Non-banking financial companies (NBFCs) that provide small-ticket loans to micro, small and medium enterprises (MSMEs) are expected to record a deal flow of more than $15 billion in the next decade on the back of regulatory tailwinds, technology and maturing balance sheets.
This would be an increase of 10 times from an equity deal flow of about $1.5 billion over the last decade, financial services firm Avendus Capital said in a report.
The report said there is a large white space for MSMEs who borrow Rs 10 lakh and lesser. It said that even though these MSMEs contribute roughly 30% to the country’s GDP and employ over a fifth of the country’s population, the funding deficit is a major obstacle.
The report estimates this credit gap at $120 billion currently and said higher capital inflow will allow the NBFCs to fill the white space in the MSME lending segment.
The capital inflow to drive this growth can come via both private equity or the public markets, but over time bank loans will become important as the MSMEs mature and gain scale.
“Bank debt will become increasingly important as these balance sheets mature. They will look for lower dilution by private equity investors and more debt capital,” said Snigdha Khemka, Director of Consumer, Financial Institutions Group and Business Services Investment Banking.
Khemka also said there are likely to be more secondary transactions in the space in the future.
“This credit gap is being addressed by high-quality specialised NBFCs who are agile and nimble,” said Anshul Agarwal, Managing Director and Co-Head of Consumer, Financial Institutions Group and Business Services Investment Banking at Avendus Capital. He added that these NBFCs, with their penetration in specialised pockets in the country, will lead this change, as banks support them through capital or co-lending.
Khemka noted that the understanding of regional credit dynamics and customers with limited documentation is an advantage for these NBFCs.
Additionally, reaping the benefits of the India Stack and JAM (Jan Dhan bank accounts, Aadhaar and Mobile), besides improving the underwriting process for lending, NBFCs are also leveraging their deep and on-the-field presence in urban, rural, and semi-urban areas in the country.
“We also have a deep conviction, given the favourable tailwinds and process improvements, that marquee lenders will deliver a 20% return on equity (ROE) on a sustainable basis,” Agarwal said.
The report highlighted that as companies in the MSME lending segment scale and balance sheets mature, operating expenses and cost of funds will reduce, making them a ripe target for lenders. It pointed out that operating leverage will reduce with increased use of technology, stronger underwriting models and with COVID-19 comfortably in the rear view. These factors will help improve the profitability of MSMEs the report said.
Over time, as cost of funds and operating expenditure decrease, this will further allow lenders to pass the benefits of low cost of capital to borrowers, fuelling further growth and a virtuous cycle, the report said.