As a vital contributor to India’s industrial landscape, the MSME sector plays a crucial role in manufacturing, exports, and employment. With 5.93 crore registered MSMEs employing more than 25 crore people, these enterprises generate a significant share of the country’s economic output, according to the latest Union Budget. The MSME sector contributes around 30% to India’s GDP and accounts for around 62% of the workforce in the business sector. The sector has been struggling to thrive because of the lack of access to credit
MSMEs in India face a substantial credit gap of Rs 20-25 lakh crore, with only about 20% having access to formal financing. MSME credit penetration is much lower than developed economies. In countries like China and the United States, credit penetration stands at 37% and 50%, respectively. The credit gap is particularly pronounced in specific segments like service-oriented businesses, women-owned enterprises, and sectors such as ready-made garments, grocery retail, food processing, and IT/ITeS, which face disproportionately higher funding challenges.
The need for the hour is significant. As per ‘India Digital SME Credit Report’, there is an existing credit gap of over $170 billion and the working capital requirement for MSMEs is expected to grow to over $570 billion by 2027. The challenge that the system faces in India is that it is still chained to collateral.
MSMEs struggle to provide collateral because they often lack immovable assets like land, property, machinery to offer as security for loans. This “collateral curse” makes it difficult for them to access formal finance, pushing them towards informal and often costly lenders.
Without collateral formal finance institutions hesitate to lend to MSMEs because they find it difficult to get reliable financial information about them. A significant part of MSME business is carried out in cash and personal finances of the owner and those of the businesses are often co-mingled, which makes banks wary of lending to them. Owing to increasing digitalisation, many MSMEs follow asset light models and generate digital transactions instead of owning warehouses or investing in machinery. This makes it even tougher to provide banks and financial institutions with concrete collateral.
Cash-flow based lending & the role of account aggregators
Interestingly, cash-flow based lending, a financing method where a loan is granted based on a business’s anticipated future cash flows and revenue-generating ability, rather than its tangible assets or traditional credit history is picking up. Cash-flow lending gives lenders a real-time picture of financial health. Most businesses at the growth stage require quick access to short-term finance to meet their daily operational as well as multiple working capital financing needs. There has been a substantial increase in the requirement for small-ticket loans. Loan sizes in the Rs 5–50 lakh range typically represent working capital needs of MSMEs. By leveraging real-time cash flow data, FinTechs are redefining the end-to-end digital lending process for MSMEs.
The Account Aggregator (AA) framework introduced by RBI makes cash-flow lending viable today. The Account Aggregator (AA) system is a digital public infrastructure in India that allows individuals and businesses to securely and consent-based share their financial data among regulated financial entities. Under the regulation of the Reserve Bank of India (RBI), Account Aggregators act as trusted intermediaries, receiving data from Financial Information Providers (FIPs) like banks and insurance companies and sharing it with Financial Information Users (FIUs) who need it for services like loan applications. The AA framework has the power to transform MSME lending
The advantages of an AA system are immense. The sharing of information through digital channels ensures that the process is faster and disbursal of funds can take place more quickly. With digital data flowing via AAs, the turnaround time for loan approvals shrinks from weeks to days. Since the process is system-driven, there is a very low chance of fraud by any of the participants. It can also help lenders offer their customers more personalised loan products for their needs. It also helps millions of asset-light businesses, especially in services and retail, enter the formal credit ecosystem.
Challenges that lie ahead
Many lenders are still hesitant to fully embrace cash-flow lending. For cash-flow lending to become mainstream, policy push is required from regulators and the government. FinTechs, NBFCs and traditional lenders must co-create cash-flow-based products tailored to MSME needs. MSMEs must be educated about how AAs work and reassured that their financial data is safe.
If executed well, cash-flow lending will not merely complement collateral-based lending; it will overtake it. Over the next couple of years, it could become the default model for MSME credit. This shift will democratise finance, reduce dependence on informal lenders, and give millions of small businesses the growth capital they deserve.
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