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How Supply Chain Financing is Making MSMEs Credit Ready

Aman

The micro, small and medium enterprise (MSME) sector is known as the Indian’s economy’s backbone as it accounts for nearly 29% of the country’s gross domestic product (GDP). To top this, the sector contributes a whopping 49% to the country’s exports. The Government of India is known to take periodic measures to increase the MSME sector’s contribution to the country’s GDP to more than 50% while it aims to increase MSME exports to 75% in the near future.

MSMEs and the lack of credit financing 

A large number of MSMEs are excluded from various formal lending channels and this suppresses their growth. As per a report on MSMEs furnished by an expert RBI committee led by UK Sinha, the sector suffers from a credit gap estimated to be around Rs. 20–25 trillion. A majority of MSMEs lack access to sufficient credit. This impacts their liquidity requirements which are primarily meant for daily working capital needs.

Did you know –

29% contribution to the country’s Gross Domestic Product (GDP) is made by only six crore MSMEs in India. While these establishments offer 11 crore jobs in the country, they enjoy less than 2% automation when it comes to supply chain financing. 

What is supply chain finance?

Supply chain finance is a solution that aids in business cash flow optimisation by allowing businesses to avail extended payment terms with suppliers. It is a form of supplier finance under which suppliers can collect early payment towards their invoices. It helps in reducing the supply chain disruption risk while enabling buyers and suppliers to optimize their working capital. 

Supply chain financing (SCF) help in:

  1. Fill the credit gap for MSMEs 
  2. A cost-effective and efficient manner

SCF involves various options for financing suppliers through invoices and receivables used as intermittent collaterals. Two commonly used SCF methods are:

  1. factoring 
  2. reverse factoring. 

Under factoring, suppliers sell their accounts receivable at a discount to a third party (usually a bank or a FinTech). Reverse factoring is also a type of accounts receivable financing under which the transaction is usually initiated by the buyer.

What is the role of supply chain financing in resolving the credit gap for MSMEs?

SCF services can enable MSMEs to:

  • Increase their working capital 
  • Become globally competitive. 
  • Lenders can make use of existing commercial relationships to easily offer working capital finance to MSMEs.
  • Helps large corporations in improving their working capital management 
  • Enables financiers to easily and effectively assess and manage the risks involved in extending financing to MSMEs 

Since India is fast scaling up its expansion operations in the export market, SCF availability for MSMEs can significantly help in managing the working capital pressure and enhancing global supply chain linkages.

Banks have historically preferred lending working capital loans as compared to supply chain-based financing. This is primarily due to the absence of borrower data and hardships in assessing the collateral offered. However, this scenario is seen to be fast-changing due to growing digitisation and numerous government initiatives. 

How to lower the credit risks faced by MSMEs?

Here are some important points that can help MSMEs in containing credit risk:

  • Any funds sourced on credit by a business must be considered a liability and should be repaid.
  • MSMEs must try to be very cautious with regard to cashflows as market ups and downs are a constant. These could be aggravated with situations like the ongoing pandemic.
  • Businesses can try to shorten their production plans, reduce finished goods inventory to only confirmed orders, especially during unpredictable market conditions.
  • Focusing on a strong supply chain finance(SCF) program is a must.

Evolution of FinTechs in the SCF space

The surge in the number of FinTechs in India has revolutionised the SCF space. They are largely attributed to the digitisation of the interaction between the various entities. By utilising analytics for offering app-based financing arrangements, technology is set to revolutionise the lending process while making it more transparent, efficient, and flexible. 

FinTechs have managed to launch various solutions and analytics capabilities that are enabled by remote technology. These provide seamless platforms for buyers as well as suppliers. They have further positioned themselves differently from banks by largely focusing on well-established e-commerce platforms as primary clients. This has helped them in understanding the entire supply chain within the MSME segment to offer e-vendor financing for supply chain-related purposes as against general working capital services.

Conclusion

The MSME sector faces nearly 50% of credit being prolonged while most of the sector relies on loans from casual finance sources at exorbitant charges. One of the most important aspects to focus on is a formalisation and appropriate incentives that can help the MSMEs to fall within the eligibility limits of formal credit.

Supply chain financing is an answer to the plight of MSMEs as it can offer a number of advantages while supplying the sector with much-needed resilience. It is important to educate MSMEs and associated anchors about such options for streamlining their cashflows.