In December 2020, India crossed the threshold figure of digital payments worth `4 lakh crore in a month. This milestone is a testament to the power of private sector innovation built on digital public infrastructure (UPI) and its principles should guide the future of FinTech. With digital payments reaching critical mass, the foundation for a FinTech revolution is firmly in place.
The rise of FinTech offers a rare window to craft an inclusive financial ecosystem that works for all Indians and not just the top quartile. Poor citizens and micro and small enterprises have been forced to utilise 20th century financial products that are incapable of supporting the demands of 21st century growth. As the private sector innovates and the government guides innovation, the focus must be on closing this gap.
In this process, FinTech that helps MSMEs must be prioritised. This will have a multiplier effect, given their linkage with employment, exports and the rural economy. After 2015, MSMEs underwent the first wave of digitisation with payments and GST. Increased digitisation presents an opportunity to solve two key problems for MSMEs: delayed payments and costly, inaccessible credit.
These issues are interlinked and have been haunting MSME growth for years. Delayed payments disrupt an MSME’s cash flow cycle, stopping payments to workers and suppliers (typically micro, informal enterprises). They are forced to take costly working capital credit from informal sources, which increases their cost of doing business.
Delayed payments: The issue of delayed payments plagued MSMEs even before the Covid recession and has been acknowledged by Union Minister Nitin Gadkari himself. Regulatory mandate of a 45-day rule in the MSMED Act, 2006, has not worked so far. The problem occurs largely due to the skewed bargaining power of MSME sellers vis-a-vis the large buyers (government, PSUs, conglomerates). Expectedly, MSMEs don’t raise complaints due to the fear of losing the buyer and the lethargy of our dispute resolution process. The solution to delayed payments must be led by the government as its departments and PSUs account for 94% of the pending payments, as per a CII survey .
The MSME ministry started the Samadhaan portal in 2017 to facilitate these pending payments. But it has had limited impact as it has facilitated payments worth `2,000 crore, miniscule compared to outstanding payments worth `5 lakh crore. The U K Sinha Committee’s recommendation of uploading all MSMEs invoices and facilitating payments through the platform can be considered. To minimise compliance burden on MSMEs, the portal can be integrated with GSTN to automate invoice uploading. The portal’s data can be processed to generate ‘timeliness ratings’ for buyers, indicating the average time taken for a payment threshold. Akin to a credit rating system, this will give MSMEs information about the buyer’s payment behaviour and incentivise buyers to improve.
Invoice financing: Allowing businesses to avail advances against outstanding invoices from buyers is a low-cost solution for delayed payments. In 2014, the RBI started the TReDS platform for MSMEs to receive payments against outstanding invoices through factors (banks and NBFCs). While the platform has grown from `815 crore in 2017-18 to `11,165 crore in 2019-20 , there is untapped potential. To grow the platform, it needs more factors, buyers and MSMEs.
As of now only banks and selected NBFCs can act as factors on the TReDS platform. The upcoming amendment to the Factoring Regulation Act will permit all NBFCs to act as factors. This will improve the platform’s competitiveness and reduce the discount rate.
TReDS also needs to onboard more buyers and MSMEs to democratise access to invoice finance. To enable this, more entities should be allowed to operate the TReDS platform. This will have two benefits: first, they will work to onboard more buyers and MSMEs, thus removing the need for government mandates. Second, they will tailor the platform workflow to the business cycle of each sub-sector. As a result, even micro enterprises that account for 99% of MSMEs will be able to benefit from TReDS.
Access to credit: The story of MSME credit is a paradox—micro and small loans have the lowest default rates but occupy a small share in overall lending. As per TransUnion CIBIL, micro and small loans have the lowest NPA rates of 8.7% and 10.3%, respectively but constitute only 21% of the overall credit exposure. The financial sector’s unwillingness to lend to them despite being safer remains a puzzle.
In its report, the U K Sinha Committee suggested that high cost-to-serve and low lender coverage are the key barriers to lending. Emerging digital lending services can solve these challenges. MSMEs can borrow through digital lending platforms, which have easy access app-based interfaces. Alternate data points like cash flows, GSTN, payroll and utilities payments are being used to assess credit risk of MSMEs without a credit history. Such innovations across the credit value chain promise flexible, low-cost credit. MSMEs can expect better turnaround times, lower processing costs, robust risk assessment and flexible repayment schedules. Take for instance a farmer who has never availed formal credit but pays for inputs and receives payment for her produce digitally. She can now receive a short-term, cheap loan before sowing where the repayment is linked to harvest and payment cycle instead of an EMI.
But the promise of digital lending is threatened by the rise of rogue apps that lend at usurious rates and use illegal collection methods. Some act like digital loan sharks and have Chinese ownership. The RBI’s tepid response in checking the malpractices has worsened the problem. Rogue lenders threaten the growth of the entire ecosystem by eroding customer trust and inviting burdensome regulation that can chill innovation.
The solution must be found together by the government, regulator and digital lenders. The RBI’s Internal Working Group on digital lending should suggest loan service provider guidelines. These shall streamline the role and responsibility of the online platform or digital lending app and the lender (bank/NBFC). The private ecosystem—online platforms, apps, banks and NBFCs—should constitute a self-regulatory organisation, which can formulate ‘light-but-right’ regulation for the ecosystem. The guiding principle in this process must be to balance cutting edge innovation with customer protection.
India’s FinTech ecosystem is nascent yet growing rapidly. This offers us the golden opportunity of nudging it towards serving the underserved and unserved MSMEs. With credible solutions to delayed payments and access to credit, MSMEs can triple their gross value added from `60 lakh crore to `180 lakh crore in the coming decades. The benefits will be disproportionately felt by the poor and middle class.
Lavu Sri Krishna Devarayalu
YSRCP MP from Narasaraopet, Andhra Pradesh
(Assisted by Raghav Katyal, LAMP Fellow)