in SMB Finance

With an estimated 26 mn small businesses providing employment to over 60 mn Indians, small businesses are a key growth engine of the economy. It has also been identified in numerous studies that access to credit is one of the key pain points for the small business. In a recent report on the working capital financing gap in the country published by International Finance Corporation outlines that the bulk of the working capital demand is for short term credit.


But conversely, most of the options available in the market are for longer term credit (12 months or longer). Lets take a close look at why that is:

Reason 1: Loan sourcing costs

Both loan agents (DSAs) who advise small entrepreneurs in securing credit and banks have their incentives aligned towards longer-term credit.

DSAs and banks have their incentives aligned towards longer-term credit. Click To Tweet

Let us assume that there are 2 small businesses who need Rs.100,000 as a loan. The first is a restaurant which needs it for furnishing the restaurant, so would prefer an upfront loan amount which it would pay back over 3 years. The second is a staffing company which has raised invoices on an IT services firm and needs money to meet monthly payroll for 2 months till the funds are credited to it’s account.

 RestaurantStaffing Co
Loan AmountRs. 100,000Rs. 100,000
Period36 months2 months
Interest p.a18%18%
Total to repayRs.164,303Rs.103,000
Can Pay DSARs.2,000 – Rs.3,000Cannot cover costs

In the restaurant’s case, a DSA (direct sales agent or loan agent) can be paid the standard 2% fee that banks pay DSAs for assisting in putting together the loan file. Of the 64,000 total earning on the capital, the bank can afford to part with Rs.2,000 for sourcing. The math for the staffing co. however doesn’t stack up. Much less pay the loan agent, the bank would typically struggle to cover the cost of finding and evaluating the borrower. To understand why that is the case, let us take a look at a typical bank’s cost structure.

Reason 2: Banks Cost Structure

Given that most banks source of capital is deposits and that they offer a wide variety of products catering to a cross section of society, they need to have a strong physical presence. In the context of business loan underwriting, the branch serves the function of multiple visits/ meetings to evaluate the business/ entrepreneur and also for ongoing visits to evaluate stock if collateral is inventory. However, this imposes a significant cost of evaluating loans which by design forces banks to focus on larger, longer term earning assets so that the fixed costs of a large employee base, branch operations can be recovered. As a case in point, let us take a look at Karnataka Bank’s (selected for no reason other than it’s in the same state as we are) income statement to understand the magnitude of the costs and why small loans are not economical for banks.


The network of 709 branches, 7,669 employees that the bank has create a cost structure that incentivizes longer term loans. For the same bandwidth reasons that several consumer banking services went the way of the web and app, we believe it is the time of ‘bill discounting’ the workhorse product of small business lending globally to move to an entirely digital experience that saves on these costs and provides a far better experience to the millions of small entrepreneurs.

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