MSMEs – INDIAN ECONOMY’S STEP – CHILD

When the Finance Minister announced the launch of a new portal to fast-track loans for micro, small and medium enterprises with a promise to approve funding up to Rs.1 crore in 59 minutes you could have heard a pin drop.

No whooping, no loud shouts welcoming this unbelievable announcement. You cannot blame entrepreneurs for reserving judgment and remaining cynical. 70 years of disappointment with successive Governments, and a license-permit Raj which refuses to go away. Yes, even with so-called liberalization in 1991 and a supposedly rightist Government in the saddle.

What’s this 59-minute loan all about?

An MSME can avail a business loan from Rs.1 lakh to Rs.1 crore through the internet at www.psbloansin59minutes.com

You don’t need to pay any registration fees. You need your GST Identification Number and User Name to upload your Income Tax Return and Bank Statements for the past 6 months, along with details of the Directors / Partners / Proprietor and the loan required.

Once an MSME fills up the application form online and submits the required details, a single gateway will integrate platforms that will help perform back-end checks with the Ministry of Corporate Affairs and credit information bureau for fraud and product checks before the loan is sanctioned.

Any borrower whose proposal matches with the products of lender Banks and wants to receive an In-Principle approval will be required to make a nominal payment of Rs. 1,000 + Applicable Taxes. The borrower will be shown a list of Banks with whom the Application got matched and the Borrower can select her/his preferred lender.

The In-Principle approval is given, based on the data provided by the borrower. After offering In-Principle Approval, the preferred lender (as selected by borrower) will conduct a thorough due diligence and decide on whether to Sanction/Disburse the Proposal. The final decision will be at the lender’s discretion.

Even if the borrower does not have collateral security, she/he can avail business loan through the portal under CGTMSE scheme.

The loan eligibility is determined by one’s income/revenue, repayment capacity, existing credit and any other factor set by lender. Generally, post in-principle approval, the loan is expected to be sanction/disbursed in 7-8 working days.

Is it working? What’s good about it?

Many MSMEs, made cynical by years of neglect, delay and corruption are inclined to trash it. But many changes have occurred incrementally, rather than all at once. So patience!

The very fact that the Government has cooked up a scheme like this, indicates, both to the Bank and MSMEs that an attitudinal change has occurred.

Secondly, an impersonal algorithm doing the number crunching and giving prima facie approval is a powerful force for quicker assessment and faster disbursement by Banks. It also equips the Borrower with very valid reasons to pursue his loan application in case of delay.

Providing an option to the Borrower to borrow from the Bank of her/his choice may not be strictly practical. But again, it is the signalling of “informed choice” for the Borrower that makes it very important.

Anecdotal evidence from Banks indicates that so far the r e is no flood of applications. Loans are being sanctioned online but it is apparently taking around 15 days for the selected Bank to do the verification process and be ready for disbursement.

By linking online loan approvals with GST and tax returns, the Government wants to reward those who are part of the formal economy. Funding small businesses through schemes like MUDRA is also a priority for this Government as it sees them, as an engine of growth and a generator of jobs.

Several new initiatives include, ranking states on financial inclusion, plus a mobile app to help consumers locate the closest bank branches and ATMs. Banks have been asked to provide banking facility to 8,800 villages across the country, which currently do not have any touch point in a 5-km radius.

Looking back – MSMEs role in India

MSMEs account for more than 80% of total industrial enterprises, employing an estimated 117 million people. They contribute more than 40% to manufacturing output and exports. MSMEs are widely distributed across low-income states and over 50% are rural enterprises. This makes MSMEs a powerful force for inclusive economic growth and poverty reduction, which are important national aims. But the way mandarins of the Finance Ministry and our Banks have treated MSMEs in the last 70 years, one would hardly think so.

Step-child of the Indian Economy

MSMEs have consistently outpaced India’s GDP and have been significant contributors to employment, poverty reduction and economic growth. But they have received very inadequate support in terms of finance from Banks. The MSME census of 2006-07 found that about 87% of MSMEs in India did not have any access to finance and were self-financed.

One facet of the problem has simply been the cornering of bank credit by large corporates. Of the Rs 26 lakh crores lent by Indian banks to industry, large firms have taken away Rs 21.5 lakh crore or about 83 per cent of those loans.

Most MSMEs have relied on their own funds or finance through relatives and friends or through Co-operative Banks. Many have horror stories to relate regarding endless delays and an uncaring bureaucracy at nationalized Banks, and private Banks would not touch them with a barge-pole.

If we discount this, genuine reasons for the, disconnect could be that Banks perceive lending to small businesses a relatively risky proposition and have adopted conservative policies to minimize both credit risk and cost of delivery. Many of these businesses are in the informal segment, lacked proper documentation and liquid collateral, making underwriting difficult for banks. For risk-averse Bankers, financing formal and medium sized enterprises was far safer.

What is constricting flow of finance to MSMEs?

The big problem is Non-Performing Assets or NPAs which is a nice term for the bad loans of Banks.

It stood around Rs.4 lakh crores in 2014 when the present Government took office and had risen to Rs.10.5 lakh crores by the middle of 2017 because under the then Governor of the Reserve Bank of India they had instituted new norms for identifying stressed NPAs.

In December 2015, the RBI initiated an asset quality review (AQR) to ensure banks were taking proactive steps to clean up their books, listing 150 borrowers that were to be downgraded as NPAs. Gross NPAs of scheduled commercial banks rose from Rs.3.23 lakh crore at the end of March 2015 to Rs.6.1 lakh crore by March  2016 and Rs.10.4 lakh crore by March 2018.

Rising NPAs not only stalled credit disbursal to the industry in general but in the case of the micro, small and medium enterprises (MSME) industry, credit actually shrank.

“Even to the large industry, the growth of credit came down to 1% and 2 ½% in some months, and even negative in some quarters. Never had we seen such a continuous and persistent year upon year deleveraging of credit,” NITI Aayog, Vice-Chairman Rajiv Kumar said. “This is the cause of slowdown of growth.”

Government compensated for this by ramping up public capital expenditure, using the oil revenue bonanza in boosting capital expenditure while maintaining fiscal prudence.

“So, it has been because of the government that you have now seen a rise in the quarterly growth rate since the second quarter of 2017-18,” he claimed.

Enter S. Gurumurthy – A champion for the MSMEs

What S. Gurumurthy is saying today as a part-time Director on the Board of the RBI is nothing new for him. In 2014 he has been reported as making a strong pitch for a separate financial architecture for small and medium enterprises in India. According to him there were 20 million small financial institutions in India which were financing small businesses and the Banks needed to lend to them at a cheaper rate. The cost of funds needed to be made cheaper by Banks lending to small financial institutions at 10-12%.

He felt government must provide wholesale financing and retail financing must be done by a small business finance corporation, which the government should register separately ,considering that barely 5% of the non-corporate sector was getting finance from the Banks and Banking sector. What he is saying today is no different.

Government and the Banks need to be on the same page for MSM According to Gurumurthy the key challenge today is access to credit for small businesses, which play a crucial role in the economy. He says:

  • All listed companies contribute only 5% of India’s economic output. All unlisted and listed entities put together account for only 15% of the country’s gross domestic product (GDP).
  • MSME’s account for half of the country’s economic output and 9 0 % of employment and 70% of exports.

Consequently, 50% of the economy which is the economic lifeline of India is starved of money.

Unlike the US, where businesses prefer to raise capital from the stock market, the main source of funds for businesses in India is banks.

Rules that limit access to finance for small businesses will have serious implications for the Indian economy. There is a strong case for the Reserve Bank of India (RBI) to improve banks’ lending capacity by easing regulations, as small businesses, the lifeline of the country’s economy, are starved of funds.

Ease the capital adequacy parameter for banks and lending restrictions on certain weak banks.

Improve the liquidity for non-banking finance companies, a key source of funds for micro, small and medium enterprises (MSMEs).

Frame Capital adequacy norms with the big picture in mind.

We have to align our rules to the Basel rules. Not more. This should be looked upon as a bank driven economy,” he said, arguing that the minimum total capital to be maintained by banks as a share of their total risk-weighted assets (RWAs) need to be lowered to 8%, against the RBI mandated 9%. This, he said, will enhance banks’ ability to lend.

“We are doing more than what Basel mandates and banks have less money to lend. Why should we? When problems do not exist, we create them ourselves,” he said.

Once money is released to this sector, growth rate, consumption, and investment will pick up because it is a bottom-up economy. A new thinking is needed. We have to be rooted to the ground,” said Gurumurthy.

Is there another view to this issue?

Here is Raghuram Rajan, former Governor of the Reserve Bank of India speaking in 2015 on the business opportunity of lending to MSMEs.

“Lending to MSME entrepreneurs, especially in e-commerce space makes a strong business case for the banks, given the changing dynamics in the economy, such as, demographic patterns; urbanization trends; increasing disposable income and dependence on technology platforms; growth in internet user base and availability of easy payment options.”

“With continuous handholding of MSME entrepreneurs, bankers can help them sell their products on e-commerce space and reach a huge market space without having brick and mortar presence,” he said at the Town Hall, then, organised by the RBI.

“Financing of micro, small and medium enterprises (MSMEs) across the world has become very significant in recent years,” he said, while addressing MSME entrepreneurs, who were also suppliers for e-commerce like Amazon, Snapdeal and Flipkart.

What Raghuram Rajan is now saying about MSME Finance

The next build-up of non-performing assets (NPAs) could be in the loans to medium and small enterprises (MSMEs) under the SIDBI-run credit guarantee scheme, he warned. The government should focus on sources of the next crisis, and in particular, it should refrain from setting ambitious credit targets, he said.

Rajan said credit targets were sometimes achieved by abandoning appropriate due diligence, creating the environment for future NPAs.

“Both MUDRA loans as well as the Kisan Credit Card, while popular, have to be examined more closely for potential credit risk. The Credit Guarantee Scheme for MSME (CGTMSE) run by SIDBI is a growing contingent liability and needs to be examined with urgency,” he said in a 17-page note to the Parliamentary Estimates Committee, according to a Bloomberg report.

The committee had invited Rajan to brief it on the matter after former Chief Economic Advisor Arvind Subramanian praised him for identifying the NPA crisis and trying to resolve it.

Uday Kotak, of Kotak Mahindra Bank also shares Rajan’s views.

“If you and I spoke in 2011-12 about project finance and large corporate loans, I was the one who raised concern about fundamental credit worthiness of some of these large project finance loans. I am today raising similar concerns over fundamental role of collateral valuers and the real truth of those valuations… I believe there is a reasonable reason to believe that there is significant overvaluation of collaterals across the banking and finance industry,” Kotak said.

Launched in 2000, the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), now known as UDAAN, has recorded cumulative guarantee approvals of over 25 lakhs with an aggregate loan amount of over Rs.1,25,000 crore in FY 2016-17.

In June 2018, a joint study by SIDBI and credit bureau CIBIL had said that risky loans worth Rs.1.2 lakh crore to MSMEs in the system could potentially create NPAs worth Rs.16,000 crore by March 2019. However, NPAs were actually moderating, but it was too early to say that they were bottoming out, it said. But rising credit demand from MSMEs, partly driven by formalization of credit demand is likely to keep the overall NPA rate in this segment in check, it said.

To tackle trade finance woes of MSMEs, the government announced in May this year that it would double the credit guarantee up to Rs.50,000 crore for 2018-19 under the CGTMSE scheme.

“We are allowing non-banking financial companies partial collateral, and this year, unlike previous years where we used to guarantee a credit flow of Rs.19,000- 20,000 crore every year for last three years, we plan to cross Rs.40,000 crore, it may touch Rs.50,000 crore,” MSME secretary A.K. Panda said.

Who is filling the gaps in Bank finance?

In spite of having over 3,000 specialised branches that deal with MSMEs, bank lending to the sector has remained lukewarm. According to RBI estimates, the total requirement of funds for SMEs is around ₹26 lakh crore but banks have provided just 40 per cent of that so far.

By some estimates India’s 51 million MSMEs are facing a credit short fall of an astonishing $400 billion. The Indian government has been trying hard to mobilize credit and funding for this critical sector of the nation’s economy, which is one of the major sources of friction with the RBI.

Not that the public sector Banks and even the private sector Banks are up to the task even otherwise. The two biggest reasons for the financial exclusion of MSMEs were their lack of a comprehensive credit score, and the long-winded and difficult application process to get a loan.

Even with a good credit score MSMEs would still find getting a loan difficult because of the complex paperwork need, visiting the Bank offices and the long wait. Nor are Bank Officers with targets to fulfil very happy to deal with MSMEs because of the small ticket size and the risk perception compared to larger companies.

Dealing a lot in cash and not having a long transactional history denies them the kind of credit ratings required and automatically disqualifies most MSMEs from getting credit.

India’s MSME entrepreneurs are finding digital start-ups and alternate lending platforms to be the most effective sources for credit.

Evolving solutions to meet MSME Financial needs

India is seeing the evolution of various models to try and fill this gap and to meet the credit needs of the unorganised sector. Non-banking finance companies (NBFCs) which are closer to the ground see small business finance market as a great growth opportunity.

From a time when finance was mostly from one’s own savings or from family, friends and relatives, the entrepreneur next reaches out to money lenders, co-operative Banks, nationalised Banks, Private sector Banks, NBFC’s and most recently to digital start-ups providing an alternative lending platform.

The small business finance market comprises of NBFC-MFIs, large and old NBFCs along with new NBFCs. The aggregate Assets Under Management of NBFCs focussing on small business financing is estimated at INR 33,000-35,000 crores.

Traditionally the lenders to the under-served truck and transport system, NBFCs are now gradually expanding their lending to MSMEs.

Factors contributing to the growth of NBFCs:

Stress on public sector units (PSUs) Latent credit demand Digital disruption, especially for micro, small and medium enterprises (MSMEs) and small and medium enterprises (SMEs) Increased consumption Distribution reach and sectors where traditional banks do not lend

NBFCs as a force in MSME financing

An article in The Hindu of August 13, 2018 provides assuming up of the revolutionary change which is taking place in MSME finance through NBFCs:

If one adopts the definition of an MSME as a unit with investment of up to ₹5 crore in plant and machinery… even financing a truck operator who owns 15 trucks (₹30 lakh each) should qualify as a MSME lending.

The scope and scale of funding is wide, with both small exposure of ₹5-20 lakh as well as lending to enterprises with a turnover of ₹100-1,000 crore coming under the umbrella.

The loans being given to MSMEs are mainly under project finance, e q u i p m e n t finance, business l o a n o r l o a n against property (L A P) . Srinivasaraghavan, MD, Sundaram Finance says that a majority of what passes for MSME lending is really LAP, where the entrepreneur’s residential house is the collateral and the risk is perceived to be lower. By whatever name, the overall quantum of advances by NBFCs to these enterprises is on the rise.

Key players

Companies such as Mahindra Finance, Bajaj Finance, Reliance Commercial Finance, Fullerton India, JM Financial and Centrum Finance are among the many NBFCs who are expanding their MSME lending portfolio. Fullerton, f or instance, has seen a doubling of its MSME portfolio in three years from around Rs 1,900 crore in FY14 to Rs 4,150 crore in FY 2017. Reliance Commercial Finance’s lending to SMEs saw 8 percent growth in 2016-17 to about Rs 8,830 crore. For Mahindra Finance, about 5 per cent of its nearly Rs 44,000 crore loan book is for SMEs.

Rakesh Makkar, Executive VP and Fullerton India, said: “NBFCs have become a major source of working capital for small and mid-size companies. New-age NBFCs, with the help of technology, are redefining turnaround time and product offerings. The trend is picking up at a faster pace as SMEs find this option very convenient to access funds easily and quickly.”

Ecosystem Lending

NBFCs are displaying a new confidence in lending to small businesses. Some of them have begun cautiously, terming it as ‘ecosystem lending’.

Mahindra Finance, for instance, lends to MSMEs that are suppliers of components and parts to its parent Mahindra & Mahindra and other original equipment manufacturers. This gives them better visibility of cash flow and the supply chain dynamics that impact the ability of the borrowers to repay.

NBFCs are in a sense supplementing what banks are doing, although it would be premature to say that they will replace banks in this sector.

Covering the range – From the biggies to the very Small

Large NBFCs cater to borrowers in both the formal sector, who are able to produce documented proofs of income, and the informal sector. Large NBFCs such as Sundaram, Chola, Bajaj and Shriram, dominate the market with over 90% of the aggregate Assets Under Management.

Other players include NBFCs, a number of whom have partnered with Northern Arc Capital, to focus on mortgage loans or secured and unsecured loans to small businesses. Semi-formal and informal sectors remain largely under-served; this is especially true when the loan requirement falls below INR 5 lakhs.

NBFCs catering to the informal segment rely on their ability to assess the clients’ income, develop models to understand the margins and cash flows of local businesses, and have a strong in-house process of credit and security verification. The number of originators in this market and their assets under management is very small in proportion to the demand-presently, they collectively manage less than INR 4000 Crore.

Microfinance has emerged as a step forward in addressing the challenge of greater financial inclusion.

Some MFIs such as Grameen Financial, Grama Vidiyal and Ujjivan have started offering Individual Loans to customers with long-standing relationships, while others like Swadhaar, Arohan and Utkarsh have created a small customer base of individual run micro enterprises.

Newer NBFCs, sensing opportunity, have made a foray into SME lending with innovative business models. These NBFCs analyse informal records that banks generally do not accept, and conduct background checks on potential customers through an exhaustive evaluation process.

They have built unique credit methodologies to undertake cash-flow based assessment of MSME financials, even in the absence of conventional income documents, by assessing customers’ economic activity. Several new players have entered the market.

These new entrants are a mix of new entities and offshoots of existing financial institutions. New NBFCs such as Vistaar Finance, Kinara Capital and Intelle Grow have commenced business with a focus on micro enterprise lending, while others like Shriram City, Bajaj Finance, Religare Finvest, and Au Financiers have leveraged upon an existing branch network and customer base. Large NBFCs including Sundaram Finance and Cholamandalam have increased their portfolios in mortgage and home equity loans especially to small enterprises.

Private Banks & NBFCs eat into PSU banks’ market share’

Private Banks which took some time to warm up, at least to MSMEs at the upper end of the scale, and NBFC’s who service the total range of MSMEs, have ensured that the share of the 21 public sector Banks has fallen from 59.4% of MSME credit in June 2016 to 55.8% in June 2017 to 50.7% in June 2018 according to a quarterly report by TransUnion Cibil and SIDBI.

The overall credit to the MSME segment grew 16.1 percent for the year to June 2018, it said, adding Public Sector Banks reported a 5.5percent growth, compared with 23.4 percent for the private sector competitors.

One reason is that 11 out of the 21 Public Sector Banks are under the Reserve Bank of India’s prompt corrective action (PCA) framework because of earning pressures and net worth concerns, which puts restrictions on lending.

In the meantime, the share of private sector banks has grown to 29.9 percent in June 2018, against the 28.1 percent in the same month last year, while the same for non-bank finance companies (NBFCs) has grown up to 11.3 percent from 9.6 percent. What is more, they fare better on asset quality, as well.

Better & Faster Service for MSMEs

The PSBs’ non-performing assets (NPAs) from the MSME book increased to 15.2 % from last year’s 14.5%, while Pin case of private sector banks, the ratio decreased marginally to 3.9% from 4%.There has been an increase in the turn-around times (TAT) for loan processing across all the three segments of lenders with an average of 26 days for a MSME to avail credit from the date of enquiry.

The NBFCs’ TAT has come down to 18 days from the 24 days two years ago, while the same for PSBs is down to 31 days from 41 days earlier. Private sector banks process loans in an average of 29days now as against 32 days two years ago.

“This finding signals a definite positive correlation between digitisation and increase in efficiency of the commercial l ending market, “said Mohammad Mustafa, chairman and managing director, Small Industries Development Bank of India (SIDBI).

Credit on the upswing-MSMEs lapping it up

The liquidity challenges also appeared to have receded with improvement in the working capital parameters particularly the debtor position which has declined from 100 days as on March 2017 to 78 days as on March 2018, the study of a representative set of 327 MSMEs with rated debt up to Rs.25 crore conducted by Acuite Ratings observed.

Revenues of micro, small and medium enterprises surged by 27 per cent and operating profit by 66 per cent in 2017-18, signalling that vibrancy is returning to the sector after challenges posed by demonetisation and GST rollout, according to a study. “These figures reinforce the belief that the MSME sector is already on a recovery path and should continue to sustain the improved performance in FY19, Acuite Ratings CEO Sankar Chakraborti said.

“SIDBI’s MSME Pulse report jointly released along with TransUnion CIBIL estimates that 5 lakh new borrowers are likely to tap the formal borrowing channels in the first half of 2018 as compared to 4 lakhs in the second half of 2017.

Summing up

After 7 decades of restricted finance MSMEs may finally see good times with Private Banks and Non-Banking Finance Companies(NBFCs) increasing their share of MSME finance.

The present Government and S. Gurumurthy on the Board of RBI is likely to ensure a greater infusion of funds on tap for MSMEs.

The use of technology and new methods of assessing borrowers is already creating enough pressure for the Government & PSU Banks to come up with the 59 Minute Loan Sanction Scheme.

Continued low inflation and Governmental pressure is likely to see a downward trend in interest rates for MSMEs.

Increased competition & technology is likely to help better differentiation and result in preferential rates and terms for consistent performers among MSME units.

Difficulty to believe for MSME entrepreneurs who spent a good part of their lives, cooling their heels outside Bank Manager’s cabins. But the winds of change are blowing. The elephant is on the move!

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