Micro, small, and medium-sized businesses (MSME) provide employment and opportunities for innovation for millions of people in India. More than 63 million MSMEs in India are responsible for more than 30 percent of the country’s gross domestic product and are among the largest employers in India. One of the MSMEs is known as a nano enterprise, which is a very small, informal business that is operated by a nano entrepreneur. They often do not possess the benefit of a college degree, which makes it difficult for them to acquire a job in the mainstream business. They have an average monthly income of less than Rs 25,000, but they manage complex businesses with tremendous growth potential, making them a market for loans worth billions of dollars.
Conventional bankers and banks have been hesitant to participate in nano firms, despite the large market. Due to the unstructured nature of nano firms and their limited financial requirements, traditional lenders find it difficult and expensive to analyze and assist these businesses. Traditional lenders also worry about the absence of credible data and collateral in nano entrepreneurs.
In this particular scenario, the use of credit guarantees is recommended. This enables nano firms to enhance their credit ratings, despite the fact that this market lacks data and collateral. As a direct consequence of this, a source of funding is generated, which nano entrepreneurs may tap into in order to expand their businesses.
Also Read: Lines of Credit: Online Lenders Vs. Traditional Banks
Credit Guarantees And Their Framework
The Indian financial market is mostly comprised of banks and non-bank financial enterprises (NBFCs) as its two primary participants. Large banks and financial organizations have sufficient resources and have an interest in entering the Indian market; yet, the rules and structures of the country require them to avoid taking risks and instead concentrate on lending secured by collateral. Therefore these players are not able to manage the small-ticket finance demands of nano businesses.
Fintechs (Financial technology companies) and smaller NBFCs might work with grassroots organizations or interact directly with nano entrepreneurs in order to reach them. By building new technologies on top of existing partnerships, NBFCs and Fintechs may provide nano companies with loans without requiring collateral in the future.
Nevertheless, since major institutional capital sources do not have a high level of confidence in the MSME sector, NBFCs that make nano loans have restricted access to financial resources because of the Covid outbreak, and large lenders are less likely to invest in these small businesses than they did before.
Credit guarantees alleviate the concerns of large lenders over their exposure to credit risk by offering a portion of the risk protection against defaults. This increases liquidity for Fintechs and NBFCs, enabling them to lend more aggressively to the nano enterprise and MSME sectors. This, in turn, results in a domino effect of business growth for over 63 million MSMEs in India, which in turn compounds the impact on companies and the economy.
Also Read: How to get a line of credit for a new business?
Impact of Financing Nano Entrepreneurs
Because of the pandemic, eighty percent of MSMEs decreased or temporarily stopped operations. Concurrently, there has been an increase in the perceived risk associated with providing finance to MSMEs, which has limited the ability of lenders to assist nano entrepreneurs. During the pandemic, financial service organizations that specialized in providing loan financing to retail NBFCs (that lend to MSMEs) tightened their credit requirements in order to compensate for the higher risk of lending to MSMEs. This was done in order to combat the spread of the virus. The lives of nano entrepreneurs, the people who work for them, and the society at large are all influenced as a result of this.
Because of the credit guarantees they acquired from their partner organizations, businesses that provided specialized financing was able to expeditiously provide (to micro-businesses) liquid assets and credit up to five times more than before. In addition, the provision of partial guarantees assisted in surpassing the capital requirements of retail NBFC borrowers, as well as in reducing the risk that was thought to be associated with the provision of loans to such NBFCs.
This kind of portfolio pooling across a large number of partners offers sufficient risk diversification for guarantee providers, allowing them to expand their appetite for risk. In addition, as a risk mitigator, they use their assessment of the quality and strength of their partners, which enables them to provide support in certain areas such as MSMEs, international trade, and agricultural production.
Credit guarantees help retail NBFCs that lend directly to nano companies and also enable wholesale lenders to continue lending to this sector by enabling them to get more capital from traditional lenders. When developing a loan portfolio for MSMEs, guaranteed risk protection is helpful to lenders in improving or maintaining their credit ratings. Small and medium-sized businesses and other high-risk sectors may get additional funding via the use of financial guarantees.
Credit guarantees have a great deal of potential for meeting the needs of India’s small and medium-sized enterprises. Guarantees could be used by NBFCs and financial technology companies (Fintechs) to lend to first-time borrowers, thereby integrating this sector into formal financial markets and significantly expanding business.
When these tiny borrowers are able to successfully make their repayments, further unsecured loans will become available to the MSMEs and nano sectors. This will produce data and credit records for these borrowers. Because of this, NBFCs and commercial banks will be able to re-calibrate the underwriting and credit assessment algorithms that they use, which will result in a reduced perception of the risk that is posed by MSME and nano businesses. People who have a demonstrated history of responsible debt repayment will have a far lower need going forward for the protection provided by a third-party credit guarantee.
Also Read: 6 Smart Ways For Small Businesses To Use A Line Of Credit To Their Advantage
A few things must happen in order to accomplish this aim. Financial institutions need credit guarantee programs that are easier and more accessible. The market requires a diversified collection of blended finance providers, including development financial institutions, impact investors, and charitable organizations, to issue credit guarantees. It should be explored to reduce risk weightage for loan guarantees. With all of these safeguards in place, credit guarantees might become the first domino effect that sets in motion a new funding market for India’s nano entrepreneurs.
Also Read: Business Loans vs The Line Of Credit