#99- Crossing the MSME Credit Chasm
How India Stack & OCEN can enhance credit, and provide a lifeline for MSMEs in India - Part 2
Dear Readers,
In my previous post, I highlighted the credit problem affecting India’s MSMEs. Despite contributing to 29%1 of India’s GDP, 36%2 of India’s manufacturing output, and providing employment to ~11cr3 of India’s 41cr workforce; the sector grapples with the lack of access to credit.
However, India Stack and its three core pillars of Identity (Aadhar), Payments (UPI), and Data (Account Aggregator) seem to finally be coming together to provide the guardrails of a beautiful solution - the Open Credit Enablement Network (OCEN).
TLDR
MSME Credit Challenge: Despite contributing significantly to India's economy, MSMEs struggle with limited credit access despite being a key GDP contributor and employer.
OCEN and Embedded Finance: OCEN, driven by India Stack's digital infrastructure, offers standardized APIs enabling the integration of financial services (Embedded Finance) seamlessly into non-financial platforms.
Rise of Embedded Finance: India Stack's APIs like Aadhaar and UPI, along with OCEN, democratize access to finance. This shift aids MSMEs, simplifying credit access and streamlining financial processes.
Revolutionizing Financial Integration: Companies like Ola, Flipkart, and others are integrating financial services into their operations, leveraging comprehensive transaction data for risk assessment and financial integration.
Future of MSME Lending: OCEN bridges lenders and mediators, driving scalable financial products, opening tech-driven avenues like data analytics, blockchain finance, and API-based services for MSMEs.
What is OCEN?
OCEN is standardized set of APIs so that applications that already interface with individuals and MSMEs can effectively ‘plug-in’ lending capabilities into their current product and service offerings.
What is Embedded Finance and why does it matter?
The plugging in part in the above paragraph is called embedding. It is the integration of financial services seamlessly into non-financial platforms and ecosystems. It's about bringing banking, payments, insurance, and other financial functionalities directly to where consumers are already engaged. Whether you're buying a product online, managing your expenses in a budgeting app, or even securing insurance through a ride-sharing platform—Embedded Finance is the invisible force making these transactions possible. Think of it as financial functions becoming an integral part of everyday business operations, from payment processing and lending to insurance and beyond. This integration occurs within the customer's journey, eliminating the need for separate interactions with traditional financial institutions.
Multiple payment options in your Uber app? Embedded payments
Insurance purchase in your company’s payroll app? Embedded insurance
EMI options in your favourite shopping app? Embedded credit
Embedded Finance’s Why Now Moment
The stars have aligned, and the time is ripe for Embedded Finance to take center stage in India. Two key factors catalyzing this transformation are the India Stack and the Open Credit Enablement Network (OCEN) Protocol.
India Stack, a revolutionary set of APIs that allows governments, businesses, startups, and developers to utilize a unique digital infrastructure, is a pivotal force driving the rise of embedded finance. The India Stack comprises Aadhaar for identity, UPI for payments, and other layers like eKYC, Digilocker, and eSign, creating a robust foundation for seamless and secure digital transactions.
This digital infrastructure has not only democratized access to financial services but has also paved the way for the rapid adoption of embedded finance. MSMEs, often faced with bureaucratic hurdles and limited access to credit, stand to benefit immensely from this shift.
The Open Credit Enablement Network (OCEN) protocol acts as the enabler for embedded finance. OCEN is a bridge, connecting lenders, fintech companies, and businesses to create a unified and interoperable financial services ecosystem. It is designed to standardize the language of financial services, allowing different entities to seamlessly plug into the financial ecosystem. This interoperability is a game-changer, especially for MSMEs, as it opens up a plethora of financial services within their existing digital infrastructure.
Why is this the opportune moment for MSMEs?
Simply because embedded finance, powered by India Stack and OCEN, addresses the perennial challenges faced by these enterprises. Access to credit, streamlined payment processes, and integrated financial management become a reality, empowering MSMEs to focus on growth rather than navigating financial complexities. OCEN is breaking down silos and transforming every transaction into a potential financial interaction.
Banks and businesses, especially the smaller ones, have historically operated in separate spheres, with financial services requiring active pursuit. But as business shifts increasingly into digital spaces, the boundaries between them are blurring. Early pioneers in the West like Shopify and Square led the charge by integrating banking functions into their platforms, setting the stage for significant venture capital investment.
Now, a growing number of companies, even in India, are embedding financial services at the core of business operations:
M2P Fintech empowers businesses like Ola with a full suite of payment options, a physical card, and a credit line for their drivers to utilize when they face a cash crunch. It has also enabled Finin by Open (India’s first Neo-Bank) to deploy M2P’s Bank-in-box solutions to provide instant savings bank a/c, virtual and physical debit cards along with bill payments.4
Vyapar has partnered with FinBox to offer credit to 900,000 MSMEs5
Flipkart & Rupifi joined hands to offer 150,000 kiranas and MSMEs on Flipkart Wholesale get instant and digital credit, with flexible repayment terms and transparent pricing6
These integrations make sense for several reasons. The core operations of a business already generate the bulk of financial activity, providing a rich landscape for seamless financial integration. Platforms like Ola, Flipkart, etc. possess comprehensive transaction data, offering a deeper understanding of a business compared to traditional banks, which need time to familiarize themselves with specific enterprises. The challenge lies in swiftly evaluating risk by tapping into internal and external data sources. Unlike the traditional banking model, where decisions are delayed by days or weeks due to limited data and personal evaluations, software can now draw on multiple sources instantaneously, clarifying risk assessment and streamlining financial processes.
While credit bureaus have long conducted similar analyses, the real shift lies in the growing embedded finance ecosystem. This ecosystem operates like an iceberg: what users see, such as an MSME seamlessly acquiring a loan, represents only the tip. Beneath the surface lies an infrastructure enabling this seamless user experience, leveraging data in real-time.
The force behind this industry's growth is immense, resembling a shift from traditional finance to shaping the very essence of future commerce. Reflect on how software, especially the internet, transformed shopping: no more constrained by store hours, always having what you seek.
The outcome? Reduced hurdles, amplified commerce. Embedded finance mirrors this. By leveraging data streams to offer personalized financial products in real time, it unravels transactions effortlessly, eliminating obstacles and amplifying commerce once more.
Regarding momentum: 97% of the logos in the above infographic didn't exist 15 years ago. While payment processing has matured, there remains untapped territories ripe for innovation.
The crucial query now is: What shape will this market take in a year? Or a decade?
I firmly believe the magnitude of this opportunity has never been more profound.
The Magnitude of the Opportunity
Online shopping has introduced us to embedded finance, notably through the Buy Now, Pay Later option that's now almost everywhere during checkout. While this is a prime example, most embedded finance products serve consumers, thanks to their simpler and more digitizable purchasing process.
However, the real challenge lies in B2B. Unlike consumer transactions, B2B sales involve substantial, often mission-critical purchases ranging from USD 1,000 to over USD 1mn, where financing isn't a luxury but a necessity. The sheer scale of B2B transactions dwarfs B2C, hitting a whopping USD 120tn in payments annually versus USD 20tn.
The majority of B2B transactions, despite being digital in nature through phone calls, emails or ERP systems, still cling to archaic payment procedures akin to those of decades past—write a cheque, wire funds, authorize transfer. Picture having to do this for every Amazon purchase, and the disparity between digital and online becomes stark. Revolutionizing this could not just secure a significant market advantage but transform the entire B2B landscape.
This isn't overstating it. Most businesses die not because of lack of demand, but due to cash flow issues, particularly working capital. Bridging this gap directly into a company's operational framework, such as what Ola or Flipkart offer, can alleviate or eradicate this hurdle altogether.
So, why hasn't this been fully captured yet? It's a mix of old-school mindsets and technology. Established enterprises are slow to adapt, often led by decision-makers unfamiliar with the technology driving embedded finance. Aligning everyone's views is tough. Moreover, there's the burden of entrenched workflows and systems that, despite being cumbersome, have held ground for years.
The psychology of B2B purchases is vastly different from consumer behavior. While individuals might comfortably buy a low ticket product online, businesses pause and deliberate before spending on high value purchases.
But truthfully, the real challenge is the technology itself. The B2B buying process is intricate, demanding multiple elements to seamlessly execute real-time financial evaluations based on the macro and micro environment.
After substantial growth, the embedded finance ecosystem has finally hit a tipping point, offering us a glimpse of the complete picture we're striving for.
Revolutionizing Credit Access: The OCEN Protocol
The Open Credit Enablement Network (OCEN) has emerged as a game-changer since its inception in 2020. Designed for loan service providers (LSPs), lenders, and account aggregators, OCEN embodies a bold attempt to democratize credit access and foster financial inclusion. By leveraging the principles of embedded finance and tapping into the digital infrastructure of India Stack, OCEN acts as the universal language bridging lenders and mediators, paving the way for scalable financial products.
Let’s take the help of a fictional example - An SME on the Zetwerk marketplace is in need of credit. It approaches Zetwerk which can be a Loan Service Provider under the OCEN Protocol for credit. Zetwerk seeks Account Aggregator consent from the SME to pull financial data. Upon receiving consent, it uses APIs (say from SETU) to pull the relevant data and send it to the lender i.e. Kinara Capital. Upon seeing satisfactory data points, Kinara disburses the loan to the SME. In the midst of it all, KYC is done via Aadhar, and documents signed via eSign.
Coatue said Balance Sheets (lending) are Necessary Evils7 - but I don’t fully agree. Why?
Cost of borrowing
In a country where large and mature lenders (i.e. banks) exist, it is virtually impossible to have a lower cost of borrowing then the leaders. Lending is a commodity business where one with the lowest cost wins. A higher cost of borrowing is akin to starting the race a hundred steps behind the leader.
Risk profile
Additionally, the lender with the lowest borrowing costs has another advantage to lend to less risky borrowers. This means, the safe borrowers will typically go to large lenders leaving the riskier ones for small lenders. While small lenders can provide more expensive credit to riskier borrowers, it is difficult to earn a spread (of lending over borrowing for a lender) which is far richer than a large lender.
It makes little sense to just be a traditional lender to riskier borrowers with expensive cost of borrowing.
So what can be white spaces in the MSME lending space?
All things tech!
1. Data & Underwriting Platforms using proprietary algorithms and ML models
Develop advanced data analytics platforms that leverage India Stack's data points (e.g., UPI transaction history, GST data, etc.) and OCEN's standardized data-sharing capabilities to offer MSMEs tailored risk assessment solutions. It can provide MSMEs with real-time risk evaluation, aiding lenders in making informed decisions and enabling more accessible credit facilities.
2. Embedded Lending Platforms with alternative credit scoring algorithms and predictive models
Build lending platforms that integrate with various MSME ecosystems using OCEN. These platforms utilize India Stack's eKYC and transactional data to assess creditworthiness and offer personalized loan products. This can facilitate quick and efficient loan disbursements, fostering financial inclusion and growth opportunities for MSMEs.
3. Blockchain-based Supply Chain Finance for supply chain transparency
Develop a secure, transparent, and tamper-proof supply chain finance system using blockchain technology. Leveraging OCEN for seamless financial integration, this system can track transactions, verify authenticity, and automate payments based on predefined smart contracts. This has the potential to ensure trust and transparency in transactions, reduce fraud, and optimize cash flow for MSMEs by enabling quicker access to financing against verified transactions.
4. AI-driven Invoice Financing Platforms
Using advanced AI algorithms for invoice verification and risk assessment creating platforms that analyzes invoices, predicts payment cycles, and assesses the creditworthiness of buyers and sellers. Integrating with OCEN, these platforms can facilitate invoice financing options for MSMEs based on verified invoice data. This can accelerates cash flows for MSMEs by providing early access to funds tied up in unpaid invoices, reducing liquidity gaps.
5. APIs
Build a suite of APIs that leverage India Stack and OCEN to enable MSMEs to access a variety of financial services such as banking, insurance, payments, and lending from different providers through a single interface. This can simplify integration of financial services into MSME workflows, fostering innovation and customization while ensuring compliance with industry standards.
In India’s fintech ecosystem where a majority of players are under 5 years old, these new-age business models can capitalize on the convergence of Embedded Finance, India Stack's data infrastructure, and OCEN's interoperability to create solutions tailored to the unique financial needs of MSMEs.
If you are building a business in this space, please reach out to me at siddharth.shah@sianacapital.com for a chat.
The author, Siddharth Shah, is a Senior Associate at Siana Capital, a VC fund investing in IP-led businesses from Pre A stage to B stage in India with cheque sizes between $1-3mn.