Real-time alternative data for holisitic assessment of financial health of businesses that aren't tax compliant
Small businesses have always faced constraint of capital when it comes to scaling up their business. It is no secret that lenders have been facing challenges in underwriting loans for small businesses for decades because there’s hardly any reliable data to estimate the true health of their business. Furthermore, the benchmark set by banks to estimate borrower’s income in the moderate-income group is too high.
Though the owners transact in low value, high volume business, they have limited access to lumpsum money and usually resort to private lenders to scale their business. Just as informal lenders depend on intuition to judge the intent and ability to repay because they have access to the borrower’s circle of influence, so were banks stuck for a large enough time with old age ways of underwriting a borrower before the credit scoring became the norm. Even the traditional ways are becoming a passe.
The traditional approach followed by formal lenders to gauge the ability to pay typically relies on review of tax statements or income tax returns. This approach of estimating a prospective small borrower’s income suffers from major draw backs:
How do you underwrite loans for such businesses?
An alternate approach to underwrite loans in this segment is to follow a high touch point process of doing on ground estimation of borrower’s income. This is the approach followed by NBFCs and MFIs is not only time consuming but also highly prone to errors. It also leads high cost of underwriting that is eventually passed on to the borrower in the form of higher rates of lending.
With rapid pace of evolution in technology, lenders too need to find out more efficient ways of underwriting beyond using tax returns and income statements. There are various emerging supply chain aggregators that can be potentially leveraged by lenders as data source for loan underwriting.
Exemplifying the above statement, fin-tech players in real-time micro-payments and remittance services is a large industry where large market places have developed and the web has become a trading platform for such small businesses. These fin-tech companies are prepaid instruments (aka e-wallets) that convert real cash into digital money which facilitates small businesses for transacting with large enterprises such as telecom, railway, DTH and banks (especially for remittance). Therefore, they are a trove of business transaction data. This data is the most rewarding tool for lenders and can be used to assess flow of moderate-income borrowers based on which loans can be underwritten.
These benefits of this data counters the drawback of ITR based under-writing.
Another source which is better evaluation than tax assessment is bank statement analysis that is also available in real-time. Bank statements capture detailed description of credit and debit transaction with much more granularity. We extract business turnover, loan repayment, utility bill payments, point of sales transaction, etc. All these are signals much more valuable than information which is based obtained from historical tax statements. These data points are available in digital format and is fairly easy to extract and analyse if the right technology and data model is build around it.