Financial Services
Commercial banking: The next frontier
02 Jun 2023
You
are only as strong as your weakest linkThey
say little drops of water make the mighty ocean. This is true for the
multitudes of SMEs in India that propel the Indian economy. With 63 million of
them contributing to 30% of the GDP, India is the world’s largest SME market.
They are of strategic importance to the country as they serve as catalysts in
driving economic activity, generating employment, and increasing industrial
output. A recent Praxis study pegged the revenue pool of the BFSI industry
catering to the SME segment at INR 2 trillion. There has been a push from the
MSME Ministry for the development of SMEs in India through multiple schemes and
offerings like launching the Udyam platform to bring more SMEs into the formal
sector among other initiatives. With the advent of platforms like ONDC and
OCEN, SMEs can now sell their goods to a wider market, boost their
discoverability, and create a digital identity. This creates a huge opportunity
for financial institutions because SMEs are now emerging as an attractive
segment and have shown increasing demand across the range of credit, deposit,
transactional and advisory products.
Despite
being such an attractive segment, SMEs are underserved; they find it difficult
to navigate the complex operating models of their financial services providers
who are often not in the best shape to meet the distinct needs of SMEs.
Providing access to credit and other financial services to this segment, which
is a vital link between large businesses and consumers, is imperative if India
has to become an economic powerhouse. This article aims to understand the
challenges that players in the financial sector face while catering to SMEs and
how can these challenges be overcome to cater to this segment.
Falling
between the cracks
Like
the unfortunate middle child of a household, the needs of the SME sector are
often overlooked by financial institutions due to their highly profitable
retail and corporate counterparts. Conceptually, SMEs occupy the space between
the retail and corporate customer segments. Despite contributing to 30% of the
GDP, SMEs form only 4% of the overall deposits and 14% of total credit. They
are either too small to avail the high-priced and sophisticated products that
are offered to corporate clients or are too big to be financed by retail
products. SMEs need current account facilities, working capital loans, supply
chain financing, cash management services, etc. which are all products that are
available in the market. However, when offered to SMEs, these products are
presented as refurbished versions of the existing retail and corporate
offerings which do not adequately serve SME needs. So, the question arises, why
aren’t financial institutions doing more to tap into this market?
What
we don’t understand, we fear
Our
hypothesis is that financial institutions have not invested enough time and
bandwidth in understanding the needs of SMEs, with obvious consequences on the
sophistication of their operating models for serving SMEs. We believe that
there are two distinct sets of challenges faced by financial services providers
when it comes to the SME segment:
Low
discoverability coupled with high risk perception - Information
asymmetry: Out of the 63 million SMEs in
the country, only 6 million are formally registered with the MSME Ministry.
With a large chunk of these enterprises operating in the unorganized sector,
there is a lack of verifiable information to appropriately gauge their
financial standing. More often than not, SMEs do not maintain an exhaustive
record of their transactions, and the financials of these enterprises are
inadequately documented. Financial institutions cannot conduct satisfactory
assessments and hence view SMEs as risky. Furthermore, the underwriting models
are not advanced enough to incorporate non-traditional data sources to
effectively assess risk. Evaluating SME risk is a challenge that financial
institutions are yet to crack.
- High
diversity among SMEs: Risk assessment
and collateral issues aside, financial institutions are unable to adequately
cater to the segment because there isn’t a one-size-fits-all model to serve
this segment. SMEs vary significantly in their business models and needs, thus
presenting significant complexity to financial institutions, who struggle with
the trade-off between standardization and customization in this segment.
- Lack
of collateral: Even with sufficient risk
evaluation, SMEs do not possess the necessary collateral to avail loans. They
lack the typical collateral that lenders usually accept while lending to
corporates such as large books, a marquee clientele, heavy machinery,
factories, etc. The only asset that most SMEs own and can pledge is property.
However, very often these properties are handed down over generations, and
hence, quite often, do not possess the clear titles that lenders seek
Gaps
in the operating model of financial institutions- Insufficient
tech adoption: While technology has revolutionized the financial sector,
financial institutions have been somewhat slow off the blocks in putting
technology to work in this segment. Better credit assessment models by
analyzing data from a wide range of data sources can help develop tailored
credit solutions. The overall experience of SMEs can also be enhanced by
improving the digital experience, akin to how consumer banking has been
transformed in recent years.
- Legacy
systems: Readily adopting tech solutions
has also not been easy as it seems – compatibility challenges have hindered
financial institutions from undertaking a full-fledged tech overhaul. The
current tech landscape serving SMEs in a typical financial institution is
dotted with several product-centric applications (often bespoke and sub-scale);
assimilating them into a customer-centric architecture is a daunting task.
- Competition
from fintech players: The gap in the
market of catering to SMEs has led to the emergence of fintech players.
Equipped with newer technology, these players are seamlessly integrating with
various platforms and providing comprehensive embedded solutions. Incumbents
often find themselves in competition with these new-age players, though the
right way forward appears to be a collaborative approach to meet the needs of
SME customer.
The
road not taken…yet
It
is time for financial institutions to rethink the current approach while
engaging with SMEs to capture this large segment. This could entail a complete
overhaul of the current operating model, with products and processes designed
keeping SME requirements at the forefront, leveraging capabilities in retail
and corporate banking to the extent needed, but building anew where needed. By
developing value propositions that are modular and tailor-made to meet the
needs of SMEs, financial institutions can build a granular and profitable
business. The SME segment is emerging as the new battlefront - armed with the
right strategy, winners will make quick and deep inroads to seize this
opportunity.
Author:
Shishir Mankad, Managing Partner & Head – Financial Services