Capital has become cheaper than ever. Globally, an upwards of $600 billion has gone in Venture Capital funding startups this year alone. India alone produced 42 unicorns. However, amidst all the euphoria and brouhaha of this being the best time to do business, we as a society have grossly ignored the pulse of the Indian Economy- our very own Micro, Small and Medium Enterprises (MSMEs) to our own disadvantage. The 6.63 crore MSMEs account for 30% of India’s GDP, 45% of exports and 96% of all Industrial Units, and employ over 112.5 million Indians. Yet, their credit needs have been ignored. Indian MSMEs face a working capital deficit of $380 billion (this figure has been pegged at $5 trillion globally). The fact that such a large portion of business is capital starved and financially excluded does not bode well for growth and employment. Previous research on this subject matter has indicated that around 60-70% of this deficit arises due to late payments. Businesses work on a post-payment cycle with terms of payments being net30, net60, net90 etc., essentially meaning that payments become due after 30, 60 and 90 days respectively. It implies that businesses have to use the cash from the previous working capital cycle to finance the inventory of the current cycle.
This highly constrains the ability of businesses to achieve a higher inventory turnover. Moreover, most businesses, especially B2B, have net margins of about 6-20% only, thus relying on volumes to drive absolute profits. However, the inability to deal in higher volumes is a hindrance to this end. At this juncture, one may wonder- if a merchant provides a credit period to the buyer, he/she also avails a credit period from his/her supplier. So why does this gargantuan deficit arise? Well, let me draw your attention towards the Cash Conversion Cycle which basically indicates the days taken by a concern to convert inventories to cash. It is measured by - Cash Conversion Cycle (CCC) = Days Sales Outstanding (DSO) + Days Inventory Outstanding (DIO) - Days Payable Outstanding (DPO) As per economic theory- as goods flow down the supply chain, Gross Value Addition takes place ( Sales - Intermediate goods). Consequently, there is a requirement to fund that value addition. Thus, DSO>DPO as the supply chain progresses.
Another determinant is the quantity of the goods dealt in at the firm level. It has been noticed that the Average Order Value (AOV) reduces as the number of buyers increases. The elasticity of such increase/decrease impacts CCC. Also, an often ignored element while studying this deficit is DIO. It does not matter how DSO and DPO cancel out each other. If a firm’s DIO is high, it would continue facing a huge deficit. According to this hypothesis, sectors operating with negative DIO (on-demand manufacturing/procurement/service), would face the least deficit. With traditional financial instruments, firms have been able to optimise for DSO and DPO, but DIO has been left to the markets to be taken care of. Speaking of traditional modes of financing this deficit, we have secured loan against inventory, unsecured loan, line of credit, bill discounting, factoring, merchants cash advance, packing credit, credit against hypothecation/pledge etc. They are based on the idea of balance-sheet based lending. However, this does not make sense for over 70% of MSMEs given that they have inadequate collateral. Due to this structural deficiency, around 92.7% of MSMEs rely on informal sources which comes with high rates and inflexible payment terms.
However, we are at the cusp of change. We are entering a paradigm of Cash-flow based lending aimed at democratising access to credit. All thanks to OCEN (Open Credit Enablement Framework). This protocol is a new addition to the India Stack which is already credited with successful projects like UPI, GSTN, Bharatpay, e-KYC, e-Sign etc. It won’t be an exaggeration to call OCEN a ‘UPI’ moment for MSME credit. Let’s understand what exactly is OCEN and how it works. Just like UPI, OCEN works through an interplay of APIs (Application Programming Interface) which, in fact, makes OCEN extremely scalable and globally deployable. APIs act as a middle layer between digital platforms and lenders. Digital platforms that attract huge audiences can now offer lending services, popularly known as ‘Embedded Finance’. It signifies transition from ‘Credit as a product’ to ‘Credit as a feature’.
There are four primary stakeholders in the entire OCEN work flow-
1. Borrowers- These include MSMEs looking to finance their working capital.
2. Loan Service Providers- These are digital platforms that attract huge audience to transact with their platform. They can be payment apps, tax-filing softwares, CRMs, inventory and receivable management softwares, invoicing softwares etc. They hold huge data of their customers and thus, can facilitate lending based on this.
3. Technology Service Providers- These are fintech players that actually implement the OCEN protocol and help create tailored credit products based on the data aggregated.
4. Lenders- These include all banks and NBFCs that provide credit for embedded finance players to build upon. Thus, OCEN provides for loan application and disbursal by making it extremely standardised and efficient. For example- a merchant could apply for an intraday credit facility to buy inventory over WhatsApp, using payments history.
The amount can be repaid by automatic debit from cash flow received in the bank account over time. This, combined with the ‘Account Aggregator’ framework that enables selective yet seamless data sharing among banks, would make it an exceptional medium to implement cash-flow-based lending. I won’t be surprised if merchants will get loan disbursals within ten minutes. OCEN holds the promise of financial inclusion for all. Experts estimate that in one year alone, it can cut the deficit amount by half. It also does away with high processing fees and interest rates. However, it is important to keep in mind that OCEN provides for loan application and processing. It does not provide for credit risk in a big way. Therefore, we would be required to develop advanced credit underwriting models deployed over OCEN rails to realise its benefits. Can OCEN replicate the success of UPI? Or maybe more? Or is it just a shot in the dark?
Krishiv Agrawal
First Year Undergraduate Student, SRCC.
