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Democratizing Credit for India’s 60 Million Microenterprises

India’s digital public infrastructure promises a new lending paradigm

India’s remarkable economic growth owes much to its vibrant micro, small, and medium enterprises (MSMEs), which account for nearly a third of the country’s GDP. However, MSMEs, especially those in the “micro” category, which are the smallest firms but form the backbone of India’s MSME landscape, face significant constraints in unlocking their full potential. One of the most pressing obstacles is their lack of access to formal and affordable credit and financing, which hinders their growth due to inadequate working capital reserves and flows.

To address this challenge, a new digital public infrastructure called the Open Credit Enablement Network (OCEN) is being developed in India. The OCEN promises to enable a revolutionary paradigm of digital lending known as “cash flow-based lending.” This has the potential to dramatically improve financial inclusion for small businesses, particularly micro-entrepreneurs, who represent 99% of all MSMEs in India.

A mere 11% of all MSMEs – typically the largest – possess access to formal credit.

The credit gap for MSMEs in India is estimated at around USD 800 Billion. This gap arises from constraints on both the demand and supply sides of the traditional lending process.

On the demand side, MSMEs are constrained in accessing formal finance, primarily because:

  1. They lack the collateral and assets required to prove their creditworthiness
  2. Their credit history and formal records are limited
  3. They lack awareness about existing financial products and services.

On the supply side, financial institutions are inhibited in disbursing small-sized and short-term loans – which microenterprises often need – because:

  1. High transaction costs on small ticket loans leave little room for profit
  2. Data and formal records about the activities of microenterprises is scarce due to their informal and unorganised nature
  3. Their loan products and processes are not tailored to the needs of microenterprises who demand quick turnaround on loans, and prefer to repay via weekly, rather than monthly instalments

Thus, in attempting to break-even and maintain healthy balance sheets, financial institutions disburse fewer loans to MSMEs who need it the most.

Indian microenterprise storefront

Due to these limitations on both the demand and supply sides of the traditional lending system, more than 80% of MSMEs lack access to formal financing, compelling them to seek out informal sources of credit. However, the interest rates on these informal loans are at least twice as high as those of formal credit, leading to insufficient working capital for micro-enterprises and preventing them from expanding to become mid-sized enterprises. This phenomenon, known as India’s “missing middle,” hinders economic growth and employment opportunities. To address this issue, OCEN aims to revolutionise the way credit is offered to micro-enterprises, tailoring it to their unique financing needs.

The cash flow-based lending paradigm: Unlocking sachet-sized loans by leveraging information as collateral

OCEN is being developed in India to facilitate credit for the country’s “next one billion”. Its decentralised and open-source protocol reimagines and reorients the flow of information, people, and money, such that overall costs are reduced across the entire lending value chain. This makes it economically viable for financial institutions to underwrite fast, small-sized, and customised loans to financially excluded groups.

OCEN is a piece of a larger open digital public infrastructure called the India Stack, that comprises three foundational layers which communicate with each other: a digital identity layer, a payment layer, and a data management layer. India Stack will also consist of entities called Account Aggregators (AA) -— which will collect, assemble, and synthesise user information from multiple accounts in a single place, which is essential for OCEN to work.

Indian hands exchanging currency

Furthermore, Loan Service Providers (LSPs) are being introduced to bridge the gap between borrowers and lenders, as mainstream lenders find the cost of acquisition and underwriting prohibitive. LSPs will act as marketplaces, e-commerce platforms, and business networks that will possess insight into the status of the MSMEs’ activities, and their low-cost customer acquisition will be beneficial in the lending process.

Together, OCEN and AA will enable the seamless exchange of credit information between different actors. It will also facilitate the creation of decentralised credit applications and services that can operate independent of centralised institutions, thereby providing consumers with greater access to the credit market. OCEN’s key innovation is that instead of relying on physical collaterals and assets that microenterprises may not have, it seeks to leverage new and more granular data sources – the borrowers’ existing digital data and financial trails – to accurately assess a borrower’s creditworthiness. Extending credit on the basis of real-time and continuous projections of a borrower’s cash flows is why OCEN is being hailed as ushering in a new “cash flow-based lending” paradigm.

Street vendor sourcing graphic

Figure 1: Use case of a street vendor sourcing a loan via OCEN, which leverages the vendor’s digital financial trails that they generated on the Unified Payments Interface (UPI), India’s real-time payment system.

Beyond overcoming the requirement of physical collateral and reducing the cost of credit, the advantages of digital lending for both consumers and lenders are numerous. Consumers can enjoy flexible loan sizes, faster approval times, automated account analysis, and the convenience of not having to visit a physical bank. Meanwhile, lenders can leverage technologies like OCEN to access reliable financial information about borrowers, allowing them to make informed decisions and gain real-time insights into their credit behaviour. This ultimately optimises the risk assessment process for lenders and enhances the overall lending experience for consumers.

To sum up, the Open Credit Enablement Network (OCEN) can bring about a significant transformation in the credit landscape for micro-enterprises in India. With the potential to address the constraints on both the demand and supply sides of traditional lending, OCEN can facilitate financial inclusion for microentrepreneurs, which can in turn unleash the complete potential of India’s MSME sector. However, the effective implementation of OCEN is crucial for its success, and this will require collaboration among stakeholders in the digital financial inclusion ecosystem to overcome critical challenges.

To learn more about the promise of OCEN for Microenterprises, read this article.

References iSPIRT 2020a, Open House on New Credit Enablement Network (OCEN) #1

iSPIRT 2020b, Open House on OCEN Varied LSP & Cashflow Lending Models #2

iSPIRT 2020c, Open House on OCEN API Specification #3

Ministry of MSMEs 2022, MSME Annual Report 2021-22, Ministry of Micro, Small and Medium Enterprises, Government of India

RBI 2019, Report of the Expert Committee on Micro, Small and Medium Enterprises, Reserve Bank of India

Sahamati 2022, OCEN & Account Aggregators Will Change Digital Lending in India

Sattva 2022, Financial Inclusion of MSME, Sattva Knowledge Institute. Sattva 2022

Enabling Financial Inclusion through Digital Platforms, Sattva Knowledge Institute

Sattva 2022, Decoding the Open Credit Enablement Network with Hrushi Mehta, Sattva Knowledge Institute

Asawari Luthra is a social impact research consultant at the Sattva Knowledge Institute, where she is currently investigating the potential of digital public goods to deliver affordable finance to underserved populations. Previously, Asawari has primarily been steeped in academia – pursuing and teaching Cultural Anthropology. Her prior research has focussed ... Read more
Abhishek Modi is a Senior Practice Manager at the Digital Platforms Practice Area of the Sattva Knowledge Institute. He has more than eight years of experience in the social sector across the diverse domains of education, health, livelihoods, and technology.

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