Digital public infrastructure can solve MSMEs’ credit problem

This article is authored by Kunal Walia, partner and Vineet Bhandari, associate partner, Dalberg Advisors.

When India laid down its G20 Presidency vision for 2023, it recognised “Accelerated, Inclusive, and Resilient Growth” as one of its priorities. The integration of micro, small and medium Enterprises (MSMEs) in global trade was identified as a critical part of this growth, which is fitting given that MSMEs contribute to nearly 30% of India’s GDP. The paucity of credit deters growth for small businesses across the world, and especially in developing countries, where MSMEs find it difficult to acquire adequate and timely credit. As per the International Finance Corporation, the credit gap for MSMEs in 128 developing countries was estimated at $5.2 trillion in 2018 alone. In India too, despite the government’s continued focus on the development of the sector and an increase in MSME financing, the credit gap is estimated at nearly ₹16.66 lakh crore, or $240 billion. And as per a report by Avendus Capital, only 14% MSMEs in India have access to credit, compared to more than 30% in developed nations.

MSMEs (iStock)

Digital Public Infrastructure (DPI) is rapidly changing this now. The unveiling of the Open Credit Enablement Network (OCEN) 4.0 on August 17 makes cash-flow-based lending available to MSMEs with greater ease. Similarly, the Account Aggregator Framework, launched by the Reserve Bank of India in September 2021, enables responsible data sharing between financial information providers and users, reducing bottlenecks in credit provision. Scaling such models and replicating India’s successes with financial DPI can help connect MSMEs and small business owners to timely, affordable, and inclusive credit sources.

A recent report by the UNDP and Dalberg Advisors on “The Human and Economic Impact of Digital Public Infrastructure” suggests that an open source DPI can bridge nearly 50% of the credit gap for MSMEs, easing credit access for 16–19 million additional MSMEs in low- and-middle-income countries (LMICs) in 2030. So how can DPI make credit access easier for MSMEs? Here are three key ways.

Firstly, most MSMEs, especially smaller businesses in LMICs, lack formalised financial histories, making it difficult for credit providers to measure their credit worthiness. DPI, through systems like the Goods and Services Tax Network (GSTN), can help MSMEs maintain records of revenue, and further bolster the business’s credibility by upholding the quality of financial information. This information in turn will help banking as well as non-banking loan providers establish whether the business is worth the credit risk.

Secondly, the prevailing market cost of credit significantly impacts whether and how MSMEs can access funds and loans. In informal and unmonitored lending systems, loan providers are free to charge interests at their will, depending on the urgency and need of the credit seeker. However, DPI can help make the credit market transparent, accessible, and affordable for both borrowers and creditors. Increased competition results in lower credit rates and an easier and time-efficient digital system reduces application costs. Moreover, visibility on the business’s financial history minimises the risk of default for banks, further encouraging credit flow to MSMEs.

Finally, credit for MSMEs is hindered by the lack of innovation and inclusion. DPI can resolve this by introducing new mechanisms, such as the enabling of cash-flow based lending for MSMEs instead of relying on credit history. Open Credit Enablement Network (OCEN), for instance, gives MSMEs access to a wider pool of credit providers to choose from, while ensuring security because of the transparent network. Additionally, financial DPI has the potential to make credit access more inclusive. As per the International Finance Corporation, the credit gap for 15 million women-owned MSMEs in India stands at $158 billion, or around ₹12 lakh crore, with 90% of women entrepreneurs relying on informal sources of financing. DPI can fill this gap by connecting them with reliable, formalised sources of loan.

In addition to generating benefits for small businesses, optimising DPI for MSMEs can translate into wider, national-level gains. According to our report, organised financial DPI can increase LMIC’s GDP by an estimated $200 billion to $280 billion by 2030. By simplifying and democratising credit access, financial DPI for MSMEs can bolster India's MSME sector, improve the state of employment in the country, in turn pushing it further on its development path.

This article is authored by Kunal Walia, partner and Vineet Bhandari, associate partner, Dalberg Advisors.