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
|
Strength
|
Weakness
|
Opportunity
|
Threat
|
Funding Feature
|
|
Inception
|
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.
|
|
Growth
|
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.
|
|
Maturity
|
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
|
|
Decline
|
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.
Government
·
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.
Banks
·
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
·
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
