Using credit scores to provide loans has become quite a common phenomenon in the lending sector. It enabled banks to process loans faster with reduced risk. However, no such application of credit scoring in the trade credit sector exists.
Maintaining credit score of business: Micro, Small, and Medium Enterprises (MSMEs) constitute a substantial portion of the global business ecosystem, contributing significantly to the GDP and employment of their respective countries. Operating across diverse sectors, MSMEs serve as a breeding ground for innovation, creativity, and entrepreneurship. Unfortunately, despite their significance, MSMEs usually face a dual-fold challenge: They must supply their customers on a credit basis while they are unable to access affordable credit, thus severely constraining their growth. Credit Scoring of B2B payments (i.e., payments between sellers and buyers) in the trade credit sector can transform in enabling secured growth for MSMEs and improved access to finance.
Using credit scores to provide loans has become quite a common phenomenon in the lending sector. It enabled banks to process loans faster with reduced risk. However, no such application of credit scoring in the trade credit sector exists
The amount of credit extended in the MSME sector is so huge that the late payments stuck are to the tune of ?10 Lakh crore. Today, there is no way that an MSME can do a credit check on a prospective customer who asks for credit on products/services. A large number of MSMEs conduct their business within the framework of a push-the-product strategy which leaves them with less possibility to follow the cash-and-carry model.
With the introduction of credit scoring in the trade credit sector, MSMEs can look up a potential client’s credit score and decide on the extent of the risk they wish to undertake before fulfilling an order. Depending on the credit score of the prospective customer, they can offer terms ranging from “cash-and-carry” to full credit.
Introducing credit scoring in the trade credit sector helps MSMEs build a credit history which helps them access to finance. A positive credit history enhances their reputation in the financial market, making it easier for them to secure credit in the future. A credit score for MSMEs accurately establishes their creditworthiness to lenders which, in turn, allows them access to affordable credit. As the risk associated with lending to MSMEs decreases, lenders become more inclined to extend credit to these enterprises. This increased access to affordable finance empowers MSMEs to invest in expansion, research & development, and other growth-oriented initiatives that were previously hampered by inadequate funding. Having access to credit scores of MSMEs also enables lenders to differentiate between higher and lower credit risks. This differentiation allows lenders to offer competitive interest rates to MSMEs with favourable credit scores, further incentivizing responsible financial behaviour.
Encouraging Financial Discipline, MSMEs striving to improve their credit scores are likely to adopt better financial practices, such as timely repayment and accurate record-keeping. This instils a culture of financial discipline that can contribute to long-term sustainability and growth.
mplementing Credit Scoring for MSMEs
The successful implementation of credit scoring in the trade credit sector for MSMEs requires collaboration among four main stakeholders:
1. Lending Institutions: Financial institutions should invest in developing sophisticated credit scoring models that cater specifically to the unique needs and challenges of MSMEs. These models should consider alternative data sources and innovative techniques to ensure accurate assessments.
2. Regulators: Regulatory bodies play a vital role in establishing guidelines and standards for credit scoring practices. These regulations should foster transparency, fairness, and ethical conduct.
3. MSMEs: By actively engaging with lenders and working to improve their financial documentation and reporting practices, MSMEs can demonstrate their creditworthiness and thereby position themselves for favourable lending terms.
4. Technology Providers: Technology companies specializing in data analytics and artificial intelligence can contribute by developing advanced credit scoring algorithms that harness the power of big data to provide accurate risk assessments.
Fostering the growth of MSMEs is essential for creating a more inclusive and resilient economic landscape. The introduction of credit scoring in the trade credit sector represents a pivotal step toward unlocking the growth potential of MSMEs. This approach enhances the accuracy of credit assessments, enabling risk management and, in turn, leading to increased access to finance, competitive interest rates, and improved financial discipline among MSMEs. Through collaboration and innovation, stakeholders can collectively drive the adoption of credit scoring and pave the way for a brighter future for MSME.