FinTechFinTech Revolutionizing Supply Chain Finance: Bringing Credit Solution for MSMEs

INTRODUCTION

Micro Small and Medium Enterprises (“MSMEs”) are one of the key players in the market and contribute immensely to the Indian economy. They contribute to about 29% in the GDP, 49% in Exports and provide employment to about 117.1 million people.

The Government of India (“GOI”) has introduced several initiatives to develop the MSMEs sector of India and increase the contribution of MSMEs to India’s GDP to over 50% and exports to 75% in the forthcoming years. However, a significant inadequacy exists in financing facilities for MSMEs.

The GOI despite focusing on developing credit and liquidity related policies for MSMEs, the flow of credit to the MSME segment has remained weak and one of the major issue for this has been the reluctance of banks to lend to MSMEs due to high risks.

However, the days of misery for MSMEs are now over. MSMEs with the help of Supply Chain Finance (“SCF”) can fill the gap of credit in a cost-effective and efficient manner, SCF will enable MSME suppliers and distributors to increase their working capital and compete globally.

In this article we attempt to discuss about what is Supply Chain Finance, its types and how FinTech have revolutionized the SCF mechanism, which has helped in the exponential growth of MSMEs in India. 

WHAT IS SUPPLY CHAIN FINANCE?

Supply Chain Finance is a method which aims to lower financing costs and improve business efficiency for buyers and sellers. It works by automating transactions and tracking invoice approval and settlement processes, from initiation to completion. There are two common SCF Methodologies used that is –

A. FACTORING 

The Factoring is a mechanism, which allows a business to “sell” invoices to a third party to get immediate injection of cash to maintain revenue stability. This mechanism helps companies improve their immediate cash.

B. REVERSE FACTORING 

Under this transaction, buyer allows supplier to get early payments on approved invoices. Suppliers participating in a reverse factoring program can request early payment on invoices from the bank or other finance provider, with the buyer sending payment to the financial institution on the invoice maturity date.

FINTECH REVOLUTIONIZING SCF MECHANISM

FinTech have revolutionized the SCF segment by digitizing the interaction between entities and by utilizing analytics to provide a seamless platform for buyers and suppliers and furthermore, FinTech with the help of app-based financing arrangements has make the entire lending process more efficient, flexible and transparent.

The GOI with the help of FinTech Platforms have launched multiple solutions to help unlock the credit facility and encourage the growth of MSMEs with the help of faster exchange of data between buyers, sellers and financiers, such as –

A. Trade Receivables Discounting System (“TReDS”)

The Reserve Bank of India (“RBI”) established the TReDS. It aims to facilitate easy and feasible financial trading from corporate to various buyers including the Government Departments and the Public Sector Undertakings (PSUs).

The TReDS platform works on Invoice Discounting mechanism, which in simple terms means the practice of utilising a company’s unpaid accounts receivable as collateral for a loan given by a finance company.

The invoices are released on a daily basis on completion of work or when orders are met. Pursuant to receiving the invoice, an invoice discounting provider credits the pre-agreed amount. After establishing that the invoices are valid, the provider pays the value of the raised bills, deducting a tiny percentage.

Since it is a system where cash flows are made daily, daily release of invoices is crucial. Once the clients have paid the MSME, the discounting company has to be refunded the loan plus an agreed-upon charge to cover costs, risk, and interest. The cost is normally between 1% and 3% of the entire invoice amount.

The platform enables MSMEs to receive payments on scheduled time while also allowing corporate buyers to extend credit terms up to 180 days, aligning their cash flows and obtaining a better discounted rate. This allows buyers and their MSME suppliers to better manage their working capital cycles, resulting in significant cost savings.

TReDS transactions are to be executed without recourse to the MSMEs, thus, providing a greater benefit to the MSMEs. These transactions can be initiated by both the MSME supplier as well as the buyer. MSMEs have easier access to capital at lower rates, without having to put up any additional collateral.

B. ACCOUNT AGGREGATOR PLATFORM 

India Stack, the public digital infrastructure behind UPI, introduced the concept of Account Aggregators (“AAs”).

AAs is an entity which is engaged in the activity of financial data aggregation, under which it gathers financial information as defined under Section 3 (ix) of NBFC-AA Direction, 2016 (“The Regulation”) of the Customer on a single platform and then shares it with explicit consent of the user with the financial information user via Open Application User Interface (API).

The AA framework and its centralized data management will allow MSMEs and its buyers to access financing options with the transaction data stored on a centrally managed and regulated framework.

AMLEGALS REMARKS

In India, digitization in the financial industry has made the process of obtaining credit much easier. MSMEs can now obtain funding without much hindrance and difficulty, thanks to this financing alternative. TReDS, an online financing platform, was established to augment the benefits of invoice financing.

RBI has permitted only three entities to perform the functions of a TReDS Platform and provide Invoice Discounting, thus, indicating that such platforms are heavily regulated and such financing cannot be provided by any unregulated financier. Hence, it is anticipated that TReDS platforms will facilitate MSME financing, along with ensuring strict compliance with legal and regulatory requirements.

Furthermore, with the introduction of Account Aggregators, the creditors now have built a certain degree of trust for the loans recovery. Thereby making it easy for the MSMEs to secure loans without long waiting periods.

The AAs has paved the way for transformation of digital delivery of financial services in an efficient and secured manner, since the AA Platforms acts as entity which collects, compiles, consolidates and organizes financial data on a single platform and it has a strong integrated network, which will allow MSMEs to obtain finance from any part of the country.

For any query or feedback, please feel free to connect with rohit.lalwani@amlegals.com or mridusha.guha@amlegals.com