Why information transparency is essential to access credit

As businesses expand, they need financing to scale up operations, invest in systems and process technology, finish ongoing projects, and/or enter new markets. Bank loans usually provide the much-needed injection of capital. Current or potential shareholders and joint ventures could be other avenues to generate finance.

One thing remains constant in all loan processes. The potential capital source will need access to pertinent, authentic, and accurate financial information about the company. The prospective investor should be able to comprehend this data. The information may include the company’s loan repayment history, the potential for the business’ growth, management risk evaluation, short- and long-term liquidity scenario and Non-Performing Assets (NPAs). MSMEs are generally known to be vulnerable to NPAs that afflict the economy. These reviews determine the firm’s creditworthiness.

Records matter

The likelihood of a loan increases if the business produces the relevant records. However, inconsistencies in information make the loan process cumbersome and, in certain cases, even stall it. This holds much prudence for the Micro, Small and Medium Enterprises (MSME), the unfailing growth engine of India’s economy.

Nations withstand economic slowdown when MSMEs are allowed to prosper. These business entities contribute approximately 30% of India’s GDP. About 64 million Indian MSMEs employ 111 million people and contribute 52% of exports.

Even in economic conditions that make them vulnerable, MSMEs swiftly cut through the traditional boundaries of industries to adapt. This was evident during the pandemic. The Mint, in an article published in December 2022, observes: “Given the circumstances, it has been remarkable to witness the speedy recovery of the sector. Capacity utilisation in many industries across the MSME sector nearing 70% and sales reaching 88% of the pre-pandemic levels is a testament to the resilience and adaptability of these businesses.”

Asymmetric information, the bottleneck

It’s ironic thus that asymmetric information hurts their credit options. Delays in getting timely finance through orthodox channels could cause irreversible losses. Naturally, credit-starved entrepreneurs affect countries that rely on MSMEs to restore a bit of economic equilibrium. 

Essentially, information transparency means sharing critical data with potential investors. This could be information about management, business performance, projects, financial performance over the years, and upcoming products. Businesses without collateral that have strong prospects and sound financial reporting procedures are more likely to get credit since banks will have sound data to make their lending choices. This lessens the financial institutions’ need to impose strict collateral requirements.

A complex area

That said, MSME information transparency is a complex area. For instance, lending institutions might still have basic information about the firm, but that needn’t translate into loans. Lenders could obtain details about MSMEs either from materials provided by the business owner or access information in the public domain, which might not be adequate. In many cases, the business entity concerned might not even be aware of why the loan wasn’t sanctioned. Thus, many MSMEs could be discouraged from applying for loans on account of this skewed relationship and information asymmetry.

Also, lenders might suspect that the organisation is withholding crucial information. Banks, for example, are eager to improve their underwriting standards and allocate credit in a disciplined way. Since they’re usually wary of bad loan cycles, it helps when they can authenticate records from an independent assessment authority to get a clear picture of the MSME’s performance and finances.

Fortunately, the Indian financial system has MSME-specific institutions that eliminate gaps in MSME information transparency.

Importance of credit rating reports

For instance, SMERA, India’s first SME-focused credit-rating agency, facilitates easy access to finance for SMEs and MSMEs. This is done through all-comprehensive credit rating reports that reduce information asymmetry. Credit rating reports act as a useful reference for bankers since they contain in-depth information about the operations of companies, their advantages, and the risks to which they’re exposed. While banks do their appraisals before approving loans, MSME credit rating reports quicken the assessment processes. As a result, the turnaround time for loan requests is much shorter.

Why advantage SMERA?

Over the past 18 years, SMERA has bridged this gap among businesses, banks, and financial institutions to create a network of over 50,000 rated MSMEs. In recent times, SMERA has emerged as one of the most credible voices in this sector by:

  1. Promoting MSME information transparency
  2. Building trust amongst stakeholders and
  3. Facilitating lending decisions

Additionally, SMERA’s wide coverage of MSMEs through rating results in financial inclusion, facilitates timely and adequate credit for MSMEs, and helps them in self-benchmarking and building financial discipline. Now, with MSME information transparency becoming imperative in business practices, SMERA’s role has become all the more significant.

How does SMERA access critical information?

SMERA considers the data provided by the MSMEs and those available in the public domain, including information to which it subscribes. The credit risk of an enterprise is evaluated on the:

Industry risk

Management risk

Business risk

Financial risk

Project risk

SMERA relies on various other sources for information and verification of financial, non-financial, legal and compliance, behaviour patterns and regulatory aspects. SMERA carries out an individual study for each MSME in detail to understand all the risks associated with the entity. SMERA’s rating methodology identifies and evaluates credit quality drivers of the enterprise being rated and includes both quantitative and qualitative aspects. It carries out a 360-degree assessment of an MSME since the factors influencing credit quality can emerge from sources within or outside the enterprise.

Credibility matters

In the past, Peer to Peer (P2P) lending platforms would connect borrowers with lenders and facilitate easy access to loans by leveraging technology. Borrowers could secure funds with minimum documentation.

Cut to the present when new-age lending platforms are leveraging Artificial Intelligence and Machine Learning tools to gain information about MSMEs from additional data sources. The digital landscape is also bringing in a holistic assessment of the borrowers.

That said, certain sensitive details are beyond the balance sheet’s scope. A rigorous assessment of a business calls for something more. This is where SMERA’s Credit Due Diligence system, set up in 2014, comes in. It includes financial documents, site visits and management discussions which physically verify and authenticate an entity’s claims. SMERA also launched an integrated tamper-proof QR code in the rating reports to facilitate easy access to crucial information.

Presenting a broad sweep of information gives SMERA a definite advantage. The information may include an industry evaluation highlighting the general operating environment. SMERA also considers the niche strengths and weaknesses of the credit-seeking entity arising out of numerous factors such as linkages with suppliers and customers.

Quality for credit remains a sensitive topic in business practices. For MSMEs, applying for credit isn’t always a positive experience. Rejection of credit can have an inhibiting effect on their businesses. Now, lack of information transparency shouldn’t be a constraint anymore, with SMERA acting as a guide to facilitate information. It’s time for MSMEs to hop over to banks with loan application papers with confidence. With SMERA’s guiding hand, financial information and data reservoirs are assured.

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