There are so many instances where we are bombarded by messages promoting ‘easy and pre-approved loans.’ While one is compelled to think of these loans as simple, a lot of grunt work happens in the background. 

The traditional process of proposing a loan to a potential borrower has several stages of due diligence that have to be mandatorily completed by lenders and investors. It is crucial for lenders to do so to ensure appropriate underwriting can be done. Especially when the ticket size of a loan is large, the number of checks and references increase to ensure the borrower’s creditworthiness and whether they will be able to repay the money back without defaulting.

One of the critical checks put in place by banks to help do this is credit underwriting. 

In the simplest terms, credit underwriting can be understood as a process wherein the lending party assesses the borrower’s creditworthiness. This helps them make the important call of granting or not granting a loan to the borrower. As for the lender, the loan underwriting process ensures that the quality of their loan book is top-notch, and the amount of risk in granting the said loan is minimal.

Irrespective of the nature of the loan, credit underwriting is an indispensable part of loan processing. It includes mandatory check-boxes that need to be ticked off, which helps the lenders understand the risk. Some factors used by lenders to do this include:

  1. Credit score: A good credit score indicates that the borrower has a history of timely loan repayments.
  2. Debts and liabilities: Lenders ensure that you save enough money after considering your current debts and liabilities to pay your loans without defaulting.
  3. Income: Mandatorily, you need to have proof of stable and adequate income.
  4. Collateral: Most conventional lenders will ask for collateral equal to or higher in value than the loan the borrower seeks.

This is the traditional credit underwriting process that we have seen for decades in the country. However, the incumbent process has several downsides, especially for the MSME sector, which demands readily available credit but is pulled down by the frills of the conventional underwriting process. 

Traditional underwriting is a resource-intensive process for the lender as well as the borrower. They have their roots in underwriting standards for large corporates being extended to SMEs. As a result, MSMEs and small businesses in urgent need of capital often are left in the dark, mainly due to the lender’s stringent and obstinate due diligence processes.

Moreover, the underwriting process can be extremely long and tiresome. This not only makes the end-to-end loan process lengthy, but it may also prove to be counterproductive for a borrower who might be in dire need of credit to expand their business, fulfil an order, or make an urgent payment. Additionally, the exhaustive paperwork required by traditional lenders for underwriting can seem never-ending, especially to MSMEs that are already tight-staffed. 

There are also hordes of data that need to be compiled and submitted- 80% of this data is unstructured, and assessing it manually can sometimes yield erroneous or inefficient results. This adds to the woes of borrowers who want to experience a smooth and hassle-free credit process.

More importantly, the archaic underwriting process still being widely used seems to miss the mark since the underwriter’s analysis might be inaccurate. In addition to this, it has often been noted that most lending institutions have a one-size-fits-all approach. This includes the same underwriting rules that apply to all borrowers, regardless of the loan size, the industry they operate in, their business growth, projections, and other factors that hold relevance in India’s developing credit market. 

At this juncture, it feels slightly discriminating that to get an unsecured line of credit, MSMEs and small business owners have to fight the age-old lending and underwriting system.

The evolving MSME sector that is fast becoming a major contributor to the growth of the economy is now hunting for an innovative lending marketplace that is not restricted to a select few check-boxes on a sheet that determine their creditworthiness. 

This is where fintech companies like Yubi have stepped up to help revolutionize the conventional underwriting process in the country- especially for MSMEs looking for unsecured credit for small and medium-sized tickets. 

Yubi and its lending partners have been exploring newer ways to assess the creditworthiness of potential borrowers to help them boost their supply chains. There is a pressing need to retire parameterised credit underwriting process. 

Moving away from stringent criteria and asset-based lending is critical to giving MSMEs the edge they deserve. Additionally, while Indians spearhead technological revolutions across the globe, when we have the technological resources at our disposal, why shouldn’t we make the best use of it and transform the quintessential underwriting process?

Let us talk about some of the newer forms of underwriting parameters that lenders and investors may mull adopting, while some have already made changes to their underwriting process based on it. 

Cash flow-based underwriting 

The financing needs of an MSME change with every phase of its growth cycle – while there might be a need for a high frequency of funding in growth and renewal phases, the frequency might take a dip in the maturity phase. MSMEs have often asserted how the underwriting process and its factors tend to remain the same in each phase.

To counter this to some extent, there is an option of using the cash flow-based underwriting process instead of taking the borrower’s assets into the assessment. Cash flow-based underwriting is a process wherein the lender considers the borrower’s past and projected cash flow to assess the risks against them. In a nutshell, the company shows the lender their projected growth and revenue streams as an underwriting criterion. The real-time cash flow of a company can give a robust evaluation of a company’s competency to repay the loan.

Former RBI Deputy Governor Viral Acharya coined ‘shampoo sachetization’. This means offering credit of smaller ticket size for the short-term to companies that need it the most via cash flow-based underwriting. To add depth to the idea of cash flow-based underwriting, a report submitted by former SEBI Chairman UK Sinha to the RBI pushed banks to focus on cash flow-based lending models in a cumulative effort to ease the mounting credit gap in the country.

Compared to balance sheet-based underwriting, cash flow-based underwriting gives an edge for companies seeking short-term loans. Besides, 70% of MSMEs in India that desperately need credit wouldn’t be able to get their hands on the funds based on balance sheet underwriting. Apart from the fact that the process of credit assessment itself is generally excruciatingly long, the process becomes complex because the balance sheet might not really be the most accurate representation of the company’s financial health. When there is an estimate and a projection about the short-term inflows of cash, getting short-term loans based on the said cash flow makes the most sense instead of going after several other metrics that might be suited for long-term or legacy loans.

For example, understanding a company’s future income in terms of purchase orders, pending orders, payments to be collected, and projects in the pipeline can be a great way to assess a potential borrower’s creditworthiness. A company’s credit rating and future income is an enhanced way of underwriting and can give a well-rounded estimate of the borrower’s ability to pay back to the lenders. Through cash flow-based underwriting, borrowers can get financed faster without having to pledge collateral.  

The credit gap in India is gaping large. With stringent and parameterised underwriting, companies that lack hard assets to pitch as collateral struggle to access funds to supercharge their growth journey. Moving towards cash flow-based underwriting, MSMEs with small credit requirements will benefit the most since they will get quicker access to funds, undergo faster due diligence, and get the aid their supply chain needs for effective functioning.

GST data-based underwriting 

India is home to a community of 6.3 crore MSMEs that is constantly expanding. Most of these MSMEs do not come into the ambit of formal creditworthiness assessments based on traditional underwriting processes. Many are unsure about being able to access credit at all due to a lack of credit history, accurate balance sheets, and many other factors.

However, almost all MSMEs, irrespective of their sizes, do file GST as per law. Filing GST may seem painstaking for most companies, but it is a precious stash of data related to finances, administration, sales, and many other aspects. The GST data is highly granular and may include the majority of the details a lender needs to know to assess the borrower’s creditworthiness. The GST filing gives an accurate picture about a company’s financial health and its ability to make timely repayments. Lenders can have access to the company’s past sales, purchases, monthly, quarterly, and annual summaries, in addition to their tax settlements and dues. All this data can be used to build the company’s credit score, underwrite the loan, and extend credit to them. What’s more, the GST filed by MSMEs gets recorded, verified, and digitally stored. This data can, therefore, be a treasure trove for lenders and can be accessed at any time with the particular filing company’s consent. 

What we foresee is that GST filing can be treated like a data source where everything is available at the click of a button; the borrower need not be poked multiple times to submit scores of documents to be printed, photocopied, or scanned. Moreover, assessing all data at one go will reduce the time taken to perform due diligence and result in faster loan disbursement.

A two-way impact of GST data-based underwriting can be gauged when a larger adoption of this method prompts MSMEs to file their GST on time which can also help streamline the majorly unorganized MSME sector.

Using alternate data points for underwriting 

The lack of a cogent financial history for many MSMEs in the country is a concern that mars their efforts to get unsecured credit from lenders or investors. For small, home-grown, and new businesses, this further leads to a pain point if they don’t have a valid credit history, a company credit card, or have never taken loans in the past.

With active support from fintech companies like Yubi, lenders are looking at alternative data sources for the credit underwriting process and trying to bridge the credit gap in the country. A survey has found that potential borrowers are 70% more likely to furnish additional financial information if it would increase their chances of getting credit.

Ancillary financial information like bill payment data, the borrower’s behavioral data, emails, and digital footprint can help lenders build a credit report for the company, aiding them in the process of underwriting. Other information like cheque clearances, cheque bounces, EMIs, number of accounts, frequency of payments, utility bills, bank account transactions, property records, eWallets, and other factors can also help lenders get an exhaustive idea about the borrower’s creditworthiness.

The Takeaway

The MSME sector makes up 30% of the country’s GDP, and the need to give MSMEs access to readily available credit has never been stronger. The demand for quick access to capital to meet its needs is high from the currently underserved MSME sector. The potential is high too.

Credit analysis, risk assessment, and the underwriting process adopted by banks decades ago are in dire need of an overhaul to meet the strong demands from the changing dynamics of business models and also the paradigm shifts seen in the credit market itself. Revolutionising the underwriting process is one of the ways to ensure the capital penetrates where it is needed the most.

Financial inclusion for MSMEs and other entrepreneurial ventures can only be achieved when the lending process in the country is made easy to navigate through. Tech-led lending marketplaces like Yubi are helping do this by getting lenders onboard who have opted for a multi-faceted underwriting process.