The Emergence of Deep-Tier Supply Chain Financing: MSMEs' Gateway to Financial Inclusion

The Emergence of Deep-Tier Supply Chain Financing: MSMEs' Gateway to Financial Inclusion

Pramit Joshi, Senior Director, Credlix, 0

Pramit is a seasoned corporate banker with over 17 years of experience in Trade Finance, Treasury, and Financing Solutions across India and the Middle East. He had worked previously at Citibank, IndusInd Bank, and Yes Bank Ltd., specializing in financing for Mid-Large Enterprises. Holds a B.E and Masters from SOM, IIT Bombay.

Micro, Small and Medium Enterprises (MSMEs) are rightly regarded as India’s growth engine. However, challenges faced by MSMEs in accessing finance in India only allow it to run like a steam engine, as opposed to a modern superfast engine. In 2022, the global trade finance gap reached an unprecedented $2.5 trillion, marking a significant increase from the $1.7 trillion recorded two years prior. Till date there is an estimated credit gap of $530 billion within the MSME sector. Out of the 64 million MSMEs in India, merely 14 percent currently have access to credit. This financial exclusion impedes the capacity of MSMEs to invest in technology, expand operations, and weather economic uncertainties.

In response to these challenges, a groundbreaking solution has recently emerged, that is, Deep-Tier Supply Chain Financing (DTSCF). This innovative financial model is reshaping the landscape for MSMEs, offering a gateway to financial inclusion previously deemed unattainable.

Understanding Deep-Tier Supply Chain Financing: A Game Changer
Deep-Tier Supply Chain Financing is a financial solution strategically designed to mitigate the financing challenges encountered by MSMEs situated in intricate, multi-tiered supply chains. This innovative approach capitalizes on the robust creditworthiness of a prominent and well-established company, referred as the ‘anchor buyer’, to extend financing support to its smaller suppliers positioned deeper within the supply chain. Refer below information.

Anchor Buyer (Automotive OEM) Tier 1 Supplier (Steering, Brakes, etc.)

Tier 2 (Fabricated Casting) Tier3 (Moulds, Spared)

Traditional financing models predominantly rely on the credit history and collateral of individual businesses, often leaving MSMEs at a disadvantage. At best traditional bank led Supply Chain financing programs provide financing for Tier 1 suppliers and not beyond that. DTSCF, on the other hand, assesses the health of an entire supply chain as well, allowing for a more inclusive evaluation. This not only benefits MSMEs but also mitigates risks for lenders by providing a comprehensive view of the interconnected relationships within the supply chain.

DTSCF is founded on key principles of inclusivity, transparency, efficiency, and risk mitigation. It aims to provide financing opportunities to all supply chain participants, utilizing blockchain for real-time transaction visibility. DTSCF also employs data analytics to assess supplier creditworthiness, aiding financial institutions to make informed lending decisions and mitigate risks effectively.

The Role of Technology in Deep-Tier Supply Chain Financing
Blockchain technology ensures transparency and security in financial transactions by creating an immutable and decentralized ledger. This not only reduces the risk of fraud but also enhances trust among supply chain participants and lenders, especially when lending to small businesses that lack a financial track

AI and ML algorithms are helping speed up the decision-making process, while allowing for more accurate risk assessments, especially around interconnected supply chains.

The government is doing its part as well to enhance credit access for MSMEs. Through the rural broadband connectivity project - BharatNet, it aims to connect the country's 2.5 lakh-gram panchayats through high-speed internet which will enable increased access to digital financial services for MSMEs.

By promoting technological adoption, a secure digital data infrastructure can be built to facilitate efficient data sharing and risk assessment.

Furthermore, e-invoicing is helping MSMEs streamline their invoicing process. With better transparency and efficiency of the invoicing process, MSMEs can enjoy faster payments, leading to improved cash flows and overall financial health.

Regulatory Landscape and Policy Implications
Currently, DTSCF in India operates within the broader framework of existing financial regulations for trade finance, invoice discounting, and microfinance. No specific regulations currently govern DTSCF. However, the Reserve Bank of India (RBI) has taken steps to encourage DTSCF through initiatives such as Trade Receivables Discounting System (TReDs) which is an electronic platform for discounting invoices, facilitating smoother flow of funds to MSMEs. Priority sector lending status is also being given to MSMEs with banks being mandated to allocate a portion of their credit to priority sectors such as MSME and providing subsidized lending. The Account Aggregator Framework is also an initiative by the Government of India, to streamline the sharing of financial information among financial intermediaries.

Moving ahead, the government should work to reduce the procedural burden for MSMEs and financial institutions involved in DTSCF transactions. By promoting technological adoption, a secure digital data infrastructure can be built to facilitate efficient data sharing and risk assessment. This must go hand-in-hand with conducting outreach programs to educate MSMEs, financial institutions, and policymakers about DTSCF benefits and best practices.

Challenges and Risks in Deep-Tier Supply Chain Financing
Despite the transformative potential of new-age financial solutions such as DTSCF, there are challenges such as resistance to technological adoption, data privacy concerns, and the need for standardized protocols across industries. Overcoming these obstacles is crucial for the widespread adoption and scalability of innovative financing models.

Technology-driven financing models are not immune to risks, including cyber threats, system vulnerabilities, and algorithmic biases. To ensure the sustainability of DTSCF, it is essential to address and mitigate these risks through robust cybersecurity measures, regular audits, and ethical AI practices.

DTSCF is a transformative solution for MSMEs' financial challenges, offering inclusivity by considering the entire supply chain. With technological advancements in blockchain, AI, and IoT, DTSCF holds the promise of accelerating MSME financial inclusion. Stakeholders, including businesses, financial institutions, policymakers, and technology providers, must collaborate for its success. This collective effort is crucial for unlocking the full potential of MSMEs and fostering economic growth. Embracing DTSCF goes beyond business strategy; it signifies a crucial step toward building a more equitable and prosperous future for all.