SUPPLY CHAIN FINANCE - A GROWING TREND IN INDIA FOR BANK FINANCE TO MSMES

The coming decade is bound to drive-up the share of the MSME sector’s contribution to India’s fast paced economic growth along with the growth of the supply chain finance market

Covid-19 changed the world, literally. But it transformed the world digitally. As people locked themselves up indoors and work from home became the new norm, more and more businesses and services got caught up with the electronic world. The banking and finance industry, which had already made good strides in the move towards digitization, started to become synonymous with e-commerce and fintech post Covid. This proved to be a saviour of sorts for the struggling MSME sector, which given the global monetary tightening, and coupled with banks involved in the clean-up of their loan book in the wake of the changes to the insolvency law had virtually no access to bank finance.

This article takes a look at the rising trend and growth of the supply chain finance market for bank finance to MSMEs and some of the legal aspects contributing to that.

The MSME sector is the silent backbone of all manufacturing nations and India is no exception. Despite its importance and significance, as a general matter, the sector has always suffered from access to credit. With limited security collateral to offer and smaller cash flows and operation sizes, their credit risk has always been an issue for banks and lenders. Consequently, due to lack of financing, there is no credit history built and that exacerbates their problem. Scaling up for MSMEs on the strength of outside finance therefore remains difficult despite viable business models. In fact, banks have largely funded this sector only where there is either huge trust based on the personality of the promoters or to meet some social impact or other such soft target. However, in the business world, trust without legal recourse and social trends without a regulatory process are simply fickle. With a change in this direction due to new legal practices and regulatory backing, supply chain finance has established a solid footing as a means of financing to MSMEs.

Supply chain financing largely involves the discount funding of invoice receivables of suppliers within a supply chain of a large corporate in advance of their due dates of payment, with the large corporate purchaser making the full payment to the financier on the due date (thereby the financier earning the discount margin on the due date in exchange for credit advanced to the supplier).One of the key problems for banks funding MSMEs was that there was no real legal recourse to a defaulting supplier. With little or no security offered, a litigious claim against the defaulter is not worth the money to pursue. With the introduction of the Factoring Regulation Act and the new insolvency laws as well as with Government and the Reserve Bank of India (RBI) promoting tech digitisation to discount trade receivables via the TReDS system, there is now a robust legal environment to ascertain the rights of the suppliers, purchasers and the financiers involved in the supply chain finance. Further, due to the information sharing among banks, businesses and authorities as a result of technological advancement, the impact and consequence of a voluntary payment default can be far reaching beyond just the one transaction in question. The supplier could be boycotted not only from a supply chain financing program run by the purchasers with the help of their banks but from even supplying their goods to the purchaser. Lastly, due to the judicial progress of the new insolvency law, recourse to the defaulting supplier is much easier and more importantly, certain.

With the growth of the MSME sector - by several public accounts, contributing to about one-third of India’s GDP – it is hardly surprising that banks have now trained their eyes on the business opportunity beingoffered by the sector. The earlier rush of fintech companies and private credit to close the funding gap has now created a sea change in the attitude of banks, who now armed with the legal developments mentioned above and the technological systems of electronic documentation, disbursement of money and transaction monitoring are using their existing large corporate relationships to develop programs of supply chain finance for all of the corporate’s suppliers in the business supply chain. Banks are also using technology’s innovative solutions to cater to various businesses in a bespoke manner rather than a “one size fits all” approach. Several public statistics report a year-on-year growth of the supply chain finance market at close to 10% per annum with future growth only growing. Some Indian banks have reported growth of even 100% in their supply chain financing business. The overall market in India for supply chain finance is currently estimated to be in the region of 100 billion US dollars.

It is no surprise therefore that more and more banks are now tapping into this market opportunity, though it must be added that not all banks have gotten there yet. Seeing the developments in the last two to three years though, it is but a matter of time before supply chain finance becomes a mainstay product in banks operating in India. On the other hand, suppliers who export products overseas are also involved in supply chain finance programs of their overseas purchasers and are imbibing the benefits of the latest fintech advancements. Their experience and consequent interaction with their Indian bankers to match such solutions has also been a source of encouragement to banks looking for furthering their business product offering.

In conclusion, the coming decade is bound to drive-up the share of the MSME sector’s contribution to India’s fast paced economic growth. With it we will also see the supply chain finance market grow. The certainty of the legal issues around this financing product have come a far way from the earlier gaps, but with technological advancement to further finesse it, there will be challenges which will arise. Banks and financiers looking at India will be well advised to continue to look at all legal aspects as they are bound to be involved in supply chain finance for the long term.

Disclaimer – This article has been authored by Anish Mashruwala, Partner at J. Sagar Associates. The views expressed in this article are personal and are not the views of the firm. This article has been prepared on request for general information purposes only.