Article by Mr. Sundeep Mohindru, Promoter & Director, M1xchange
Supply Chain Financing, also known as SCF has become very popular over the last few years while positively impacting the business transaction between the suppliers and the corporates. According to a report, the Indian supply chain finance market size is expected to grow at a CAGR of 8.42% during the forecast period between 2023 and 2029. However, conventional supply chain financing (SCF) predominantly serves large corporations and their immediate suppliers, leaving smaller players in the lower tiers of the supply chain in need of quicker capital infusion. This is where the recent RBI-approved solution small-to-small (S2S) financing can be a game-changer as it goes beyond traditional SCF, effectively bridging the credit gap faced by Tier 2 and Tier 3 MSMEs, empowering them to sustain and grow their businesses.
Challenges faced by MSMEs
Access to finance has always been a significant challenge for the MSME sector. Despite their pivotal role in the supply chain, the smaller businesses often face difficulties in securing funding. Existing methods neglect SMEs despite their prominent economic role. Reasons include lack of collateral, lower credit ratings, and financial instability. Economic disruptions, such as the COVID-19 pandemic, exacerbated these challenges, underscoring the need to fortify supply chains against potential disruptions and empower these SMEs.
Expanding Coverage of TReDS
TReDS in its current avatar serves MSME suppliers of large corporates. The banks are taking a risk call on the customers of these MSME suppliers and providing finance against the receivables of suppliers.
This model of S2S is expanding the boundary of coverage to include MSME suppliers of MSME Buyers. These buyers are not rated enterprises and therefore do not avail supply chain finance limits for financing their MSME suppliers. The model offers twin benefits to the MSME suppliers:
Financing of their receivables from large enterprises.
Financing of their purchases from other MSME suppliers.
This process is making them self-sufficient in financing their business needs using the SCF mechanism and getting away from limitations of collateral and past year financials.
What is small-to-small financing and how does it work?
S2S financing is a one-stop plug and play solution for cash-flow based financing to small MSME sellers. MSME buyers lack balance sheet strength, and this new model enables cash flow-based credit analytics for MSME buyers instead of the traditional approach of balance sheet-based risk assessment. Enabled through a credit analytics engine (CAE), the model offers digital credit assessment of MSMEs that leverages data available from multiple online data sources such as bank statements, GSTN, TReDS transaction data, etc. This CAE also enables banks to follow a programmatic approach to credit decisioning as per business rules permitted under the respective bank’s internal approved risk policies.
As the credit limits get sanctioned to MSME buyers from banks, they can utilise this credit to make early payment to their sellers and in turn manage to get better pricing for their purchase. This enables the MSMEs reduce their cost of business and thus emerge competitive. This also benefits the MSME sellers as they are able to realise their dues faster and in turn meet their working capital needs.
Revolutionizing MSME Financing in the Digital Era
The increasing demand for SCF has proven difficult for banks and other traditional financiers to meet owing to the high-risk factor. Technology becomes a great way to solve such roadblocks. For instance, during the 12-month pilot in RBI’s 3rd regulatory sandbox for MSME lending, we created and leveraged a credit analytics engine to analyse the health of SMEs for over five participating banks. The analysis helped identify over 50 data points based on MSME’s cash flow statements that enable financial institutions take a credit call with deeper confidence.
The Future of S2S Financing:
S2S financing is becoming a critical tool for businesses to manage their supply chains, improve their financial performance, and address the credit gap for Tier 2 and Tier 3 MSMEs. This inclusive approach offers a win-win situation for both suppliers and buyers, ensuring stable cash flows and reducing the risk of disruptions in the domestic and global supply chains.
S2S financing is likely to be critical in formulating a sound and robust corporate economy as supply chain finance advances. This gives an opportunity for the Tier 2 and Tier 3 MSMEs to survive and contribute to the economy of India. Ultimately, it acts as a lifeline, bridging the credit gap and fortifying a more resilient economic landscape.