Supply Chain Finance: Silver Bullet For MSME Credit Woes
The micro, small and medium enterprise (MSME) sector is the backbone of India's economy, accounting for about 29 per cent of the country's GDP and 49 per cent of its exports. The Indian MSME sector has around 63 million enterprises out of which an estimated 51.25 per cent are in rural areas and 48.75 per cent are in urban areas. According to a CII Report, MSMEs have created more than 11 crore jobs across the country and are the second-largest employment generator in India as of FY 2022. To bridge the gap between supply and demand and for the purpose of capacity building of these MSMEs, the Ministry of Micro Small and Medium Enterprises in collaboration with several entities such as the National Skill Development Mission, National Apprenticeship Promotion Scheme, CII and other private firms (as part of their CSR) have devised several plans for training, upskilling and capability creation. However, one of the major hindrances to MSMEs’ growth continues to be the lack of sufficient credit for financing their operations and further expansion. According to a recent report by the UK Sinha-led Reserve Bank of India (RBI) expert committee on MSMEs, the sector has an estimated credit gap of Rs 20-25 trillion. The MSME sector took a significant hit during the pandemic. Nearly 5,900 businesses shut down during FY 2020-21 and 2021-22. With increasing inflation and interest rates, most of them still continue to face issues such as having access to finance, marketing their products, and even struggling to cover expenses such as employee salaries, office rent, bills, taxes and loans EMIs.
While these credit woes can be addressed by formal financial institutions such as banks and NBFCs, two issues still persist for MSMEs. First, access to credit comes with a requirement of collateral which many of them might not have. Second, even if the credit is available (with or without collateral), the interest rates are just not viable for the margins that they operate with. Some of these interest rates are as high as 36 per cent. Supply Chain Finance is one of the market-based solutions that effectively solves some of these woes.
Supply Chain Finance (SCF)
SCF is a technology-based solution that provides affordable and quick working capital loans to all supply chain participants thereby increasing liquidity in the system. It differs from traditional loan issuance as it involves a Buyer (typically a large, well-established company) and several suppliers (typically SMEs doing business with the Buyer), with the interest rate calculated by the Buyer's creditworthiness rather than the suppliers.
While SCF is not a new phenomenon for large banks, the high cost of onboarding suppliers and manual paperwork were significant barriers to its growth and widespread adoption. However, with the digitisation of banking processes, the rise of new-age Fintech firms and a strong focus on the manufacturing sector in India (Aatmanirmbar Bharat), SCF has tremendous growth potential in Indian markets.
As per the World Supply Chain Finance Report, globally, supply chain finance market is estimated to have a volume of $1.8 trillion in 2021 which is expected to grow at a CAGR of 17.1 percent. The Asian SCF market has grown at a CAGR of 29 per cent over the last seven years. Indian supply chain finance gap, on the other hand, is estimated to be around Rs 60,000 crore, with the total market value being estimated at Rs 18 lakh crore. The current SCF penetration in India is less than 1 per cent of GDP and currently, it contributes to only 5 per cent of the entire banking system's outstanding assets.
Currently, there are multiple types of Supply Chain Financing options available in India such as Dealer Finance, Vendor Finance, Receivable Finance, Payable Finance, Factoring, Reverse Factoring, Invoice Discounting, Purchasing Order Finance, etc. which in turn can be broadly divided into two groups of Buyer-led financing and Seller-led financing.
RBI’s initiatives to boost SCF
Reserve Bank of India (RBI) has implemented a number of policies to promote the growth of transparent SCF mechanisms and enable faster data exchange between buyers, sellers and financiers.
Trade Receivables Discounting System (TReDS): TReDS is an electronic platform that facilitates the financing/discounting of Micro, Small and Medium Enterprises (MSMEs) trade receivables from corporate buyers via multiple financiers. This platform contains all the MSME firms with annual turnover of over 500 crores or public enterprises, their buyers and financiers which makes the entire credit access process effortless.
Account Aggregator (AA) framework: The RBI has launched an account aggregator framework to consolidate customers' siloed financial data on a single platform. Customers would be able to choose who has access to their data, and financial institutions would be able to access data through a centralised platform. With transaction data stored on a centrally managed and regulated framework, the AA framework and its centralised data management can enable suppliers and buyers to access multiple financing options in a safe and seamless manner.
Future of SCF – the way forward
Some of the ways in which the entire SCF ecosystem can be improved for better adoption and growth of MSMEs are listed below:
Co-Lending Model: This model requires universal banks to take a mandatory share of the loans originated by NBFCs on their books in order to improve credit flow to the unserved and underserved sectors of the economy, benefiting from banks' lower cost of funds and NBFCs' greater reach. The co-lending model has the potential to bring about significant change because NBFCs' expanded customer reach and integration of technology, allowing end users in remote areas to benefit from the scheme, combined with the strong financial backing of large financial institutions, has the potential to transform the lending and borrowing market in the priority sector, including MSMEs.
Deep-Tier SCF: A supply chain typically includes several partners upstream and downstream to the focal firm. In the manufacturing sector, it is usually the farther upstream firms in supply chains (Tier-n suppliers, who are closer to the raw materials) who need access to funds given the small scale at which they operate. It is important to note that a disruption at any upstream point in the supply chain can have a ripple effect leading to inbound risks for downstream firms (closer to the end consumer). Another important aspect of these upstream players is that they usually do not rely on multiple sources of supply and any disruption at their end might create bottlenecks that can stall the entire flow of goods if they can supply to their buyers. It is thus very important to create credit access for smaller upstream suppliers. The evolution of the supply chain leverages deep-tier or multi-tier finance to help the smaller suppliers, the unsung heroes of the supply chain, access the funds they require.
Inclusive and data-driven TReDS platform: Currently as per TReDS, only MSME firms with a turnover greater than 500 crore are mandated to be part of the platform. This can slowly be expanded to cover other smaller firms with turnover greater than 100 crore as these are the firms that actually have a severe crunch. As more data gets generated with transactions in the TReDS platform, using machine learning-based models, matchmaking between the financial institution and the firms receiving the funds can be done thus reducing the chances of NPAs.
Fraud Prevention: Given the presence of multiple SCF platforms, it is possible for a single supplier to use the same invoice to access credit from multiple financers which might be problematic. To avoid this, a central database that captures invoice details (like Invoice number and GST number) from each invoice used for financing could be created and made available to all financers; thereby eliminating the possibility of duplicate financing.
