to deploy the loan to purchase more vegetables and to expand his business. He has plans to open another shop and also sell his own brand of green peas. Like the first entrepreneur, he too wants his loan limit to be increased soon.

The third entrepreneur we met has been running a gas distribution agency for the last 15 years. While he had taken a motorcycle loan in the past, he had never taken a business loan in the last 15 years. When Paytm approached him, he applied for a UBL of Rs2 lakh with a tenure of six months, from Capital Float. He kept repeating how he could not believe that the loan was credited to his account on the same day, and added that he always found the documentation requirements of main street banks to be very daunting. He plans to use funds for working capital needs and to rent a bigger godown to store the gas cylinders.

The common thread with all the three entrepreneurs is that they were unwilling to go to the main street banks and submit reams of paperwork. They were content with using their own cash flows to run and expand their business, until they were proactively approached by Payworld, in the first case, and Paytm in the other two cases. All three entrepreneurs exuded tremendous confidence in running, and growing, their own businesses. SMEs like these are the fastest growing sectors of the economy and lenders who plan to lean back and wait for these SMEs to knock at their doors are guaranteed to lose this opportunity.

Another thing that stood out is the ‘wow’ experience that these entrepreneurs had with getting a loan instantly. Each of these entrepreneurs expressed their surprise at the speed of disbursement more than once. The ability to look at their cashflows using data from Paytm and Payworld, combined with data on their smartphones, enabled instant loan decisions. India Stack components like eKYC and eSign enabled the transactions to be completed immediately. (India Stack is a set of application programming interfaces, or APIs, aimed at enabling an ecosystem to be developed for Digital India.)

Three entrepreneurs in a country of 1.2 billion people is an itsy-bitsy sample size but it points to the enormous opportunity that lies ahead. Most SMEs in India do not have much collateral to offer and have therefore never accessed loans from the formal banking sector. If lending to this sector is unlocked through cash flow-based lending, it could unleash millions of entrepreneurs and lead to greater job creation. A KPMG report points out that the contribution of MSME (Micro SME) segment to GDP in some of the global economies is in the 25-60% range, while it is a mere 8% in India. However, this sector is growing faster than the national GDP and has the potential to contribute 15% to the GDP by the year 2020. More critically, for a jobs-starved economy, the employment created by MSMEs is around 28% and this has the potential to go up to 50% in the next decade.

Recognizing this fact, a number of banks, NBFCs and fintech firms are chasing this opportunity. The newly formed Digital Lending Association of India (DLAI) has attracted 39 members within a few months of being formed, and this sector has attracted significant inflows of venture capital. This promises to be an exciting journey and we plan to revisit these three entrepreneurs at the end of 12 months to see how they have progressed. Watch this space for more details.

Venkatesh Hariharan is a fellow and director (fintech) at the Indian Software Product Industry Round Table (iSPIRT).

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