As India stands at the threshold of a digital revolution, MSMEs gain newfound importance

Gunja Kapoor 30th November 2017

Micro, Small and Medium Enterprises will eventually be formalised

On multiple occasions, Micro, Small and Medium Enterprises (MSMEs) have been denied access to financial services on account of multiple factors including insufficient documentation, the absence of unencumbered collaterals and credit history. Moreover, their small ticket size instantly makes these customers unattractive to the large formal financial institutions. Expansion in the e-commerce sector has been a recent driver in the growth of MSME market in India. There are 51 million MSMEs in India, of which only 32 percent are digitally engaged.

Role of FinTech firms

This gap was immediately identified by financial technology (FinTech) companies. These companies have taken up the role of not just lenders, but business solution providers, through innovative products and solutions. Alternate credit scoring methodology and advanced data analytics have supplanted the tedious documentation requirements, solicited by banks in the same regard. This also helps FinTech companies provide services to their customers in a turnaround time to the tune of as less as 48 hours, making credit, “timely” available.

As banks undergo a restructuring of balance sheets, MSMEs have been receptive to borrowing from FinTech firms, being a part of the digital universe. However, FinTech is not the only reason why MSMEs have stepped into the digital space. Rapid migration of customers to digital platforms has also acquiesced MSMEs to adopt digital ways of doing business. It must be noted that only 2 percent of MSMEs are actively engaged in selling/promoting their business.

Challenges faced by the MSMEs

As much as new age MSMEs would want to engage with FinTech companies, they face prominent challenges. One, there is widespread inertia in the industry to migrate to digital platforms. Two, there is a lack of knowledge and skill due to which availability of talent is polarized. Three, hardware costs are high and there are recurring connection expenses. However, these challenges can be overcome by steering the policy debate in the intended direction.

Empowering feature phones

Today over 85 percent of the urban Indian population owns a mobile phone. While smartphones get most of the attention, 56 percent of this user base actually uses feature phones. Since one of the prime requirements of FinTech is internet infrastructure, we need to explore ways to empower the existing feature phone users, then wait for users to migrate to smartphones, and then eventually participate in the FinTech revolution.

To include this 56 percent of the potential customer base, an option of an add-on device similar to a sleeve needs to be explored. This will be similar to a dongle which can be connected to a feature phone (physical or wireless, depending on the feature phone).The feature phone user is onboard on the internet of things and is a part of the smartphone user community. This add-on device will be cost-effective, interoperable (device and networks), and shared. Yes, Bank has launched a similar product called SIMsePAY, which empowers feature phones to have become smartphones, which expects to reach 500,000 users by the end of 2017.

Udyog Dhan Yojna for MSMEs

Lessons from the astounding success of Pradhan Mantri Jan Dhan Yojna (PMJDY) should be applied to the MSME sector. As per PMJDY website, there are 295.2 million account holders, with a total bank balance in their accounts of INR 658.45 billion. As per bank accounts for The Unbanked: Evidence from A Big Bang Experiment (Chopra, 2017), three notable trends were observed in PMJDY. One, around 70 percent of PMJDY accounts moved out of dormancy. Two, level of activity of PMJDY accounts was significantly higher than others in similar socio-economic conditions. Three, PMJDY accounts witnessed an increase in account balance. Along similar lines, Udyog Dhan Yojna (UDY) for SMEs should be framed and linked to Udyog Aadhaar. UDY should be used as the main account for carrying all firm/enterprise transactions. Transaction trail in UDY feeds into credit assessment/due diligence and monitoring purposes. Any direct benefits to the firm must be routed through this UDY.

Strengthening the FinTech ecosystem infrastructure

The FinTech infrastructure has four primary areas waiting for policymaker’s attention. One, weak network availability and connectivity. Despite a vibrant telecom sector, India has not yet developed a capable digital infrastructure. Broadband and mobile network availability is erratic in most parts of the country while internet speeds are among the lowest in the world. The absence of affordable 3G and 4G coverage and bandwidth continues to impede FinTech growth in the country. Due to sluggish speed and erratic connectivity, payments are vulnerable to security attacks and stand low chance to see successful completion, deterring SMEs from using digital transactions ubiquitously. Two, low POS penetration is a perpetual foremost challenge. High distribution costs and poor connectivity discourages vendors from providing connectivity in remote areas. Three, low financial literacy limits adoption. Banks and financial institutions need to introduce customers to digital products. Due to the high reach enjoyed by banks, they are in a position to influence customer habits. Banks could lead from the front, by educating their respective staff members and their family members to adopt digital ways of transacting. This will have a significant multiplier effect, considering banks have their presence across rural India and undeveloped digital markets. Four, there is a weak consumer protection framework. Digital players should share transaction details, on a set frequency, free of charge. Also, with optimum use of technology, the veracity of the transaction needs to be identified. Consumers need to feel protected against identity theft or system failure. FinTech players need to assure their consumers that their personal data including sensitive details such as Aadhaar are well protected, by both, the company and regulation.

India is at the threshold of a digital revolution. With multiple structural measures, right from demonetisation to GST, it is evident that there is a concerted effort to include the informal into the formal, by osmosis. It is imminent that eventually, MSMEs will have to become formalised. Technology friendly demographics, along with a strong political push for digitization and good governance, are necessary variables that will enable FinTech companies to accelerate the growth of MSMEs in India.

Gunja Kapoor, Associate Fellow, Pahle India Foundation

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