Thursday, November 29, 2012

Banking Sector and MSMEs – Mitigating Mutual Concerns

Originally Published in TISA Nov 2012 Issue
Status Quo
Crisil had stated in January 2011 that “SMEs present Rs. 500 bn funding opportunity for banks.” Majority of these SMEs have turnover of less than Rs. 5 crore.
At the SME Banking Conclave (Feb 2012), the Deputy Governor of RBI K. C. Chakraborty was candid enough to state that “Banks have utter disregard for SMEs”. According to him, most (~ 92.7%) SMEs are self-financed. And this is a fact.
It has been reinforced innumerable times that all businesses revolve around fundamental concerns like finance, employees, product, processes, customers and enveloping legal-statutory-regulatory environment dynamics. The owners and business managers will certainly agree that employees are crucial but not indispensable, products are frequently improved upon or discontinued to give way for new lines, process is often modified to improve efficiency by cutting waste and customer pool can always be increased for sales growth or reducing exposure on receivables of single – party.
But, the principal concern that remains for MSMEs to survive and thrive is – finance. Businesses and individuals alike commonly depend on banks for finance and funding requirements. However, MSMEs often lament the fact that securing loans and credit facilities from banks is easier said than done.
Let us not jump the gun and try to frame the banks outright for being over cautious about their interest and accuse them of being stingy and unreasonable especially while lending to the MSME sector. Nevertheless, banks cannot shirk their responsibility of keeping the economy vibrant with liquidity and cash flow to the MSME sector which is generating huge employment and business both in the domestic and export segments.
We can either continue to collectively stand on the sidelines and debate what is causing autism and if it is an epidemic or we can get on the field and start addressing the real problem - a generation of children with autism. We are not focusing enough on prevention, treatments and support services. ~ Jenny McCarthy
In the same lines to the above quote, we must focus on actually working towards creating a strong relationship between banks and MSMEs, towards clear solutions, one that produces tangible and large results and not simply deliberate about the problem. There are issues and concerns that should be addressed by both sides (MSMEs and banks) to improve the relationship and prospects.
Business Life Cycle and Funding Aspect
Businesses go through selected few stages of transformation and usually follow a life cycle pattern akin to living beings with varying levels of life expectancy. Each stage is characterized by a set of internal strength and weaknesses and external opportunities and threats. These characteristics also determine the type funding available with the MSME and desired from banks.

Stage of Life
Funding Feature
Creativity, Innovative Business Idea, Lateral Thinking for execution, Motivation
Lack of resources, experience, Delivery channel, Customers, Proper operation facility
To serve the market segment, if innovative product then fulfill a gap, create an enterprise of one’s own
Established players, quality of own product/ service, untested if innovative product, lack of data-driven market knowledge, Statutory-Legal environment
Funding needed for initial investment on plant and machinery & working capital to start operations and business development. Expensive borrowing form unorganized parties who are lending at very high cost. Personal loans used in business, Owner’s equity
Bank loan or government funding is minimal. Incubation agencies are now coming into the picture to help with inception.
Orders in hand, Steady Customers, Market Insight, Resources in hand (though still limited)
Team is still weak and under development, Finances are rationed, Working capital and fund rotation are cause of concern, Production or delivery system still being fine tuned
Customer connect and profiling, Targeted advertisement for increased sales, Understanding of forces of competition
To adopt technology for smoother operations
Substitution, defaults, customer dissatisfaction and complaints, concept/ format replication, IPR issues, Statutory-Legal environment
Bank loans are possible at this stage as some collateral can be produced, The business can also show prospect of stability and growth. But rate of interest on loans continue to be expensive and banks still find faults in the supporting documents. They also seek additional guarantees. Funds are needed to add technology products. Personal equity still forms a serious part of the funding. collection of receivables also produces partial cash flow  
Expansion/ Diversification
Business has stabilized, orders are growing and a need to increase capacity is hovering with option to expand product line or start a new venture
Inability to point out how much capacity to be added, Risk of overambitious plans, Management becoming complacent,
Chances of risky exposures creeping into the balance sheet
With strong customer base, market knowledge, operation  execution experience, reasonable liquidity & funding, expansion or diversification is plausible
Risky proposition, where to expand, how much capacity, manpower, changes in overall economic environment,  competition, Statutory-Legal environment
Bank loans are more accessible, the company’s bank itself might offer loans etc proactively based on the balance sheet strength and past performance record, probability of securing venture capital is higher if the product or service is promising and the owner is open enough to management interference from the VC. There are also chances of Mergers & Acquisition or specific joint ventures with firms interested in creating synergy. Crowd-funding is an option.
Assets, strong balance sheet, reserve funds, new business ideas, in-house human resource with experience & performance
Product/ service has reached a level where there is negligible incremental growth, or increase in sales though the current level may be sustained
To venture into new business, new service ideas, opportunity to serve new markets with innovative products, to proactively change course before forced to do so
Existing competition in the market, larger companies already present, complication in setting up new business due to IPR, Statutory-Legal environment
Loans might be pending complete repayment but company is usually in a position to do so. The main funding required at this stage is working capital or few technology/ machinery addition loans.
Not much funding is required at this stage if the company handles its finances properly and complies with all procedures. Alternately, poor management will keep piling on loans and have outstanding which weakens the balance sheet
Only the physical assets and human capital as well as select customers & suppliers
Inability to foresee changes & change strategically & tactically, missed opportunities, dwindling customers & sales, lost business,  
The assets can be useful while selling off to interested parties and wind up business, Government schemes for sick companies
Outstanding payables, loans, and other  Statutory-Legal environment factors which cause obstacles in winding up
Firms need ideas for debt restructuring, one time settlement schemes to pay off banks and creditors, bank support for rehabilitation of sick units. No other source of funding or advice/ consultation is generally available at this stage but business is dynamic and these situations are undesired but do arise.

Banking Sector Concerns
It is evident that the banking sector faces certain impediments while dealing with MSMEs (based on the previous table of information) and their loan/ funding requests. Few of the issues are shortcomings on the enterprises’ side while others are inadequacy amongst our banking sector players and their policies.
·         Credibility of MSMEs is often marked as weak. There is an asymmetry of credit related information from the enterprises which is the cause of the negative perspective. Thus, banks are extremely conservative with this sector and burden MSMEs with twisty documentation.
·         The rating of MSMEs do not get adequate acceptance from banks (especially while analyzing loan requests) irrespective of the claims by the rating agencies. Banks still perform their own due diligence as per in-house parameters and circuitous checklist.
·         The ratio of MSMEs which have smaller loan requirement compared to large companies is high. Therefore, the loan processing system for MSMEs is much more resource hungry. Compound that with weak management control systems and processes that exist in MSMEs.
·         A common problem plaguing MSMEs is agreed credit terms and delayed payment which constricts cash flow and fund rotation. Though there is provision in the MSMED Act 2006 for payment within 45 days; implementation is quite difficult in real life scenario. This is more complicated in case of exports. Such cases often raise a red flag while evaluating enterprise performance.
·         Banks also view the debt servicing capability of MSMEs very critically. That is the reason they stress on more than adequate collateral.
·         Some sectors have more favorable characteristics (like pharmaceuticals, auto components, retail and financial services) which help them in getting cheaper loans from banks. This creates an uneven playing field for MSMEs while putting in request for loans.
·         Poor management, concentration of decision making with selected few who are often not educated enough to factor in the dynamics of today’s business environment parameters.  Lack of skilled staff, second level of workforce and non-existent succession planning.  These are the drawbacks of MSMEs.
·         Banks have inadequate skilled staff at branch levels especially in B and C class cities as well as rural areas (where a large part of MSME activity is happening) to scrutinize business viability before approving loan requests. They are equipped to understand straight accounting procedures and not the nuances of small and medium business which often have informal business practices (not unethical) for survival.
·         Statistically MSEs also have high failure rate (world – over) which makes them unattractive till they have gained “critical mass”.
·         Banks are concerned with type of collateral, past record (if any) including personal loan servicing capability and owner plus employees’ competency in running the enterprise profitably and ethically within defined system and procedures. Loan against property also requires extensive documentation from layout plans to municipality certificates and licenses which are not easy for smaller firms to gather.
Probable Mitigating Measures
RBI had issued a circular on SME financing in August 2005 (RBI/2005-06/131) which clearly states that SSI financing is included in the priority sector and banks should have clear guidelines on time for disbursal of loans which is a positive step towards empowering MSMEs.
Government, banks and the MSMEs have to work in cohesion to address this issue of loans and credit, business funding and rehabilitation in case of sickness.
·         There is no doubt that government will have to step in with direct lending schemes and walk hand-in-hand with banks to divide the credit risk of lending to MSMEs. It is for them to improve the economic climate of the country and push for reforms. The recent few sweeping actions seem promising at face value.
·         Simplify taxation and compliance for MSMEs and smoothen information asymmetry.
·         Government on their part has to set up a mechanism to account for all MSMEs across the nation which will help gather crucial company data on a common platform and allow banks to tap into it. It will surely reduce transaction costs and monitor business risks. It will also provide compiled information about the actual state of the sector.
·         VCs are an option though MSME owners might have to relinquish a part of their management control and allow VC nominated personnel on the board for control and reporting. But it is VCs are however, far and few when it comes to mass MSMEs. If the government plans to go ahead with providing specific tax sops to VCs then it will be an incentive for them to lend to this sector.
·         Credit Guarantee Schemes for rehabilitating sick units needs more clarity and mechanism for faster action.
·         Today banks have dedicated division or business unit to handle the specific requirements of MSMEs which was not the case earlier. This is a positive step. The need is for more branch level approval and disbursal of loans.
·         Specialized training to the loan department employees should be imparted to understand how MSMEs function. A regular bank – MSME Association interaction with representatives from both sides discussing their issues and concerns will help build a clear charter.
·         Banks must clearly state the acceptable financial parameters, ratios and numbers to MSMEs so that they can self – evaluate their position and have realistic views.
·         Even the banks need innovation in their credit delivery system and create customized offering for MSMEs considering their business attributes and case to case basis request.
·         Banks should improve their manager’s performance parameters by factoring the loans and advances disbursed by them towards MSMEs as their key performance indicator.
·         Lending at higher rates than BPLR has to be tapered off. Today the rates for very “good rating” is around 13.50 percent and above. Deregulation might aid in better credit movement in the economy.
·         What are the risks of lending Rs. 1 crore to one company vis-à-vis Rs. 10 lakhs to 10 entrepreneurs? Apart from the resource part to process the loans, the chances of 10 companies going bust is lesser than one company making few miscalculated decisions and going into red.
·         Banks have to restructure their systems and lending mechanism to aid growth and not protect against projected risks. They need to have a time bound system of evaluation and lending just like any project plan.
·         MSMEs on their part should be proactive in adopting small and steady technology improvements to enhance productivity and quality as well differentiation of their product and services which will create a favorable stance from the banks particularly while assessing credibility.
·         They have to work on creating appropriate organization structure, competency in their staff and clear succession planning.
·         Ownership and management control also requires attention because often MSMEs are owner driven firms with decision making concentrated with one or two key persons.
·         Clear systems of accounting should be implemented. Routine generation of management information reports to highlight firm performance is necessary. Management must have a clear system of receivables status and collections to monitor outstanding.
·         Specific stress on costing, pricing and control on overheads is a must.
·         Well-defined business processes and organization communication should be installed. There should be documentation and training to help each employee understand their job roles and perform accordingly.

Making and Maintaining Progress
Risk is an inherent part of our lives. We cannot remain risk averse and stay locked in a window less room forever. Businesses are not devoid of risks both internal and external. But entrepreneurs are still venturing outside their comfort zone to create value. Trust me no business owner ventures out to make losses and shut shop. People always give their best to stay afloat. Banks also should try to play safe only to a logically acceptable extent and not be skimpy towards lending to MSMEs. It does not make any economic justification to hoard cash and sit on it. Where is the value creation?
Banks have been given a mandate to lend to SMEs at a target of their own but increase the lending by 20% YoY. The initial outcome might be limited but soon it will generate bigger results.  “Reaching the unbanked” and appropriate credit delivery through various constructs is what banks have to aim for. They must change their disdain towards MSMEs. They are bankers who are in business simply because there is money generated which needs to be managed. They are not creating anything, they are care-takers.
The need has arisen for financial inclusion of MSMEs to increase liquidity and ability to compete. There are specific mechanism and schemes needed to promote women entrepreneurs specifically those creating employment opportunities in the rural and semi-rural areas. Banks must organize focused awareness drive for MSMEs to take benefit of their schemes while understanding the details and suitability of the offerings.
MSMEs on their part also need to address the legitimate concerns of the banking sector and try to create structures and functions to tackle them. They must concentrate on strengthening their internal issues and demonstrate their bankability through compliance and good governance.
There has been enough “discussion” on issues back and forth. It is time for action, for hard core numbers in black and white through public reports and real life success cases of banking sectors’ outreach programs for MSMEs. 
“Take time to deliberate, but when the time for action comes, stop thinking and go in.” ~ Napolean Bonaparte

Sunday, November 18, 2012

United Arab Emirates- Rise of the Small Kingdom in Middle Earth

Emergence of a Strategically Located Diversified Sustainable Economy
Moving away from Oil
All good things come in small packages.
United Arab Emirates (UAE) is a group of seven small kingdoms situated in the Persian Gulf; part of geographically referred to as Middle East (see Map). The seven kingdoms are Abu Dhabi, Dubai, Ajman, Fujairah, Ras-al-Khaimah, Umm al Quwain and Sharjah. Sharjah is the third largest among the seven.
It is a high income developing economy (as per IMF), that depends on oil as one of their prime produces; it is also a member of UN, OPEC as well as WTO apart from other bodies.
Physically, UAE is about the size of state of Sikkim in India but the economic potential packed within this area is simply astounding. 
The visionaries of UAE, the leaders and business community included have been astute enough to be able to foresee the vagaries of being an unsustainable Oil-dependent economy and a country served by migrants and expatriates. The direction of plans and policies of UAE have taken these concerns into account.

Wednesday, November 7, 2012

Economy & Industry - Large and Small: Creating Synergies

The perfect solution to the problems of SMEs is yet to be devised, and there is a need for creative thinking.