InCred shows expensive money no hurdle for top business ideas, execution teams

The US Fed began raising its policy rates in March 2022, in response to rising inflation, amid expectations that the rate rising practice would continue for months on end. This expectation of ever-rising rates and uncertainty over how high the rates would go and when they would stabilize and start coming down hit the supply of venture capital arising from the US, the biggest source of venture funds in the world. According to an EY briefing paper, in the four quarters to Q2 2023, US-based venture funds invested $145.6 billion in 9,758 deals, whereas, in the previous four quarters, they had invested $317.1 billion in 14,935 deals. The invested amount had come down by 54%, the number of deals, by 35%, and the average amount invested per deal by 30%.

In an era of easy money, valuations tended to be high, and the hurdle rate for receiving additional doses of capital, low. When the risk-free rate of return climbs, valuations of assets fall, as the discount rate applicable to the expected stream of incomes goes up.

As policy rates climb, the earlier rounds of capital infused in a startup would appear to have produced excessive valuation of the startup in question, making it difficult to sustain capital infusion at that valuation of the company. This has tended to create a bias towards new ventures, when it came to venture fund flows. Only companies with demonstrably strong business models would, on the whole, receive fresh, later-stage funding.

That InCred Finance qualifies to still receive fresh injections of capital is to its credit. Of course, its operating environment is more than favourable to its viability. India’s credit market is probably hugely underserved by the banking system, and there is plenty of scope for NBFCs that employ the latest tech and analytics to formalize a lot of the credit currently taking place in the informal space.

Formal credit to the private sector is about 50% in India, while it is three and a half times as much in China. Of course, the degree of business reliance on debt, as a form of capital, is determined by a country’s history and culture. A country or a region with a history of hyperinflation would typically rely less on credit than one with a history of relatively moderate inflation. A country with a history of evolved financial instruments would tend to have a larger and more articulated credit market than one with rudimentary experience with finance.

India does not have a history of sustained high inflation that would make a lender look like a philanthropist — the thousand local currency units you lend today would be worth a fraction by the time the loan is repaid. And it has a history of lending and borrowing that goes back to ancient times. Charvaka, the materialist philosopher of ancient India, is reputed to have prescribed the maxim, Rinam kritva Ghritam pibet (Rinam is debt and Ghritam is ghee, or clarified butter, and the maxim says even if you have to borrow, go ahead and drink Ghee). Live happily when you are alive, for there is no afterlife, said Charvaka.

Whether this is historically accurate or has been invented by contemporary idealist critics of Charvaka to paint him as a myopic hedonist does not concern us. What is clear is that lending and borrowing are a longstanding tradition in India. Medieval India’s hundis rivalled European bank notes of a later age.

Therefore, it is unrealistic to expect that India’s private entrepreneurs make do with credit to the tune of just 50% of GDP, especially at a stage of rapid growth at a time of scarce risk capital in the hands of entrepreneurs. Credit flow to the private sector must be much higher than that. A lot of credit is probably still informal, below the radar, and goes unaccounted for. This presents an immense opportunity to new lenders, who can use their superior capability in analytics and technology to capture a slice of the informal credit, replace it with their formal credit, attracting customers with the promise of lower rates and the gradual build-up of a formal credit history that would make these borrowers eligible to access yet cheaper formal credit from the banking system.

Shriram Capital offers a shining example of a formal entity capturing a slice of an informal market and expanding it, three decades ago. It offered finance to truck drivers to buy their own vehicles. This was considered too risky for any bank to touch. But Shriram Finance had a recovery rate close to 100% and a profitable business, as it could build in the higher costs of disbursing a large number of retail loans and collecting payments on them into the interest rate charged.

Clearly, there is a huge market waiting to be tapped. What is needed is knowledgeable and capable entrepreneurship to capture that market. Today, lenders can take the help of account aggregators to obtain a picture of the financial activity of a potential borrower. It has access to sophisticated analytics and tools.

InCred Finance’s investors credit its promoters with the needed savvy and skill to succeed in their chosen business. May their tribe multiply!