The Open Credit Enablement Network provides the building blocks for a credit marketplace, and could enable easier flow of funds to MSMEs, but we should not expect any quick turnaround in the fortunes of these businesses.
Nearly 65 million micro, small and medium enterprises (MSMEs) contribute 30% of India’s gross domestic product and employ around 110 million people. By virtue of their regional spread and local employment generation, MSMEs not only have a huge potential in creating employment opportunities and positively impact inclusive economic growth but also check migration to urban centres. However, the lack of accessibility to credit has held them back from gaining size and adopting technology. The current MSME credit gap is estimated at around ₹25 trillion. This huge unmet credit demand has led to MSMEs being referred to as the “lost middle" as their requirements fall between small-sized microfinance loans and larger-sized loans from banks.
Lenders need to solve multiple problems to be able to service this gap efficiently and profitably. First, their existing processes are designed for a high level of human intervention at each stage namely sourcing, underwriting, monitoring and repayment collection. This makes the unit economics unfavourable for loans with smaller ticket sizes, particularly below ₹10 lacs, and for a short tenure which is the requirement of MSMEs. Second, most lenders have a distribution network skewed towards urban areas. But a large proportion of MSMEs are located in semi-urban and rural areas. This increases the cost of monitoring and servicing for the lenders. The problem of information asymmetry, especially at the lower end of the spectrum of micro enterprises, exacerbates the difficulties. Most of these enterprises are proprietary and unable to provide the documents required by lenders. A combination of these factors has led to a paradoxical situation, wherein while 99% of MSMEs are micro and small, their share in banking sector credit to industry is merely 13%.
Public policy has been focussing on MSMEs right from the days of the small-scale industries (SSI) framework. Multiple initiatives ranging from the Stand-Up India scheme, Small Industries Development Bank of India’s Udaymimitra portal, Mudra scheme, mandatory buying of MSME products by public sector enterprises and public sector bank loans in 59 minutes have been introduced. A large number of fintechs are focusing on solving the problems associated with MSME lending. They aim to reduce transaction costs and turnaround time by leveraging technology and accessing newer types of customer data to develop innovative underwriting models. However, credit gap continues to widen at a time when MSMEs have a vital role to play in reviving the economy badly affected by covid.
The announcement of the Open Credit Enablement Network (OCEN) promises to be the long-awaited vaccine to cure these problems. OCEN is a digital public infrastructure like India Stack and provides the building blocks for the emergence of a credit marketplace. Lenders, loan service providers, technology and data analytics firms, account aggregators etc. can become part of this marketplace by plugging into it using application programming interfaces provided by OCEN. Account aggregators are entities that can be authorized by the borrower to fetch financial data from different sources and share it with lenders. They are expected to become operational within this year. Existing sources of data for account aggregators include income tax returns, goods and services tax network invoices, bank statements, credit bureau records, mutual fund statements, insurance details etc. Increasing adoption of digital payments by individuals and small businesses, growth of e-commerce platforms and payment gateways, and the launch of kirana-tech and accounting apps etc. has made newer streams of high-quality data available. Such data is expected to become available through OCEN. Automation of all the process steps—establishing the identity of the applicant, document submission, underwriting, signing of loan agreement, lien marking of future receivables and repayment collection—makes it possible to disburse the loan in five minutes. The open standards provided by OCEN will enable further innovation at each step of the process. It envisages a future where credit is ‘democratized’ and every service provider is able to offer it by plugging into the platform easily.
Will OCEN be able to finally cut the proverbial Gordian knot? It has the potential to increase credit availability manifold for enterprises that are already a part of the digital ecosystem. For other enterprises that operate in a data dark or grey zone, lenders would need to find a balance between physical and digital presence and adopt a “phy-gital" approach to appraisal and lending. Overcoming information asymmetry for enterprises having a limited digital footprint will continue to require the presence of feet on ground. The primary method of credit assessment also needs to change from a collateral-focussed approach to cash flow-focussed—microfinance institutions have amply demonstrated the success of cash flow-based lending. To be sure, an early use case of OCEN is invoice discounting—many more use cases based on cash-flow are expected to emerge.
New ways of doing things propagate through word-of-mouth and require social learning. The proportion of early adopters in the low-income, less-literate segment of consumers has been found to be low. Thus, adoption of an ‘only digital’ way of seeking credit might see a faster adoption by micro and small enterprises if distribution models facilitate assisted transactions. The experience with Jan Dhan accounts is instructive. While the total transaction volumes in Jan Dhan accounts have increased rapidly due to the availability of assisted transactions through the business correspondent channel, transactions using debit cards at points-of-sale and ATMs have been slow to pick up.
With increasing digitisation of every sphere of economic activity in India, OCEN holds a great promise for the future. Realization of the full potential of OCEN will be highly beneficial to MSMEs. But given the existing landscape of MSMEs, expectations of a quick turnaround in MSME fortunes might need to be tempered.
The authors are, respectively, chief executive officer of MicroFinance Institutions Network, and an economist