FinTechEnhancing MSME Performance through Financial Technology

INTRODUCTION

The rise of financial technology (hereinafter referred to as “FinTech”) has profoundly impacted various sectors, particularly the Micro, Small, and Medium Enterprises (hereinafter referred to as “MSME”) segment. By leveraging advanced technologies such as blockchain and artificial intelligence (hereinafter referred to as “AI”), FinTech is revolutionizing the delivery and consumption of financial services. This transformation offers accessible, efficient, and inclusive solutions that empower businesses of all sizes.

MSMEs are crucial to the Indian economy, contributing approximately 29% to GDP, 44% to exports, and contributing to around 62% of employment. However, they face significant challenges in accessing traditional financial services, particularly credit and insurance, resulting in a credit gap of Rs. 25 trillion.

FinTech is addressing this gap by providing effective solutions that meet the specific needs of MSMEs. Unlike traditional banks, which often hesitate to lend to MSMEs due to perceived risks and lack of credit history, FinTech companies use alternative data sources such as digital transactions, GST filings, and utility bills to assess creditworthiness.

FinTech has revolutionized transactions for MSMEs through digital payment solutions like mobile wallets and the Unified Payments Interface (hereinafter referred to as “UPI”), which processed over 10 billion transactions in a single month in 2023 (as per India Brand Equity Foundation). This shift towards digital payments enhances financial inclusion for underserved and unbanked MSMEs. FinTech tools for invoicing and expense management have also improved cash flow management, enabling automated invoicing and real-time expense tracking. With 72% of MSME payments now conducted digitally, the sector is set for continued growth driven by digital adoption.

EMPOWERING MSMES THROUGH FINTECH INNOVATION

Enhancing Access to Finance

The past few years have underscored the significant credit gap in India’s MSME sector, with the International Finance Corporation estimating a total addressable credit gap of Rs 25.8 trillion in 2021. Despite the high demand, only about 15% of the 63.3 million MSMEs in India had access to credit from formal financial institutions. The rise of digital lending presents a transformative opportunity for MSMEs, with the market potential estimated to witness a dynamic growth. FinTech companies address common industrial issues such as long loan processing times, lack of transparency, extensive documentation, and high costs.

FinTech streamlines processes such as digital identity verification, customer due diligence, data sharing, and payment schemes, thereby enhancing customer experience and making financial services more affordable and accessible. Applications like Khatabook and UPI-based apps simplify financial record-keeping, providing MSMEs with real-time sales data and financial insights.

Improving Financial Management

FinTech tools automate transaction recording and offer weekly or monthly sales information, enabling MSMEs to better understand their financial health and performance. This increased transparency and convenience in payment gateways empower both businesses and consumers by facilitating smoother, more accessible transactions.

Overcoming Creditworthiness Concerns

FinTech is revolutionizing credit access for MSMEs by catering to their unique needs. Neobanks and account aggregators are emerging as game-changers, offering cost-effective and personalized services by leveraging technology and AI. These entities enable real-time data sharing and lower transaction costs, allowing banks to offer smaller loans and customized products.

Given below are some FinTech solutions to simplified credit access:

1. Alternative Data Sources: FinTech uses advanced credit scoring algorithms that provide alternative data, such as GST reports, bank accounts, social media profiles, and mobile phone usage. This method overcomes the limitations of traditional credit rating systems.
2. Digital Platforms: Digital payment and invoicing options allow MSMEs to manage their cash flow online. FinTech provides scalable solutions by digitizing the lending process, offering mobile point-of-sale devices, and creating digital transaction records.
3. Customized Products: FinTech offers loan products to meet the specific cash flow needs of MSMEs. They provide short-term, small-ticket loans with minimal documentation and quick response times.
4. Flexible Repayment Options: FinTech offers flexible repayment plans, including loan repayment vacations and lower interest rates. They also provide direct financial assistance, such as cash grants or online advertising credits.

Reaching MSMEs in Remote Areas

FinTech innovations have revolutionized rural economies by empowering small merchants, often referred to as nanopreneurs, who operate essential local stores.  FinTech platforms have addressed these issues by leveraging technologies like UPI, Aadhaar, and mobile banking. These tools have facilitated digital payment solutions and improved financial inclusion by connecting rural merchants to formal banking systems. Nanopreneurs now offer digital payment services, manage banking operations, and access microfinance options, thereby enhancing their business scalability and financial stability.

Additionally, initiatives like the Bharat Bill Payment System and QR code payments have streamlined utility bill payments and enabled quick, efficient transactions. These digital solutions reduce dependence on cash, promote financial accessibility, and integrate rural merchants into the broader digital economy.

By transforming traditional stores into hubs of financial activity and market accessibility, FinTech solutions are fostering economic growth and empowerment in remote areas. This technological advancement promises a future where all individuals, regardless of location, can participate in and benefit from the financial revolution.

Promoting Financial Literacy

FinTech not only offers financial services but also plays a vital role in bolstering financial literacy among MSME owners. Many FinTech platforms provide educational resources and tools aimed at helping business owners comprehend financial management, budgeting, and investment strategies. By enhancing financial literacy, MSMEs can make informed financial decisions, efficiently manage resources, and plan for long-term growth.

The influence of FinTech has been substantial in the financial industry, improving consumer convenience and security. MSMEs increasingly embrace FinTech as a supportive tool for their businesses. However, the adoption faces challenges such as limited technological proficiency among employees, which hinders widespread implementation.

To enhance financial literacy among MSMEs, collaborations between banks and FinTech firms are pivotal. These partnerships facilitate the dissemination of financial knowledge and promote better financial practices among small business owners.

POLICY SUPPORT DRIVING FINTECH AND MSME GROWTH

By implementing regulations designed to promote innovation while guaranteeing consumer safety and financial stability, the Indian Government and regulatory organizations are actively encouraging FinTech integration in the MSME sector. Regulatory sandboxes, which allow FinTech businesses to test ideas under controlled conditions and help regulators establish appropriate frameworks, are among the key projects. The regulatory sandbox established by the Reserve Bank of India (hereinafter referred to as “RBI”) will help create a range of FinTech products specifically designed for MSMEs. To support MSMEs’ financial inclusion, the RBI’s Payments Vision 2025 aims to significantly enhance digital transactions and infrastructure.

In addition, the expenditure of Rs. 14,903 crore in Digital India between FY 2022 and FY 2026 is a critical step in creating a digital infrastructure that facilitates the adoption of FinTech. By streamlining financial management and compliance tasks, cloud-based solutions and AI-powered analytics are enabling MSMEs to accelerate their digital transformation and market expansion.

Additionally, there are now solutions that help organizations comply with financial rules by guaranteeing that Know Your Customer (hereinafter referred to as “KYC”) standards are met, automating regulatory reporting, and reviewing the transactions to identify any questionable activity.

TRANSFORMING ACCESS TO FINANCE IN MSMES

The landscape for MSMEs demands a holistic approach from financial service providers to facilitate digitalization, offer effective financial products, enhance credit access, and aid integration into broader markets. Post-COVID-19, MSMEs are undergoing significant transformations, providing FinTech adoption accelerated by the pandemic. This shift has enabled faster, more efficient, and cost-effective financial services compared to traditional banking, supporting business continuity, domestic demand, job creation, and innovation across sectors.

Innovations in financial technology and digital payments are crucial for improving MSMEs’ access to finance and achieving Sustainable Development Goals. Upgrading digital infrastructure is essential to facilitate MSMEs’ transition to digital business models, ensuring access to advanced tools and services. MSMEs often face challenges in securing funding due to inadequate collateral, limited credit history, and insufficiently tailored financial products.

CHALLENGES IN FINTECH ADOPTION FOR MSMES 

1. Financial and Technological Literacy: MSMEs face challenges in understanding financial and technological aspects, hindering their adoption of digital payments. The Government needs to address these gaps through targeted initiatives to enhance digital literacy among small business owners.
2. Digital and Physical Infrastructure: Insufficient digital and physical infrastructure contributes to the preference for manual transactions over digital payments among MSMEs. The Government’s efforts in digitalizing India are commendable, but more aggressive measures are needed to overcome these obstacles swiftly.
3. Credit Risk and Blockchain Technology: MSMEs often struggle to access credit due to limited credible collateral and informal structures. FinTech firms can mitigate this by diversifying credit scoring parameters using readily available data like demographic, geographic, financial, and social information. Implementing online underwriting processes, automation, statistical modelling software, and blockchain technology can streamline credit assessment, reducing risk, cost, time, fraud, and data fragmentation.
4. Regulation: Inconsistent regulations expose MSMEs to financial fraud by FinTech companies. Strengthening cyber and digital laws can build trust among MSMEs towards digitalization and FinTech solutions, fostering a secure business environment.
5. Government Interventions, Innovation, and Incentivization: Government initiatives should include incentives for MSMEs adopting FinTech solutions and provide digital financing training. Establishing robust digital infrastructure and integrating innovations into MSME operations are crucial steps toward enhancing FinTech penetration and digitalization.

IMPACT OF FINTECH ON MSME RISK MITIGATION

MSMEs in India face significant financial risks, including limited access to formal financial services and challenges in managing credit risk. Traditional lenders often view MSMEs as high-risk borrowers due to their lack of extensive credit history and collateral, which restricts their ability to secure loans at favorable terms.

Blockchain technology further enhances risk management for MSMEs by ensuring supply chain traceability, enabling secure data management, and facilitating decentralized financing options. Despite the benefits, challenges such as implementation costs, scalability issues, regulatory uncertainties, and security concerns need careful consideration when adopting blockchain solutions.

Moreover, FinTech enhances security for MSMEs by deploying AI-driven fraud detection systems that monitor transactions in real time. This proactive approach helps businesses mitigate financial losses from fraud, protecting their cash flow and reputation. Additionally, FinTech tools assist in supply chain management by providing real-time risk assessment of suppliers, thereby minimizing disruptions and optimizing operational efficiency.

AMLEGALS REMARKS

FinTech has emerged as a game-changer for MSMEs, providing innovative solutions that address the longstanding challenges of credit access, financial management, and risk mitigation. By providing advanced technologies like AI, blockchain, and alternative data sources, FinTech companies are bridging the credit gap and empowering MSMEs with tools for digital payments, streamlined loan processes, and improved financial literacy.

However, to fully realize the potential of FinTech, it is crucial to enhance digital and financial literacy, strengthen regulatory frameworks, and invest in robust digital infrastructure. This comprehensive approach will ensure that MSMEs can thrive in an increasingly digital economy, contributing significantly to economic growth and employment.

– Team AMLEGALS assisted by Ms. Shraddha Jain (Intern)

For any query or feedback, feel free to reach out to mridusha.guha@amlegals.com or liza.vajani@amlegals.com