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The Indian micro, small and medium enterprises (MSMEs) are a significant growth driver in India contributing to the tune of 33.4% of India’s manufacturing output. This sector provides employment to over 120 million persons and contributes around 45% of overall exports from India. With around 36 million throughout the geographical expanse of the country, this sector promotes sustainable and inclusive development.
Trade finance, a commercial activity, has been closely linked to the story of human trade evolution and has for centuries influenced economic conditions, public policy, living standards and degree of financial inclusion. Trade finance process for MSMEs, however, is not differentiated and typically involves hefty amounts of physical paper-based documentation. But MSMEs are limited by the lack of technical skills and knowledge to handle such financial transactions. Also, this segment typically gets caught in a self-deprecating spiral, due to its inability to prove credit-worthiness and to comply with the stringent documentation and collateral requirements required by banks. This causes banks to not prefer MSME borrowers due to high transactional and information costs. MSME’s own preferences emerge from proximity to smaller, more expensive lenders. Worse, they end up self-financing and that limits their ability to scale up. For MSMEs to survive in today’s challenging and uncertain environment, trade finance must be adaptive, agile, low cost and add value to them.
The traditional forms of trade finance such as receivable discounting, pre-shipment finance and factoring have built-in efficiencies for application to the MSME sector – right from challenges in compliance with KYC and AML norms, lack of end-to-end visibility, funding excess working capital, etc. Another impediment is the high cost, given the labor intensive, physical handling and checking of documents. This is more so the case with LCs and guarantees / standby letters of credit that are paper heavy, very fragmented and labor intensive.
New technological innovations such as E-bill of landing and blockchain technology are bringing about a digital revolution in the trade finance business globally. With the advent of digitally documented trade, we are likely to see costs reducing and greater agility in this process. Implementation of Legal Identity Identifier (LEI) can address KYC due diligence challenges currently faced by lenders.
Alternate forms of financing such as collateral free financing, transaction financing, crowd funding and invoice financing for short term finance can be employed if technology is applied, data is cleaned up and government actions are supportive. An evolving trend is that of ‘unsecured trade’ with the underlying security being the trade itself. RBI’s Trade Receivable Discounting System (TReDS) is an interesting example of how digitization can help MSMEs get access to capital, by auctioning their receivables. The benefits expected include quick turnaround and lower costs, owing to digitized information. The full benefits of the system cannot yet be fully estimated, given the mindset change the system requires among the MSME segment that is currently paper driven, as well as the quality of data that is fed into the system. However, there are cyber, regulatory and infrastructural implications that need to be further deciphered.
Implementing digital technologies such as Blockchain Trade Finance can resolve inefficiencies and make the process efficient for banks and MSMEs. Banks can avoid duplicate financing, buyers and sellers will avoid fraudulent trade and MSMEs can get access to cheaper capital.
There are specialized technology and product companies that develop products to facilitate trade financing using these digital channels. These products provide integration of an MSME’s online borrowing requests directly with the lenders’ trade processing system, thus increasing straight through processing (STP) rates and reducing the need for manual inputs. Legacy bank-supplied trade finance solutions and services were hosted on infrastructure owned and monitored by lenders themselves that needed investments of time of money. Contrary to this, new age service providers provide these services on a cloud and offer superior availability and lower costs due to aggregation of demand.