How to Move India’s Small Merchants toward Digital Financial Services

June 25, 2018

Survey points to solutions that can boost small merchants’ use of mobile banking

Key Takeaways

  • Awareness of digital banking tools is high, but use is low
  • To increase use, digital products need to be designed and tailored to the circumstances and needs of micro merchants
  • Digitizing the supply chain should be the first focus rather than customer transactions

India’s push to expand access to digital banking for small merchants is meeting the headwinds of an economy that still relies heavily on cash. Digital tools promise greater access to credit, more secure payments and less risk, but for micro and small business owners, switching to digital is difficult, as a new survey shows. The results point to several avenues to better serve this important segment.

Usage Remains Low

The Center for Inclusive Growth recently collaborated with IFMR LEAD, a prominent Indian research institute, to conduct a five-city survey of 547 micro business owners in India to understand their needs and the challenges they face in adopting digital transactions.

As the results show, access to mobile phones—the on-ramp to digital transactions—is widespread. More than 80 percent of the small business owners surveyed used a smart-phone and 70 percent had access to internet services. Yet, only about one-fourth of merchants used their phones for financial transactions. Most still rely on cash to transact with customers and suppliers.

However, insights are emerging that can help reshape digital financial services so more business owners can tap into the benefits such services offer.

“The digital revolution in India is well underway,” said Parul Agarwal, lead researcher on the report. “But now we must better understand the on-the-ground adoption and use of digital platforms among small merchants.”

These micro merchants, she said, account for 92 percent of the retail market in India. “Transitioning them to digital payments provides an opportunity to significantly further India’s financial inclusion agenda.”

Opportunities to better serve small merchants

Build trust: The survey points to several avenues for increasing usage among these small merchants including building trust. One-third of small merchants surveyed did not trust digital transactions and 21 percent believed conducting financial transactions digitally creates a security risk. Education and training are vital in helping merchants become familiar with digital services and building trust in their security, such as advisory services, help centers for call-in questions and grievance redressal.

Address pain points: Many merchants view banking as a hassle and consider banking products as a poor match to their needs. Two-thirds of small merchants are dissatisfied with their current formal lenders due to the high costs of traveling to branches and the design and delivery of loans. About half said they’d be unlikely to borrow from that lender again. 

“Combine this with the findings that micro merchant awareness about conventional banking products is high,” said Alison Eskesen, director, Asia Pacific, for Mastercard Center for Inclusive Growth, “and it seems clear to me that there is an opportunity to use digital payments as a means to eliminate the pain points that micro merchants identify with formal lenders. I suspect that the products already exist. It is now a question of how best to bring those products to the merchants in a way that ensures safety, security and affordability.”

Offer more flexible credit: Flexible credit would help micro merchants grow and expand. Many of them have increased sales during festival season when people are shopping for gifts, for example, and then hit a lull. It is difficult for business owners to borrow responsibly if the loan repayment schedule is out of sync with the normal, business cycle. One in four merchants reported that lack of targeted, tailored credit impinged on their ability to expand. IFMR-LEAD is testing flexible credit that gives borrowers a repayment structure pegged to seasonal fluctuations as a way to boost growth and thereby the business owner’s capacity to repay.

Asset- and cash-flow-based lending are other options. Solutions like Jaza Duka (“fill up your store”), a partnership between Mastercard and Unilever in Kenya, can help small business owners gain access to credit in new ways. Small operators often lack the paper trail and credit ratings that banks look for when loaning money, but Jaza Duka uses a shop’s purchasing data to assess credit-worthiness and then extend low-interest credit. In this case, Unilever has tracked how much inventory a merchant has purchased from one of their distributors. If a store consistently shows weekly purchases of $50, they could qualify for an interest-free credit line of $120 to stock their inventory. With support from TechnoServe, a nonprofit international development organization, the project also follows up with training on how to use the line of credit smartly and how to expand their business.

Partnerships between financial and fintech innovators could also provide quick and short-term loans. Collaborations between mobile money wallets and payment banks, for example, could lead to financial innovations that target the segment-specific needs of such merchants. Currently, only about five percent of e-wallet users in the survey made loan repayments through them.

Focus first on digitizing the supply chain: Another avenue for increasing use of digital payments would be to digitize the supply chain. The relationships micro merchants have with their suppliers are steady and consistent. Transitioning to digital, therefore, is required only one time, unlike having to persuade each customer to go digital. 

“The research indicates we would be more successful in first digitizing business-to-business transactions,” Eskesen said, “because the number of suppliers that merchants deal with is far fewer than the number of customers.”

New research by the Center for Inclusive Growth will map six value chains to understand where digital payments break down. “The hypothesis is that it is somewhere between second and third tier distributors,” Eskesen said.

One benefit of having a digitized supply chain is that the data can help banks to understand the cash flow of micro merchants, like the previous Jaza Duka example. For many of these small retailers, this is the first time they have access to formal credit. As they engage in the formal banking system, they establish the creditworthiness of their businesses and ultimately will have access to a greater number of tailored financial services.

For digital transactions to be widely adopted by small merchants, they must ultimately be valuable to them. Switching to digital should address the shortcomings of the existing system. Many merchants in the survey expressed the desire to transact digitally. But, without flexible credit, non-traditional banking models, training and support, merchants will be reluctant to come on board. There is a sizable opportunity right now for India and emerging markets to spur more economic growth and prosperity by taking advantage of existing digital financial services.

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