Can OCEN fill the credit gap with India’s “missing center”?

Almost 65 million micro, small and medium-sized enterprises (MSMEs) contribute 30% to India’s gross domestic product and employ around 110 million people. Due to their regional distribution and local job creation, MSMEs not only have enormous potential to create employment opportunities and have a positive effect on inclusive economic growth, but also slow down migration to urban centers. However, the lack of access to credit has kept them from growing in size and adopting technology. The current credit gap for MSMEs is estimated to be around. estimated 25 trillion. This huge unmet credit demand has led MSMEs to be labeled a “lost middle” as their needs range between small microfinance loans and larger bank loans.

Lenders must solve several problems in order to fill this void efficiently and profitably. First, their existing processes are designed for a high level of human intervention at every stage, namely procurement, underwriting, monitoring, and repayment collection. This makes the unit economy unfavorable for loans with smaller lot sizes, especially under 10 lacs and for a short term as required by MSMEs. Second, most lenders have a distribution network that targets urban areas. However, a large part of MSMEs is located in semi-urban and rural areas. This increases the cost of monitoring and maintenance for the lender. The problem of information asymmetry, particularly at the lower end of the micro-business spectrum, exacerbates the difficulties. Most of these companies are owned and unable to provide the documents required by the lenders. A combination of these factors has created a paradoxical situation where 99% of MSMEs are micro and micro enterprises, but their share of banking sector lending to industry is only 13%.

Public policy has focused on MSMEs since the days of the Small Scale Industry (SSI) framework. Several initiatives such as the Stand-Up India program, the Udaymimitra portal of the Small Industries Development Bank of India, the Mudra program, the mandatory purchase of MSME products by public sector companies and 59 minutes public sector bank loans have been launched . A variety of fintechs are engaged in solving the problems related to MSME lending. They aim to reduce transaction costs and lead times by leveraging technology and accessing newer types of customer data to develop innovative underwriting models. However, the credit gap continues to widen at a time when MSMEs are playing a vital role in revitalizing the Covid-hard economy.

The Open Credit Enablement Network (OCEN) announcement promises to be the long-awaited vaccine to cure these problems. OCEN is a digital public infrastructure like India Stack and provides the building blocks for the creation of a credit marketplace. Lenders, credit service providers, technology and data analysis firms, account aggregators, etc. can become part of this marketplace by connecting to it through the application programming interfaces provided by OCEN. Account aggregators are entities that can be authorized by the borrower to retrieve financial data from various sources and share it with lenders. They should go into operation this year. Existing data sources for account aggregators include income tax returns, invoices from tax networks for goods and services, bank statements, credit bureaus, mutual fund statements, insurance details, etc. Tech and accounting apps etc has exposed newer streams of high quality data. These data are expected to be available through the OCEN. The automation of all process steps – identification of the applicant, submission of documents, underwriting, loan contract signing, pledge marking of future receivables and repayment collection – enables the loan to be paid out in five minutes. The open standards provided by OCEN will enable further innovation at every step of the process. It foresees a future where credit will be “democratized” and any service provider can offer it by simply connecting to the platform.

Will OCEN finally manage to cut the proverbial Gordian knot? It has the potential to increase the credit availability many times over for companies that are already part of the digital ecosystem. For other companies operating in a dark or gray data zone, lenders would have to strike a balance between physical and digital presence and take a “phy-gital” approach to valuation and lending. Overcoming information asymmetry for businesses with a limited digital footprint will also need to change the primary method of credit checking from a collateral-centric approach to a cash-flow-centric approach – microfinance institutions have extensively demonstrated the success of cash-flow-based lending. An early use case of OCEN is invoice discounting – many more use cases based on cash flow are anticipated.

New ways of doing things are spreading through word of mouth and require social learning. The proportion of early adopters in the low-income, less educated consumer segment has proven to be low. Therefore, the introduction of a “digital only” method of obtaining credit could lead to a faster adoption by micro and small businesses, if sales models enable supported transactions. The experience with Jan Dhan accounts is illuminating. While the total volume of transactions on Jan Dhan accounts has grown rapidly due to the availability of supported transactions via the business correspondent channel, transactions with debit cards at point of sale and ATMs have been slow to take up.

With the increasing digitization of all economic sectors in India, OCEN has a great promise for the future. Realizing the full potential of OCEN will be of great benefit to MSMEs. However, given the existing MSME landscape, expectations of a quick turnaround in MSME wealth may need to be dampened.

The authors are each Chief Executive Officer of the MicroFinance Institutions Network and an economist

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