Role of NBFCs in the growth of micro enterprises.

Introduction

India has always been home to a vibrant spectrum of microenterprises even before that term became popular in mainstream economics. The small business sector in India is deeply rooted in familial customs and niche skills. Today, that sector has been recognized as a legitimate business sector with its own set of nuanced workings. This sector now includes 51 million microenterprises, each with its specific need for credit. These microenterprises were traditionally not financed by banks due to the need of too many financial documents and credit records.  Non-Banking Financial Corporations (NBFCs) are offering more interesting propositions to these microenterprises. NBFCs are playing an increasingly important role in the growth of microenterprises.

Why microenterprises favor NBFCs

Microenterprises are generally categorized under the riskier borrower segments of banks. While many banks have their own MSME (Micro, Small and Medium Enterprises) divisions, their drive towards evaluating the low-credit health applications of microenterprises is limited. The reason for the low-credit health is the non-availability of the traditional means of collateral. NBFCs are however, more innovative towards the evaluation of the credit risk. Factors like the business stability (which may be undocumented), family repute, product idea or market monopoly are hard to weigh on a credit scoring scale. NBFCs today carry the expertise and the technology to evaluate these seemingly unquantifiable parameters and arrive at an informed decision about the credit health of microenterprises. The banks generally fail to make such judgments or find the loan application to be too risky by their measures.

 Due to this difference in the approach towards lending, the banks’ total share in the loan market fell from 49% to 28% according to a report (https://www.bcg.com/documents/file15284.pdf) by the Boston Consulting Group. The same report also states that the share of NBFCs rose from 21% to an impressive 44%. This happened in just three years, between 2014 and 2017. 

NBFCs are also being favored by the younger entrepreneurial populace, which has taken a liking to the lesser bureaucracy and flexibility of NBFCs. The same report states that NBFCs had the lion’s share of the market for loans to persons aged between 21 and 35, at 49%.

Why NBFCs favor microenterprises

Most microenterprises seek loans under project finance, equipment finance or loan against property (LAP). In these three categories, LAPs are the most popular amongst microenterprises, where the business owner’s residential or commercial property is put up as collateral. The rate of delinquency for microenterprises are in the range of 7.4% to 8.1% as against the much more discouraging figures of 12.25% to 22.3% for large corporates. This is ironic because, microenterprises get routinely turned down to their perceived credit health issues, the keyword here being ‘perceived’. NBFCs favor microenterprises because they have the analytics to tell them the real story and not just consider the presence of large office space or employee strength.

NBFCs are also generally working with lesser opex, more flexibility and greater agility. These factors lead to NBFCs being comfortable with the microenterprise lending arena, which would generally discourage a bank. Microenterprises also offer partnership options or profit-sharing options to NBFCs that seem attractive because of the entrepreneurial spirit that NBFCs yearn to kindle. These kind of benefits are different from the traditional money-lending advantages, that NBFCs make ample use of.

The introduction of the Goods and Service Tax (GST) is a move that has placed the transactions of many undocumented microenterprises on the map. NBFCs are able to view the business activity of a microenterprise with much greater clarity than before.

NBFC 2.0 are attracting more microenterprises

The marriage of financial technology and the existing set of financial services that NBFCs provide is churning out more futuristic companies that are said to be a part of NBFC 2.0. These companies are using a mix of different analytics’ tools to conduct their credit health check. By checking the website traffic of the microenterprise, the social media activity, the track record of the entrepreneurs, the innovation introduced in the product or service, NBFC 2.0 is processing loan applications at a much quicker pace. This is helping the growth of microenterprises which in turn feeds back to the growth of NBFCs. NBFCs are also growing in terms of technology and expertise and not just size. This growth is helping them become better at providing financial services to microenterprises.

Conclusion

NBFCs will continue to do better in the microenterprises’ arena compared to their banking counterparts. They already have a competitive market share that is only expected to grow as microenterprises become more familiar to the nation and the economy.

The quickness to respond, utilization of technology, analysis of non-standard credit health aspects and desire to innovate will make NBFCs, preferred choice for credit for microenterprises.

Prest Loans (www.prestloans.com) is a new age Fintech NBFC that uses technology and analytics to provide easy finance options to MSMEs.