As the Indian MSME sector expands, there is a need for greater access to credit and working capital across the board. According to a recent report by BlinC, the formal lending sector – banks and NBFCs – currently meets only 15 percent of the total MSME credit demand, resulting in a Rs 25 trillion credit gap that is now being filled by alternative credit and financing solutions through fintechs.
Two forms of credit that have emerged as popular in recent years are asset-based/asset-backed lending and cashflow-based lending.
Both asset-based loans and traditional bank loans are based on the collateral put up for the loan, but the latter also takes into account the credit rating, credit history, and other parameters of the business/entrepreneur, while asset-based loans depend solely on the asset in question. Asset-based lending rates range from 70 to 90 percent and follow a revolving line of credit approach.
Collateral offered for ABL can include fixed assets such as property or land, or other assets such as inventory, accounts receivable, marketing securities etc.
Asset-based lending has a number of advantages, such as:
- Less processing time as compared to traditional loans
- Less financial data is required, as the loan depends on the quality of the asset
- Is a source of immediate and ongoing cashflow, thanks to the revolving line approach
- Considered low-risk and therefore has lower interest rates
Micro enterprises make up 94 percent of Indian MSMEs. These businesses rarely have access to assets or credit histories that can allow them to avail of either traditional or asset-based loans. Fortunately, increasing digitisation in India has given rise to a large number of fintech companies. These fintechs are revolutionising the credit landscape of the country by developing new products that use alternative data points to evaluate a company’s creditworthiness.
Cashflow-based loans are unsecured loans that are predicated on a business’ projected cash flow. Fintech firms also use data such as GST information, invoices, and operational data to underwrite loans. Types of cash flow-based lending include invoice-based financing, supply chain financing, Buy Now Pay Later, and co-lending.
Cashflow-based lending also has a number of advantages:
- The data-driven evaluation process provides lenders with a complete picture of the borrower, lowering the risk associated with unsecured loans
- Digitally-enabled processes and solutions reduce the turnaround time, allowing for quick disbursal of funds.
- The usage of alternate data points increases access to credit across the MSME sector and helps bridge the credit gap
What Should You Opt For?
Both ABL and cashflow lending have both risks and disadvantages associated with them. ABL is less accessible to micro and small enterprises, as well as many first-time entrepreneurs. Cashflow loans have higher interest rates and penalties are they are unsecured; they are also short-term loans, usually without a revolving credit line, and may not be suitable for long-term investments or expenditures.
However, both also have numerous advantages and can help your business enormously. In order to decide which loan is good for your business, you should examine your business’s long-term goals and short-term needs, and make a decision accordingly.