India Digital SME Credit Report 2023 Reflects $220 Billion Credit Deficit in MSME Financing, Alternate Funding Gains Ground

The collaborative report by GetVantage and Redseer Strategy Consultants - The India Digital SME Credit Report 2023 - finds a potential $220 billion credit deficit in MSME funding. Analysts suggest that alternate financing is the way forward for MSMEs to secure funds.

The India Digital SME Credit Report 2023 indicates a potential $220 billion credit deficit that poses a major roadblock for the Indian MSMEs to secure financing. The collaborative report between GetVantage and Redseer Strategy Consultants states that only $53 billion was infused into the market through various channels, serving only 30% of the overall addressable demand, resulting in an alarming capital gap of more than $150 billion.

Bhavik Vasa, Founder and CEO, of GetVantage, shared that the credit deficit is larger than the GDP of some developing countries, and it is anticipated to widen further, due to the prevalent economic and regulatory setting.

“As more businesses enter the market, it is evident that the demand for credit presents a potential to reach nearly $570 billion in the next few years,” he added.

Digitalization Challenges for Indian MSMEs
Pandemic-Driven Increase in Working Capital Demand
Traditional Funding Challenges for MSMEs
Opportunities for NBFCs and Digitally Oriented SMEs
Rise of Alternative Financing Solutions
Importance of Revenue-Based Financing (RBF)

Digitalization Challenges for Indian MSMEs

India is home to 64 million MSMEs which contributes about 30% to the country’s GDP, but is highly plagued with limited digitalization and limited access to capital. The report reveals that only 12% of them, or 7.7 million, MSMEs in India have been digitized to the fullest. These are the merchants who have already designed their platform and generate 30% of their revenues digitally. The major boost occurred during the pandemic when forced digitalization facilitated exponential growth, leading to lower transformation costs, increased utility, increased revenue, and improved communication and flexibility.

Pandemic-Driven Increase in Working Capital Demand

Before the pandemic, the working capital demand was growing at a stable annual rate of $70 billion. However, the forced digitalization during the pandemic hiked the demand by more than $100 billion in just two years. According to the Redseer consultants, over the next few years, the demand for working capital is expected to rise steadily at a CAGR of about 20% and is projected to reach approximately $570 billion.

Traditional Funding Challenges for MSMEs

The funding challenges ranging from accessibility to red-tapism have been preventing the growth of MSMEs for decades. While the government has made dedicated efforts to tackle liquidity issues faced by SMEs, conventional financial institutions for long made little headway in effectively addressing the accessibility concerns of these businesses. Traditional lending institutions perceived SMEs as risky investments. Their multiple working models and non-conventional payment terms prohibited them from securing funds. Also, financial institutions require 90-120 days to disburse credits, therefore hindering the workflow of the SMEs as they require timely working capital to meet their operational needs.

The report also noted that the absence of collateral and comprehensive documentation has consistently posed obstacles for traditional lenders like commercial banks in offering sufficient funding to SMEs.

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Opportunities for NBFCs and Digitally Oriented SMEs

Public and private banks are currently able to fulfill only 30 percent of the total demands from SMEs, creating opportunities for NBFCs (Non-Banking Financial Companies) and third-party lenders. Consequently, 40 percent of the overall capital investment in the SME market has been directed toward digitally oriented SMEs, which represent just 12 percent of the total MSMEs, as reported by Redseer.

Kanishka Mohan, Partner at Redseer said, “Small businesses account for 90% of credit demand but continue to struggle to raise capital, owing to poor business metrics, limited assets, and uncertain growth projections. If the current economic and regulatory climate continues, this gap is likely to widen significantly over the next five years."

Rise of Alternative Financing Solutions

Alternative financing has emerged as a vital resource for SMEs, where innovative lending models like revenue-based financing, recurring-revenue advances, and trade receivable financing offer accessibility, flexibility, and transparency. These solutions, which resemble quasi-equity options, are well-suited to support SMEs in scaling their operations.

Vasa commented that alternate financing has a vital role to play in extending the limited reach of traditional lenders to serve millions of new-economy businesses and emerging sectors. He said, “The $570 billion credit requirement for digital SMEs in the coming five years represents an unprecedented opportunity for alternate financing platforms, NBFCs, and traditional financial lenders like banks to collaborate and catalyze economic growth by prioritizing compliance, governance, inclusion, and innovation.”

Currently, approximately 5% of the lending market is supplied by alternative finance channels. This segment experienced significant growth during the pandemic and is expected to double over the next five years, reaching approximately 11%. This growth can be attributed to increased market awareness, a focus on serving SMEs, and the flexibility offered in repayment options.

According to Harsh Somaiya, Co-Founder, of The Bear House, the economic growth in India has been fueled by the SMEs as they play a vital role in generating employment and contributing to the overall GDP of the country. As digitalization is increasing rapidly, having access to this credit opportunity would alleviate fund-raising challenges that small businesses generally face, which would help with their rapid expansion as well. "New-age credit platforms are keeping the business goals at the forefront. This along with the credit opportunity will help build a healthy financial ecosystem for SMEs and MSMs to thrive in,” he added.

Importance of Revenue-Based Financing (RBF)

The Redseer analysts stated that RBF is now more relevant than ever before. Being data-driven, revenue-based, and flexible has made RBF one of the most robust and popular forms of alternative funding. With a standard flat fee structure ranging from 6% to 12% and loan amounts tailored to suit the working capital requirements of a variety of businesses, SMEs can benefit from convenient, unbiased access to capital at competitive costs.

Sameer Seth, Founder and CEO, of Hunger Inc., said, “The growth challenges faced by millions of MSMEs today have in a way helped shape the ecosystem, making it easier for businesses to raise capital and be much aware of what kind of capital to be raised when. This is how India is reshaping credit accessibility within the founder community.”