The development of India’s economy and upliftment of the bottom strata of society depends on the proper utilisation and growth of micro-enterprises. The credit gap is the key bottleneck for the development of micro-enterprises. Effective usage of digital technology is a key solution.
The growth of any country or society lies with the proper upliftment of the bottom strata of the pyramid, i.e. low-income groups and MSMEs (Micro Small, and Medium enterprises). Out of India’s 63.39 million MSMEs, 99% fall under the micro category where investments in plant and machinery are not exceeding ₹ 1 Crore or turnover not exceeding ₹ 5 Crores, and almost 110 million people are employed in this segment. These micro-enterprises have helped the country not only to fulfill demand and supply gaps at the last mile but also to absorb shocks from global turmoil. Furthermore, this sector helps to uplift rural and underdeveloped areas and remove regional imbalances and inequalities.
One of the key aspects of the development of micro-enterprises is the requirement of credit or bridging funding gaps to set up a business, run the business, and expand business. Despite the importance of the sector and its requirement for credit, this sector faces challenges such as credit history or standard credit rating, inadequate collaterals, lack of formal credit awareness, high interest rates, and lack of understanding of government schemes. To bridge this gap, microfinancing plays a big role. These finance companies work closely with micro-enterprises to satisfy different types of credit requirements.
Microfinancing – Structure and Ecosystem
In India, credit facilities for micro-enterprises are provided by Self-Help Group Bank Linked Program (SHG-BPL) (where self-help groups are treated as a customer segment by banks) and Micro Finance Institution (MFI). In most cases, credit from MFIs is given to Joint Liability Groups where a group of individuals (typically 4-10) apply for the loan jointly and stand guarantee for each other. This kind of mechanism lowers NPA (non-performing assets) significantly. Historically, MFIs have less than 1% NPA. In India, the credit gap for the MSME sector is almost $250B which is around 10% of total GDP. A large portion of that gap comes from the Micro segment.
At a high level, Microfinance has four stakeholders – regulators (Government including RBI), Borrowers, Investors or lenders (banks, NBFCs, and Small Finance Banks), and MFIs. In this ecosystem, MFIs provide loans to borrowers mostly in Tier III cities and beyond. MFIs ensure the creditworthiness of the borrowers and manage the collection and servicing of the loans. Banks, Small Finance Banks, and NBFCs finance those credit. Digital lending plays a key role in building a trustworthy platform for all stakeholders.
Digital Microfinancing to Build a Trustworthy Ecosystem
Digital lending infrastructure in India is backed by India Stack which is a set of APIs (application programming interfaces) managed by several agencies of the government – Open Banking based Jan Dhan Accounts, NPCI-backed UPI payments, UDAI-backed Aadhar, Digital e-signature, OCEN (Open Credit Enablement Network), etc. These are supported by advanced digital technologies along with Artificial Intelligence (AI).
Aadhar-enabled KYC (Know Your Customer) and e-sign have helped to ensure the verification of borrowers. Also, video-KYC, verification of other national IDs using Optical Character Recognition (OCR), and AI technology for fraud detection have strengthened credit worthiness of borrowers. Some MFIs have built alternate last-mile digital channels like kinara shops, mobile recharge shops, local influencers, etc., and integrate them digitally to interact, acquire, and serve borrowers.
Micro enterprises are thin-file borrowers. AI-based alternate credit underwriting using surrogate data points like utility bill payment, mobile recharge, land record data, etc. helps MFIs to understand the willingness to pay of borrowers. API-based integration with related third-party systems helps MFIs to do the necessary validation of those data points.
Timely Repayments are made easy through UPI and Aadhar Enabled Payment System (AePS). Moreover, AI AI-based chatbot built in Indian languages has helped in spreading financial literacy also micro-finance product positioning. Even *99# Service, a USSD (Unstructured Supplementary Service Data) -based payment service that enables digital payment from non-smartphones, helps last-mile borrowers make timely payments. Alternate physical touchpoints are also acting as collection centers with cash drop-box facilities.
Environmental and Social Impact of Using Digital Technology
Using digital technology, MFIs have created financial inclusion, skill training, and women empowerment thereby fostering social equality and income-growth for last-mile enterprises. MFIs are instrumental in rural development by providing financial services to agriculture and allied products. They are also focusing on sustainable development by promoting the generation of clean energy. On the other hand, outreach programs like skill development, and woman empowerment towards entrepreneurial paths conducted by several MFIs have brought significant changes in society. Those programs have helped men and women come out of poverty. Thereby, MFIs have directly impacted the environment and social levers of ESG ambition.
To achieve the vision of a $5 Trillion economy by 2025, India needs to uplift micro-enterprises and make them build more export-oriented products. Digital microfinance ecosystem operating within the India Stack and using cutting-edge technology is one the key drivers in that process. This has helped microfinancing to operate with low NPA, thereby making the model interesting for investors and start-ups. Direct ESG impacts have also made this use case strong and lucrative.
Author: Supratik Nag
Supratik Nag is currently working as Vice President of Product Management and Sales Engineering at Maveric Systems. He has almost 22+ years of experience in the Banking Industry and has spent most of his career as a Product Manager in banks like HSBC and Barclays and as a Consultant with Cognizant Consulting and Oracle Financial. His areas of interest are Digital Banking, Transactional Banking, and Artificial Intelligence.