Small and Medium Enterprises (SMEs) are the backbone of the Indian economy. They contribute about 30 percent to India’s GDP, constitute 48 percent of India’s exports, and employ about 111 million in the non-agricultural sector. Despite being a strong pillar of India’s growth story, the SME sector faces great difficulty in accessing finance from formal financial institutions like banks and NBFCs. According to International Finance Corporation (2018), only 16 percent of the debt demand is met by the formal financial sector like banks and NBFCs while the rest is met by the informal sector. One of the key reasons that deter SMEs in India from accessing credit is lack of audited financial information which makes evaluation of creditworthiness a difficult process. Further, poor CIBIL scores, absence of digital identity, and lack of compliance to regulatory procedure also impedes their ability to access finance from banks.

One of the example : Voice Payment

As a result of the huge unmet MSME credit demand, a new type of firms called FinTechs has spurred in India. India is the world’s third-largest FinTech centre, with global investments doubling from USD 1.9 billion in 2018 to USD 3.7 billion in 2019. According to Invest India, the number of unique institutional investors has doubled from 535 in the year 2021 to 1019 in the year 2022. The market size of the Indian FinTech industry is expected to reach USD 1.3 trillion by 2025.

So, what are FinTechs? To put it simply, FinTechs are companies that leverage technology to offer better financial services to their customers. There is a segment of FinTech firms in India that aim to offer innovative technological solutions to resolve the issue of credit and finance for the Indian SME sector.

The SMEs are unable to obtain funds from traditional financial institutions like banks and NBFCs as they are unable to meet the demanding requirements of collateral and extensive documentation process. As a result of information asymmetry, banks are unwilling to lend to SMEs. The FinTechs have identified the pain-point of information asymmetry as an opportunity to disrupt the lending market. The FinTechs in India use alternate data sources and advanced analytics to evaluate the credit-worthiness of the SME borrowers. For instance, FinTechs utilize data from credible sources like Goods and Service Tax Network (GSTN) which has about 9.2 million registered SMEs and has digitized trade data and invoices. GSTN is a verified database and provides a more expansive overview of the nature of the business, thus complementing the conventional financial data. FinTechs also utilize data points like telecom data, utility bills, taxes, and online transactions to assess the risk profile of the borrower.

An article by Arup Chatterjee from Asian Development Bank discusses how FinTechs have transformed the SME lending landscape. For example, CapitalFloat assesses the risk profile of SME borrowers based on e-KYC and real-time data on cash flows available from PayTM which is a digital wallet company. He also presents the example of a FinTech solution provider called CropIn Technology whose target customers are farmers. It utilizes the history of sown crops with respect to type, size, and yield to evaluate the ability of the farmer to follow the repayment schedule. Using remote sensing data on forecasted yield and selling price, FinTech evaluates the tentative cash flow statements and profitability. Accordingly, it assigns a risk score to the farmer. The article elaborates on how FinTech is efficiently utilizing artificial intelligence and machine learning, enabling it to quickly assess the creditworthiness of the farmer resulting in instant disbursal of loan. The firm continues to monitor the farmer’s productivity by using satellite images to ensure that the farmer has used the loan proceeds for the intended purpose.

The FinTechs are able to offer customized financial solutions to the SME borrowers due to its strong technological abilities. Hence, it is important that the regulations ensure a conducive business ecosystem that fosters strong partnership between FinTechs and SME borrowers. The launch of the Account Aggregator (AA) Framework in 2021 gave a big impetus to digital lending in India. Under the AA framework, all financial information spread across different entities are available in a single platform. The digital lender can request for the desired financial information on the borrower from the platform. However, the information will be shared with the lender only after receiving the consent from the borrower. The AA framework is an effective way of sharing financial information which will help in reducing transaction cost. The benefit of lower transaction cost can be transferred to the borrowers, resulting in an improved and efficient access to finance and credit. However, the key issue with the AA framework is data security, as consumers’ sensitive financial information can be shared with a large number of entities leading to financial abuse. To arrest this issue, RBI introduced Digital Lending Guidelines in September 2022 which sets the framework for responsible digital lending and protection against financial fraud and abuse. The guidelines mandate the digital lenders to conduct proper due diligence on borrowers and be transparent on pricing and servicing of loans. The guidelines also mandate the FinTechs on protecting the personal data of the SME borrowers.

Given the dynamic world of FinTechs, experts opine the establishment of an independent regulator which will oversee that the robust security practices are followed by FinTechs in India. Such practices should ensure the confidentiality of financial information and thereby decline in financial fraud and financial abuse. There is a growing emphasis on digital literacy to ensure that borrowers are using the data architecture and sharing their financial information in an informed manner. There is also a growing call for explicit guidelines to ensure robust consent to share financial information.

Meeting the credit and finance demand of the SME sector is a big challenge and requires innovative technological solutions. It is interesting to observe that FinTechs are using digital footprints, big data, and machine learning models to assess the creditworthiness of small enterprises and disburse instant short-term loans to them. It is expected that with such innovative and technological interventions, the Indian economy will soon be able to achieve its dream of being a USD 5 trillion economy.