India’s SME sector has the potential to drive innovation and job growth despite the challenges faced by the economy. However, it is hamstrung by a lack of credit as small business owners do not maintain proper books of accounts and in some cases, do not have enough business experience either. The lending risk is difficult to justify for banks and other private lenders which are currently facing a liquidity crisis of their own.
Historically, the share of SME lending in the overall portfolio of large Indian banks has been rather small, so they seem to be taking a wait and watch approach in the current economic scenario.
Here Are the Problems Faced by SMEs
Low Collateral Assets
To meet working capital requirements, SME owners are often forced to collateralise their personal assets, which pushes them into a vicious debt trap. In the absence of credit, they are left with little choice but to do so.
A slowdown in demand is also to blame. A large number of Indian SMEs serve as Tier II or Tier III sub-contractors to larger firms in the manufacturing and FMCG sectors. Any demand fluctuations have a cascading effect on SMEs which find it hard to sustain production, in the absence of a minimum number of orders.
Informal Credit Sources
With the on-going liquidity crisis, banks have become unwilling to risk defaults and NPAs even as the government is taking steps to boost priority sector funding. In a welcome sign, NBFCs have started taking the lead in providing loans to SMEs, surpassing public sector banks. However, SMEs continue to approach traditional lenders for funds, often at high rates of interest.
According to a recent survey conducted by IFC Intellecap, 84% of India’s SMEs rely on informal sources for meeting their capital requirements.
Some of these SMEs are eventually forced to liquidate their assets to make good on their loans, resulting in a social-economic crisis for retrenched employees who come from some of India’s most vulnerable rural communities.
Opportunity for Digital Banking Solutions
However, a new entrant on the SME lending stage promises to change all that. Neobanks – the latest evolution in the FinTech space – are making rapid inroads into an underserved market which is estimated to be worth $240 billion by IFC Intellecap. The immediate attraction for SMEs is that Neobanks are much easier to deal with in terms of loan documentation requirements and credit checks.
Besides, they offer low-cost loans with customised tenors which make them ideal for meeting routine cash flow as well as capital needs.
What Do Neo- Banks Bring to the Table?
Neobanks have introduced collateral-free loans with flexible repayment options. Since neo banks do not have physical branches, they can afford lower margins. They have also simplified the loan application process, making it easier for SMEs to get credit. Since Neobanks are unregulated, they are not bound by the restrictions that traditional banks have to comply with.
This allows them to offer customised solutions to SMEs, deemed too risky by traditional banks.
Alternate Risk Management
Neobanks are helping traditional lenders develop alternate credit risk models specifically for small businesses without a proper credit history. On the other hand, they are also taking the lead in helping SME business owners learn the basics of business finance in terms of budgeting and accounting.
This is increasing awareness among SMEs about alternate sources of finance such as invoice financing to fund working capital requirements.
Neobanks have cut the average time taken by lenders to process loan applications by order of magnitude. Using insights derived from social media, online payments and even POS transactions, they are making banking more transparent and responsive for SME business owners.
These alternative credit scoring techniques have enabled Neobanks to offer flexible payment solutions and manage credit risks better.
Automating Books of Accounts
SMEs have been deprived of business credit largely because they are relatively new to the formal banking system. Since they cannot afford to hire the services of a professional accountant, SMEs are often unable to prove their financial solvency. This causes them to lose out on loans offered under initiatives such as MUDRA.
Neobanks aim to solve this problem for SMEs by automating their accounting and streamlining invoices, balance sheets, accounting, payroll, vendor management etc.
Neobanks also help SMEs reconcile their payments, manage cash flow and become financially disciplined. They generate a host of reports to help owners cut operating costs and increase margins. Simplified tax filing features offered by neo banking apps save time and effort for SMEs.
Single Payment Gateway
SMEs and businesses, in general, have no option but to use a separate payment gateway when using traditional banks. On the other hand, Neobank apps integrate multiple bank accounts into a unified gateway that also lets business owners view categorised expense reports and manage their account from their mobile devices.
Neobanks also offer easy integration with a host of third party business applications through APIs and plug-ins.
To capture market share, neo banks have been focusing on providing an exclusive customer experience. In business, time is of the essence and entrepreneurs appreciate speed and consistency in terms of financial services. For example, ecommerce sellers and IT outsourcing firms need faster turnaround times when it comes to international money transfers which traditional banks may be unable to provide.
In contrast, neo banks offer instant payment services including international money transfer at little to no cost. Their dedicated payment gateways speed up transactions which until recently took up to 2-3 business days to complete.
By 2025, neobanks are set to corner a big chunk of the SME lending market. Thanks to their agile and customer-centric business philosophy, they offer small businesses a level of flexibility that was unheard of in the recent past. Expanded access to banking services may finally help SMEs in India perform to their potential in terms of innovation and employment creation.
Neobanks may well have a vital role to play in underwriting the growth of the SME sector. Given the bright prospects, traditional banks are already joining the digital banking bandwagon to try and beat neo banks at their own game.
Finezza is a leading lending lifecycle and credit evaluation platform that helps banks and NBFCs streamline and optimise their performance. Contact us today at email@example.com to learn more about our customised solutions.