Spotlight on MSME Finance

7th September, 2013

By Dilip Salvekar

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Finance, needless to mention, is the blood of every business, whether Micro, Small or Medium or otherwise. Bible, Ecclesiastes 10:19 says, “A feast is made for laughter, and wine maketh merry: but money answereth all things!” Another famous saying is of W. Somerset Maugham from ‘Of Human Bondage, “Money is like sixth sense without which you cannot make a complete use of other five.” How true for the MSMEs also! Many studies, reports, findings are available on Finance to MSMEs. The Report, ‘MSME Finance in India’ of International Finance Corporation, [IFC] distinguishes itself from former many other resembling reports not only on its contents but also on the analysis and apt way forward.


Banks, all Public, Private, Co-operative, Foreign, provide through various schemes and methods, finance to the business world of which MSME is one vital sector. Out of MSME, Sector, ‘Finance to Micro and Small Enterprises’ falls under ‘Priority Sector Lending’. Following Table provides information on Bank finance to MSEs during last few years.

Outstanding Credit to MSEs - Rs. Crore

As on last Reporting Friday of March Public Sector Banks Private Sector Banks Foreign Banks All Scheduled Commercial Banks
2009 191408 46656 18063 256128
2010 276318 64824 21147 362290
2011 361430 89115 20481 478527
2012 396993 108982 21708 527684
2013 500250 152553 31992 684796

Source: RBI

The Concept of Priority Sector emerged in the year 1968 in voluntary form covering Agriculture and Small Scale Industries. In November 1974, for the first time a target of 33.33% was rolled-out to be achieved upto March 1979. Currently as per RBI mandate, the Banks are to advance 40% of ANBC [Adjusted Net Bank Credit] to Priority Sector which now covers [1] Agriculture [2] Micro & Small Enterprises
[3] Education [4] Housing [5] Export Credit [6] Others –mainly weaker sections. The Priority Sector Lending [PSL] Targets from 20th July 2012 are as below.

Targets /Sub Targets of PSL

Category All Banks including Foreign with 20 and more Branches Foreign Banks having less than 20 Branches
Total Priority Sector 40% of ANBC 32% of ANBC
Agriculture 18% of ANBC No specific Target
Micro and Small Enterprises [1] 40% of total advances to MSEs should go to Micro Enterprises having investment upto Rs. 10 lakhs[Mfg] & upto to Rs. 4 lakhs [Services][2] 20% of total advances to MSEs should go to Micro Enterprises having investment between 5 to 25 lakh[Mfg] & between 2 to 10 lakh [Services]
Export No specific No Specific
Others No Specific No Specific

For the first time, even the Foreign Banks have been mandated target loaning to MSEs. Though there is no specific Target like 18% to Agriculture within the total 40% of ANBC for MSEs, Banks are to provide 40% of their total funding to MSEs, to those Micros in manufacture having an investment in plant & machinery upto Rs. Ten lakhs and to those Micros in Services having equipments upto Rs. Four lakhs. Further 20% are to be loaned to remaining Micro enterprises. This leaves 40% to Small enterprises.

Others two aspects of PSL in relation with MSE lending goes with the Target and Sub-target accomplishment. The Loan to any Micro or small Industry in Food or Agri-Processing will be covered under MSE-PSL only and this will be a Direct Finance. Export Credit to MSEs will also be a part of Direct Finance which also is covered under MSE-PSL.

Finance Facts:

The failure on the part of Banks to provide the adequate finance, mainly to the Micro and Small Enterprises has a direct relation with the concept of MSE, Observes IFC Research Study. It points out-

“Although investments in plant and machinery are tangible and measurable, the current definition [of MSME] provides limited information on the financial appetite and financial performance of an enterprise. As a result, many financial institutions prefer using annual sales /revenue[Turnover] to segment and target MSMEs[Table below ] and as a key parameter for product development and risk management.’’

Internal Definition of Banks for MSME

Institution Type Micro Enterprise Small Enterprise Medium Enterprise
Turnover INR Million Credit size INR Million Turnover INR Million Credit size INR Million Turnover INR Million Credit size INR Million
Private Commercial Banks 1.5-50 0.2-1 50-200 5-150 200-2000 50-200
Non Banking Finance corporations 0.05-1 1-5 5-25 0.3-5 10-1000 2.5-50

The total Finance requirement, the IFC Study says, is INR 32.5 trillion in the MSME Sector. This comprises of INR 26 trillion of Debt demand and INR 6.5 trillion of Equity demand. This study also shows that of the overall Finance demand, 78 per cent means INR 25.35 trillion, is either self financed or from informal sources. The formal sources mainly Banks, cater to only 22per cent i.e. INR 7.15 trillion. It further analyses Formal Sources and notes that 85 per cent of the said INR 7 trillion is being provided by Scheduled Commercial Banks and the rest by Smaller Banks like Urban Co-operative Banks, Regional Rural Banks, Govt. Financial Institutes.

RBI Data explains, Public Banks account for 70% of the Banking Debt to MSME Sector while Private & Foreign Banks accounts for 22% and other like RRB, Co-operatives etc. for 8% only. PSL mandate is behind large percentage of Finance by Public Banks.

The MSME Sector, the study notes, receives INR 6.97 trillion debt from banking and non-banking institutions. Scheduled Commercial Banks comprising Public Banks, Private Banks, Foreign Banks supply INR 5.9 trillion debt. Small Banks, RRBs & UCBs plus SFCs cater INR 0.55 trillion only, which just 8%. The share of debt supply between Micro, Small and Medium Enterprises is 31%, 34% and 35% respectively. It is therefore clear that Micro receives less. Banks prefer to finance Medium & mature Smalls more. Analysis of debt finance flow, suggests that Micro Enterprises on an average gets disbursed a debt of INR 0.15 -0.3 million while average credit disbursement for Small Enterprises is INR 1.5 -3.5 million.

Apportionment :

We have two types of Enterprises, namely manufacturing and Services. [Alongwith Transport, Hospitality & Tourism and so on, Retail Trade is also covered in Services]. According to the IFC Study, “the flow of debt Finance provided to the Manufacturing is about 55 per cent, amounts to INR 3.85 trillion. Services are getting the rest 45 percent which comes to INR 3.12 trillion.

The primary research indicates, on an average a Manufacturing enterprise gets a debt of INR 0.85 million. Food Processing, Basic Metal, Metal Products, Textile and Chemicals’ Product receive the majority of this debt. Only 50 per cent of the average demand of manufacturing enterprises is met, says the study. The study also observes, “although the manufacturing sector still accounts for a large share of debt by volume growing at a compounded annual growth rate at 20 per cent a year, it is still lower than the overall sector average of 30 per cent. This suggests that financial institutions are slowly shifting to financing the Service Sector.”

Services Enterprise on an average gets INR 0.55 million. Traditional Services Business like Restaurants, Transporters etc. are the main beneficiaries of Formal credit uptake as banks have developed a good understanding of these enterprises over the years. The knowledge based enterprises such as Software Companies, HR Consultants, Management Consultants get far lower debt finance than Traditional Businesses in Service Sector for financial institutions have yet to develop appropriate risk assessment framworks to assess such enterprises and most of such units require finance primarily to cover manpower costs.

Finance Gap:

IFC study notes, “the overall finance gap in the MSME Sector is estimated to be INR 20.9 trillion. The potential demand for external finance is estimated to be INR 27.9 trillion while the total finance channeled by formal sources is estimated to be INR 7 trillion. The overall finance gap of 20.9 trillion is split into Debt Gap of INR 19 trillion and an Equity Gap of INR 1.9 trillion.

This finance gap in MSME Sector is estimated to be – [1] Micro – 16.2 trillion INR [2] Small-INR 3.9 trillion and [3] Medium –INR 0.8 trillion. Thus the Share in Gap comes to 77 per cent for Micro segment and 19 per cent for Small. For Medium it is 4 per cent only. However the viable and addressable finance gap, according to the study, will be INR 3.7 trillion out of which Debt accounts for INR 2.93 trillion and Equity INR 0.64 trillion. The Micro Enterprises segment accounts for 80 per cent [INR 2.25 trillion] of Debt gap which is viable and addressable where as Smalls account for 17 per cent [INR 0.5 trillion]. Medium Enterprises account for just 3% of the said gap.

For such a large gap in Micro Segment there are many causes, of which two are leading. Number one, these enterprises mostly transact in cash and have a little in incentive to maintain proper financial records and in absence of financial documents Banks are to reject their proposals. Number two is the cost to the banks. Since the cost is similar for acquiring a micro and small enterprise account, financial institutes prefer to service small enterprises than Micros for their average demand tends to be ten times more than the Micros. For Micro Enterprises segment, a gap-to-demand ratio is 51 per cent and 18 per cent in case of Small Enterprises.

The Debt gap in the Small Sector, notes IFC, is largely due to shortfall in Working Capital. Smalls tend to have longer working capital cycles due to delayed realization of payments from buyers. The Working Capital limits sanction by banks do not meet the demand of these enterprises resulting in the gap. One of the main reason for the said gap is that, in Smalls, Financial Statements are often prepared for Taxation purposes and do not accurately reflect the performance of an enterprise, an area in which banks are more keen.

What is salient, the Manufacturing Enterprises account for 73 per cent of the sector’s viable and addressable Debt Gap. Deficient Working Capital is the result of two vital issues. One is Delays in payments by the buyers. The other one which is a neglect by majority MSMEs is that growth is planned around capacity expansion as opposed to productivity enhancement through process efficiencies. The financial institutes are wary of financing regular capacity expansion as they perceive MSMEs to be vulnerable to economic downturn, when capacity expansion goes underutilized.

In case of Service Sector where the viable & addressable Debt Gap is 27 per cent, there is greater difficulty in determining the actual financing needs of different types of enterprises in services leading to under financing for the financial institutions do not have reliable financing benchmarks for the services sector unlike for the manufacturing sector. Due to inadequate information of financial behavior of these enterprises the sanctioned finance limits tend to be lower than what they need.

Ways Forward :

To increase access to MSME Finance, a variety of interventions have been advocated. Followings are most important.

The MSME Ministry vis-à-vis RBI should come forward for the implementation of these ways forward. The MSME Associations must also act collectively and persuade the Govt. for it.