The Indian economy has survived the pandemic. After reporting a contraction of 24% in the GDP in the April-June quarter of FY2020-21, the economy witnessed green shoots in December, with the highest-ever GST collection at INR 1.15 Lakh Cr. But the Covid-19 pandemic has taken a huge toll on the economy for sure, more so on the lending sector.
According to data from the National Automated Clearing House (NACH) platform, 40.1% of auto-debit transactions by volume failed in October 2020 due to insufficient funds. Clearly, when people lose their income source, debt repayment is the first casualty.
Given the nascent stage that India’s fintech startup ecosystem is in currently, the industry expects the government to come up with a robust plan to help the companies survive and thrive.
The Indian government’s INR 20 Lakh Cr economic stimulus package announced last year had several schemes to help the lending sector. But most of them were structured to help only the MSMEs and NBFCs, leaving alternative lending entities outside its purview.
According to Sashank Rishyasringa, cofounder and MD of the SME-focussed digital lender company Capital Float, big banks and NBFCs mostly benefited from the collateral-free credit scheme for MSMEs, but many small businesses were left out as large banks and NBFCs do not service them. “Our recommendation is to continue the scheme and allow for higher pricing, which will open up the scheme to a substantial number of small businesses,” says Rishyasringa.
Seconding this, Prabhat Chaturvedi, CEO of Netafim Agricultural Financing Agency (NAFA), also points out that NBFCs have traditionally been excluded from the purview of various subsidy schemes. Now special-purpose NBFCs such as agri-NBFCs should be considered for major government subsidy schemes, through which their businesses/portfolios can be secured. This will bring about more confidence in the business of rural lending and make the system more transparent in terms of policy implementation. Additionally, customer benefits will increase significantly.
Besides, the lending startups have a few more top requirements from the Union Budget 2021 and want the finance minister to take a look at bringing in a regulatory framework that will do away with the existing (and huge) disparities among big, midsize and small players in this space. Let us look at the industry perspective and the issues it wants to be addressed.
Extend: CGTMSE Scheme To Lending Startups
“Government funding support for lower/on-par funding lines to digital lenders will certainly help ease out the situation for small businesses which ultimately generate a significant portion of the nation’s GDP,” – Harshvardhan Lunia, cofounder and CEO, Lendingkart
The Indian government has set up the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) to strengthen the credit delivery system and facilitate flow of credit to the MSME sector. The credit guarantee under CGTMSE will compensate the loss incurred by a lender if an MSME fails to discharge its liabilities to the lender.
However, only banks, NBFCs, small finance banks and some other financial institutions (barring lending startups) are currently eligible to lend under the scheme.
Rishyasringa of Capital Float thinks that “the CGTMSE scheme should be made available to lending startups too. That way, they can ensure a smooth cash flow for eligible borrowers. Furthermore, the pay-out needs to be higher in 2021 for startups to benefit from the scheme.”
Similar is the case with Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002. Last year, as part of the Union Budget 2020, the government amended the Act and lowered the debt recovery limit from an asset size of INR 500 Cr to INR 100 Cr or a loan ticket size of INR 1 Cr to INR 50 Lakh.
However, very few NBFCs were able to benefit from the amendment. Rajesh Sharma, managing director of Capri Global Capital, says, “While the ticket size for housing finance companies (HFCs) and small finance banks have been kept at INR 1 Lakh and above, for NBFCs, it is INR 50 Lakh and above. This puts a lot of hardship on small borrowers’ income. The credit cost goes up due to long litigations where the SARFAESI Act is not applicable. This needs further amendment.”
Needed: An Institutional Framework To Provide Liquidity And Liability
In March 2020, when the RBI introduced schemes such as TLTRO (targeted long-term repo operations), most of the benefits went to a handful of financial institutions. Consequently, the central bank immediately introduced TLTRO 2.0, focussing on the fund towards lower-rated NBFCs and MFIs.
These schemes, indeed, impacted a fleet of 2.5 lakh+ MSMEs, says Shachindra Nath, executive chairman & MD, U GRO Capital, an SME lender. While he argued that it was the first time the government came up with schemes where it provided 100% guarantee over the loans sanctioned to certain MSMEs, Nath asserted that NBFCs need an institutional framework to generate liability.
According to him, it is now established that NBFCs or other lending startups can play a key role when it comes to catering to an underserved market. However, what is lacking is an institutional framework for generating liabilities for NBFCs. Unlike non-banking finance companies, banks already have a well-established way of generating liabilities by taking deposits from customers to finance assets such as loans to individuals and businesses.
Lending entities other than banks mostly depend on banks while banks’ strategies depend on their credit appetite. This has to change.
“The government needs to come up with an institutional framework to provide liquidity or liability to NBFCs. Probably, a mega-NBFC, which is capitalised by the government and which then borrows based on the sovereign rating and then provides liquidity. In the long run, it will help penetrate the underserved market,” says Nath.
Neeraj Dubey, partner, corporate law, at Singh & Associates has a different view. “Given the poor lending practices of NBFCs such as IL&FS, banks (even those flush with liquidity) are wary of NBFCs and consequently the MSMEs, as a lending segment. As NBFCs and fintech companies bring many more ‘new-to-credit’ MSMEs to formal finance than public and private banks, this risk aversion affects job creation. Moreover, even NBFCs with an optimised model (one that combines physical and digital formats to keep costs low while being MSME-centric) charge upwards of 20% in interest, which is expensive for many MSMEs. Together, these factors limit the scaling up of innovative and effective NBFCs and fintech players.”
Required: Suspension Of Basel Norms For Three Years
Due to the Covid-19 fallout, startups have seen a decline in lending by banks. In fact, banks need adequate flexibility in lending, which can only be brought about through a temporary suspension of the Basel Norms, argues Dubey of Singh and Associates. MSME loans in India are linked to corporate loans for which a healthy credit rating is required. Rating agencies assign the same depending on the market base of a business, which means a small enterprise will have an insignificant market base, and hence, fewer chances of raising a loan.
According to him, “This will lead to higher interest rates and affect a bank’s lending flexibility. Given the current scenario, startups hit by the Covid-19 pandemic should be able to borrow sufficient capital in order to function. Although the RBI has permitted a reduction in the margin to recalculate the drawing power for working capital facility, and simultaneously, banks have permitted ad-hoc fund-based facility up to 10% of the fund-based limits under the Emergency Credit Line Guaranteed Scheme, these measures will end by Mar 31, 2021, and will require an extension.”
Essential: A Regulatory Push For The Digital Economy
Post-lockdown, most of the lending institutions have already adopted the digital way of doing business. However, Kunal Varma, cofounder of MoneyTap, says that several digital measures are still required from a regulation standpoint – right from the more widespread use of digital KYC to minimising process concerns as far as borrowing goes.
There is more to it. The new platforms, channels and technologies such as the Trade Receivables Discounting System (TReDS), the Open Credit Enablement Network (OCEN) and account aggregation services, expected to be an essential part of digital lending ecosystem, need a regulatory push.
As Dubey of Singh & Associates points out, less than 15% of all central public sector enterprises transacted on TReDS at least once in the past three months, and fewer than 15,000 MSMEs benefited from the three TReDS platforms. Firms with a turnover of more than INR 500 Cr must register on TReDS. But reducing the minimum threshold to INR 200 Cr will increase the number of buyers and, consequently, the number of MSMEs on TReDS.
“If it goes mainstream, OCEN, a platform created for cash flow-based lending, will greatly benefit thin-file, no-collateral MSMEs. For such platforms, incentives and innovations, rather than mandates, to encourage participation from key stakeholders will help. For example, providing trade credit insurance via TReDS will enable banks to lend to MSMEs as these are low or unrated corporates.”
Piyush Khaitan, founder and managing director of NeoGrowth Credit, concurs. “At NeoGrowth, we also propose that there should be a scheme in which retailers with digital sales over a certain limit, say 70-80% of total sales (offline and digital combined), should be taxed at a lower rate.”
It will bring more MSMEs to the digital ecosystem while reducing cash-handling, believes Khaitan.
Reset: The Rating System
The rate cuts made by the RBI do not always ensure lower borrowing costs for last-mile NBFCs. This is the case with most of RBI’s Covid-19 relief measures, including the TLTRO scheme. Data reveals that the mandate was meant to provide relief to NBFCs across the board, but the banks deployed more than 70% of the funds raised through it in papers issued by AAA-rated NBFCs. A change in the rating system to address the significant difference in size and operations of different NBFCs may help solve this problem, says Aiswarya Ravi, CFO of Kinara Capital.
According to Ravi, the existing rating system automatically excludes many last-mile NBFCs which do not fit size-related parameters. Certain categories of NBFCs, like those serving the MSME sector, can never match up to industry giants.
“So, there must be a change in the way the rating is conducted. A differentiated rating system, which takes into account factors such as asset quality, profitability and capital adequacy ratio of last-mile NBFCs, can help close the disparity in funding that exists now,” says Ravi.
Reduce Reverse Repo Rate, Penalise Lazy Banking
The central bank reduced the repo rate and the reverse repo rate time and again, hoping that the money would flow back to the market and help solve the liquidity crisis. However, Varma of MoneyTap says that none of those measures translated into major benefits to end borrowers. This is primarily because large banks often take a minimum-risk stance. Citing U.S. banks, Varma and many others have suggested that the government discourage lazy banking.
“A lot of these lenders went for the low-yield, extremely low-risk or zero-risk approach, instead of a much higher yield and maybe slightly higher-risk approach. To change this approach from doing absolutely nothing to doing something and getting slightly higher yields, maybe certain disincentives should be introduced. If a certain section of the fund is kept idle by large banks or NBFCs for a long period, there could be certain disincentives towards them,” says Varma.
Seconding this, Anil Pinapala, founder and CEO of Vivifi India, says that lending startups typically have unrated portfolios. So, there is no reduction in the actual borrowing costs. This can be corrected only by curbing lazy banking. Parking funds with the RBI should be entirely discouraged by adjusting the reverse repo rate suitably and relaxing the norms for getting foreign debt and equity.
Implement: Colending Programmes
Inadequate availability of wholesale capital limits the number of MSME customers who can benefit from digital lending. Harshvardhan Lunia, cofounder and CEO of Lendingkart, says, “The government must extend the mandate for PSU banks to partner with digital lending institutions on a risk-sharing, co-lending model and extend capital support to MSMEs leveraging the widespread origination, underwriting and delivery capabilities of digital lenders. The boost is required to increase funding lines for digital lenders, thus empowering the country’s micro and small businesses. Refinancing schemes can also be extended to younger NBFCs to enable smaller and shorter-tenure loans as most of the digital lending companies are yet to scale to reach a significant level.”
Seconding this, Sharma of Capri Global says that the RBI’s co-lending and co-origination programme needs to be implemented effectively. This will solve the liquidity and asset quality issues of the NBFCs as the entire thing will be under close monitoring. Besides, it will also help the sector grow.
“It is a marriage between low-cost funding from banks and the collection efficiency of NBFCs,” says Sharma.
On Everyone’s Wish List: The GST Relief
Since it came into effect in July 2017, the Goods and Services Tax (GST) has remained a concern for several sectors even though the GST Council, over the last 43 meetings, redefined the GST slab rates.
Explaining the current situation on the lending side, MoneyTap’s Varma says that in many cases, the lending revenue gets booked much later. For instance, if a customer borrows money today, the revenue starts coming in very late, sometimes after 12 or 24 months. In such cases, taking off some burden as far as overall cost measures are concerned will help and this can be done through some tax-related or GST-related reliefs.