Credit and financing for MSMEs: Although obtaining credit via the cash flow-based model is relatively easier than taking out an asset-backed loan, the former carries a higher interest rate.
Credit and financing for MSMEs: Banks and non-bank financial corporations (NBFCs) have in recent years started to embrace the cash flow-based lending approach to solve credit-related challenges MSMEs face, instead of asset-based secured lending. Experts pointed out that traditional lenders, mostly banks, who previously depended on collateral, are now taking a pragmatic view of the scenario. “Since, on the one hand, new companies are springing up in the country like mushrooms and, on the other hand, family assets are being shared, collateral is also running out. Hence banks are moving towards cash flow based valuation,” Dhrubashish Bhattacharya, Head – MSME Business, Bank of Baroda told Financial Express Online. The credit gap in the MSME sector was around 20-25 lakh crore as of June 2019, according to a report by the UK Sinha Committee formed by the Reserve Bank of India (RBI).
So what do MSMEs need to secure cash flow-based bank or NBFC loans without draining their assets? First and foremost, the promoters need to share appropriate business data that could help the lenders assess the financial health of the company now and in the future. Arun Nayyar, CEO of digital lending platform NeoGrowth, told Financial Express Online that alternative data sources such as digital transaction data in terms of UPI, RTGS, NEFT and IMPS, apart from GST, and previous credit histories with on-time repayments are taken as a sign of a responsible borrower of to be financial institutions. Data on income tax returns, bank statements, point of sale data and more could also be useful.
However, according to Shachindra Nath, managing director of small business lending platform U GRO, the biggest problem in lending is getting MSME promoters to share this data. This, Nath says, is a problem with MSMEs thinking that the less information they share with the lender, the better off their creditworthiness. Even today, 90 percent of U GRO customers refuse to share their GST information and 67 percent do not share their bank account details. “Just as you cannot hide your symptoms from a doctor, a company cannot hide information from a lender,” Nath said at the panel on alternative SME finance for the FE Boardroom 2022 event, organized by Financial Express last week.
While data sharing is the key requirement in a cash flow-based lending model, MSMEs must ensure that the capital is used for the purpose for which it was used, even if the promoter also has full ownership of it, regardless of the amount his/her MSME unit must take ownership of the stake they have in the company, said B Sankar, Chief General Manager-SME and SCF, State Bank of India at the webinar.
“It’s their unit and they are responsible for the people who work with them, their livelihoods and their families. Therefore, the easy-going stance on the deal is not going down well with lenders,” Sankar added. Lenders’ final request is that MSMEs repay loans on time. A bank failure can exclude not only the promoter itself but also future generations from the formal credit system. “So, pay off loans on time and work to build a robust credit history so that we, the lenders, are with you in your growth story,” he said.
Although borrowing via the cash flow-based model is relatively easier than taking out an asset-backed loan, the former carries a higher interest rate. Compared to traditional bank loans with an interest rate between 8 and 17 percent, cash flow-based loans raise up to 30 percent or more and at least about 12 to 13 percent, depending on financial information including CIBIL score. In other words, the interest rate is set based on the risk profile of the borrower.
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“When an MSME applies for a loan from us, we assess their creditworthiness, past track record, certainty of business growth and repayment. These factors are taken into account when setting the interest rate,” Alok Mittal, co-founder and CEO of MSME lending platform Indifi told Financial Express Online.
For example, a higher interest rate would lock in borrowers who may be in default on their previous loans, or their ‘degree of formalization’ could be low, meaning that while they claim revenue of Rs 2 lakh a month, they only accrue Rs 35,000 of it Account statements could be visible, Mittal explained. On the other hand, those enjoying a lower rate of around 12 to 20 percent would be companies that have been in operation for the past five years, with regular cash flows, strong banking histories, and zero defaults. Founded in 2015, Indifi has disbursed more than 40,000 loans in over 400 cities.
Especially during Covid, digital lenders had come to the rescue of MSMEs through their cash flow-based financial model. For example, Ahmedabad-based logistics company HGR Logistics has been hit by payment delays from its customers in the automotive, garment and other sectors as Covid forced several companies to temporarily suspend operations in 2020. The company even switched to pharmaceutical logistics, but had little capital to fund day-to-day operations.
“We were facing a financial crisis at the time. I knew banks would not give me credit during Covid, especially to businesses like logistics, which have been hardest hit by the pandemic. While looking for unsecured loans on the Internet, I happened to come across Indifi. My CIBIL score of over 780, GST details, my company’s sales for the past five years and other details were good enough for me to get a Rs 25 lakh loan at an interest rate of around 16 per cent. It helped me recover from that time when I had no assets for a mortgage if I had opted for a traditional bank loan,” Moral Agrawal, managing director of HGR Logistics, told Financial Express Online.
In the case of new businesses seeking credit, without cash flow data and assets to guarantee the loan, promoters can take advantage of the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) loan program set up by the CGTMSE with no collateral from the Government and SIDBI. Importantly, in her budget speech in February this year, Finance Minister Nirmala Sitharaman announced an overhaul of the scheme to allow additional loans of Rs 2 lakh crore for micro and small businesses in the coming fiscal year.
However, the current limit under CGTMSE is up to Rs 2 crore. If the founder of a new business wants to raise more than Rs 2 crore with no business records or collateral, lenders are less likely to support him/her. “How can anyone give you more than Rs 2 crore in such a situation,” said Bhattacharya. “We advise new entrepreneurs to start with an amount allowed under CGTMSE, backed by the government guarantee, and grow the business for about a year or two before applying for a larger loan,” he added.
Other well-known government collateral-free schemes for MSMEs include the Emergency Credit Line Guarantee Scheme (ECLGS). However, it only applies to existing borrowers on banks’ books as of February 29, 2020.