Highlights
- Most MSMEs need access to formal credit and short-term loans.
- Account aggregator (AA) enables lenders with new data sets to make easier underwriting decisions for cash-flow based lending.
- OCEN 4.0 (Open Credit Enablement Network) signifies a fundamental shift to the traditional lending models by leveraging the capabilities of AA to enable short-term loans.
During the last fortnight, I was on the road visiting interiors of South and North India. The journey entailed going through expressways, highways, and single track roads. The best part of the journey, other than the superb quality of roads, was the almost complete absence of cash transactions. Nearly all of my transactions - from the toll plazas, to road side vendors, to highway restaurants and petrol banks were cashless with QR codes and UPI transactions. This experience was truly exceptional, unlike any I've had before. The thrill of realizing the immense potential within India's financial services, fueled by JAM (Jan Dhan-Aadhaar-Mobile), UPI (Unified Payments Interface), and the latest additions of AA and OCEN 4.0, is simply electrifying. Imagine the vast reservoir of digital data that will be accessible and generated, a goldmine of possibilities for numerous customer-centric use cases that can revolutionize the industry.
Understanding the MSME credit needs
Across the world, small businesses struggle to access credit and tap into formal financial markets. The Micro, Small, and Medium Enterprises (MSME) sector in India plays a crucial role in the economy, contributing 30% to the GDP and employing over 100 million people. However, the sector faces a significant challenge in accessing formal financing, with over 80% of MSMEs not receiving any credit due to a lack of collateral and credit history. The credit gap in the Indian MSME sector is estimated at a staggering 500 Bn Dollars. Even pre-COVID, only about 8% of the total MSMEs in the country had access to formal finance; the other 92% are likely taking loans at onerous terms from ad-hoc sources, and are regularly facing working capital shortages. these small businesses are increasingly transacting digitally
Why is Indian MSME credit penetration so poor? The are several structural challenges that have created barriers to entry for lenders to serve the MSME needs:
- Elevated Risk Profile: The majority of potential borrowers lack robust credit scores or pertinent data, rendering the collection and repayment processes intricate for lenders and maps them to higher risk profiles as borrowers.
- Elevated Operational Expenses: The expenses incurred in customer acquisition, underwriting, and collections present a financial hurdle for lenders, particularly when dealing with smaller borrowers.
- Restricted Accessibility: Existing online and offline channels fail to connect most lenders with a vast portion of potential borrowers.
To understand this better, let us go back to the original case study with the example of Rajni - a street vendor that takes a loan in the morning, buys her supplies, converts them into sales at a small profit, and retires the loan at night. She is able to get this loan from informal moneylenders even today, but at an interest rate of roughly 3-5% a week which annualizes to about 150-300%!
Under DEPA, when people like Rajni share their financial data with account aggregator entities to prove they are credit-worthy and seek loans, the account aggregator system, operating on a tech platform governed by the DEPA protocol, ensures their data is not stolen, copied, or shared with unauthorized entities. It guarantees their data is only shared with their consent and used only for the purpose mentioned in the consent. The digital public infrastructure necessary to improve her situation has been in the works since 2013, and now the pieces are finally in place to attempt a solution.
Data and India Stack DPI for financial inclusion of MSMEs
India is data-rich but not economically rich. Data may help solve the puzzle of self-employed, informal segment and sachet lending. Open banking with OCEN and the AA framework along with the proposed Public Credit Registry (PCR), which would be a repository of all credit-related information, would together help plug the information gaps and give a fillip to MSME lending.
Indian Open Banking Statistics:
- UPI: 9.3B+ monthly transactions, Participants 473+
- PMJDY Accounts: 500M+ with $20B+ deposits
- Aadhaar: 1.96B+ monthly transactions.
- Account Aggregator: 15.35M+ accounts linked, consents 16.08M+, Participants 390+
OCEN 4.0, is a digital public infrastructure designed to bridge the credit gap and provide affordable credit to MSMEs. This groundbreaking platform leverages the power of revolutionary products such as Aadhaar, UPI, and the GST system to enable small businesses to access loans without the need for collateral. Increasing adoption of digital payments by individuals and small businesses, growth of e-commerce platforms and payment gateways, and the launch of Kirana-tech and accounting apps etc. has made newer streams of high-quality data available. Such data is expected to become available for lender to underwrite and serve new segments of borrowers through OCEN.
Account Aggregators are a vital piece of this reimagined credit puzzle and will be an important cog in the success of OCEN enabled lending value chain. By streamlining the loan application process and utilizing data from these sources, OCEN assesses creditworthiness and empowers MSMEs to secure the financing they need to thrive. One way to appreciate the potential role of OCEN for MSME lending is to think of it as a critical third source of (high-frequency) non-financial data that builds on top of traditional financial data from credit bureaus and bank statements/GST, which will be made available through the account aggregators. This coupled with the Loan Agent’s proprietary data about the borrowers it make it easy for lenders to underwrite a borrower signifying their ability and intent to pay.
This also enables the embedding of data-driven digital lending into online marketplaces and tech platforms. Imagine a consumer goods marketplace with millions of customers and thousands of suppliers. For such a company, becoming a loan-agent on OCEN and offering order-financing for end consumers and working-capital financing for suppliers seems like a no brainer - it deepens the value add of their offering to consumers, allows more commerce to flow through its system as a result of better-funded suppliers, and results in direct revenue for the company through loan origination fees.
If portability and control of data could allow an MSME owner to digitally share proof of the business’ regular historic tax (GST) payments or receivables invoices easily, a bank could design and offer regular small ticket working capital loans based on demonstrated ability to repay (known as Flow based lending) rather than only offering bank loans backed by assets or collateral. Flow based lending is the norm for individuals providing proof of salary to access home and car loans, yet these types of products are yet to take off at scale for MSMEs, partly due to frictions in accessing required data. The Account Aggregator framework could transform access to much-needed working capital credit for micro enterprises, particularly when bundled with OCEN APIs for Lending.
Big advantages for MSMEs from OCEN 4.0 would be the following:
- They can maximize their working capital for hassle-free business operations.
- Their creditworthiness increases as they take more loans, allowing them to serve bigger clients.
- They can sustain bad business seasons due to catastrophes or supply chain disruptions, supporting 100 million people and 30% of India's GDP.
Summary
OCEN 4.0 along with the power of Account Aggregator along with other ecosystem partners, agents will help meet the credit needs for the underserved MSMEs who lack access to formal credit.
The OCEN 4.0 is a game changer. Are you ready for this?