Concerns over finance to MSEs: What’s stopping banks to act as development facilitator

The Reserve Bank of India has recently launched National Mission for Capacity Building of Bankers for financing MSME sector (NAMCABS) for sensitizing and on imparting skills to bank officials. The main focus will be to up-skill 3 lakh banking personnel who have joined the system over the past six years and perhaps who have very limited exposure to MSMEs. Let us study here why so much of significance attached by the Government and RBI to this sector and why the sector is ambling down despite government has been spending thousands of crore rupees on the development of the sector by way of providing subsidies and skill development trainings. We will also discuss here why MSEs do not get adequate finance from financial institutions and how can we achieve the better balance.

The Micro and Small Enterprises (MSEs) remain dominant sector of the Indian economy both in terms of contribution to gross domestic product (GDP) as well as a source of employment to millions of people across the country. It is estimated that India has over 467.56 lakh enterprises in the MSME sector (95.05 % are micro, 4.74% small and 0.21% are medium enterprises) and the proportion of these enterprises operating in rural area is 45.38 percent. The sector provides the largest share of employment after agriculture which provides employment opportunities to 10.61 crore people. The sector is also contributing to 45 percent of National Industrial outputs including chemicals, pharmaceuticals, plastics & polymers etc.  The sector is contributing nearly 8 percent of the country’s GDP and is responsible for over 40 percent of our exports items.

Government interest in the development of MSEs:

Since independence of India, the successive Governments were working on ambitious plan to turn India into a global manufacturing hub. The National Credit Council in its meeting held in July 1968 highlighted that commercial banks must increase their participation in the financing of priority sectors, viz., agriculture and small scale industries for all round development of the country. The sketch of the priority sectors was later formalized in 1972 on the basis of the ‘Informal Study Group’ on Statistics report, linking to advances to the Priority Sectors. In the year, 2006, the Micro, Small and Medium Enterprises (MEMED) Act was enacted to address policy issues affecting MSMEs. The present Government has  taken initiation on revise the definition of MSME Act 2006 based on experience over the last eight years as it felt the need of review the size in relation to contemporary capital cost involved in setting up manufacturing units ( present definition to be amended as (i) a micro enterprise where the investment in plant and machinery does not exceed fifty lakh rupees (ii) a small enterprise where the investment in plant and machinery is more than fifty lakhs rupees but does not exceed ten crore rupees; (iii) a medium enterprises where the investment in plant and machinery is more than ten crore rupees but does not exceed thirty crore rupees). This would mean that enterprises investing a larger sum on plant and machinery than the defined under the existing act would continue to keep the enterprises in the MSME fold.

Easy Access to bank credits:

The bank loans to micro and small enterprises up to Rs.5 crore per borrower unit are treated as priority sector advance.  Since specified portion of bank lending to priority sector enterprises is mandatory, it has eased the flow of credits from commercials banks to MSE sector. There are total 467.56 lakh working enterprises across the country, out of which 95.05 per cent belonging to Micro enterprises, 4.74 per cent to small enterprises and only 0.21 percent are medium enterprises (Source: The 4^th All India Census). In order to address the grievances of inadequate credit flow to these MSE units, banks have been advised to achieve a 20 percent year-on-year growth in credit, a 10 percent annual growth in the number of accounts and 60 percent of total lending to MSE sector as on March 31 preceding year. Besides, to facilitate MSEs who do not have collateral security to offer for the loan, RBI stipulated certain guidelines to banks under which banks cannot take collateral security for loans up to Rs.10 lakh extended to MSE units. Banks may even consider sanction of collateral free loans up to Rs.25 lakh on the basis of good track record with the approval of appropriate authority.

Subsidies:

The Government of India has been extending thousands of crore rupees of financial assistance to MSEs through various subsidy schemes viz. (i) PMEGP Scheme (subsidy from 15 to 35 percent for loans up to Rs.25 lakh). (ii) under CLCS Scheme for technology up gradation 15 percent (Maximum subsidy 15 lakhs), (iii) Under TEQUP scheme 25% (maximum 10 lakhs) (iv) Projects for setting up ‘Business incubators’ (BI), 75 to 85 percent of the project cost (maximum Rs.8 lakh per idea/unit) and BIs are entitled for Rs.3.78 lakh for infrastructure and training expenses for incubating 10 ideas. (v)The Government is also reimbursing 75 percent (maximum Rs.75000/-) of certification expenses to MSEs that have acquired (QMS)/ISO 9001 and EMS/ISO 14001/HACCP certification and  (vi)Rs.1.50 lakh for obtaining product licensing/ marking to National standards and Rs.2.00 lakh for obtaining products licensing /marking International standards.

Skill development programmes:

In order to create 13 million jobs by way of self-employment and wage-employment every year, the National Skill Development Mission and National Policy for Skill Development and Entrepreneurship are being unveiled by the Government. In addition to the Government extending assistance for Cluster Development, marketing assistance to SMEs, the commercial banks in India have also set up ‘Rural Self Employment Training Institutes’ in every district across the country to plug the ‘skill gap’ presently faced by the sector. These institutes conduct various skills up gradation programmes for a short duration ranging from 1 to 6 weeks. Such training helps existing entrepreneurs to abreast with latest development all over the world in their line of business.  Also, many banks set up special cells at their branches or under Financial Literacy Centers (FLCs) to provide knowledge to MSEs about operational skills and financial literacy including accounting, finance and business planning etc.

Credit Guarantee facility:

Further, to raise the spirits of the banks to increase their stake in lending to MSEs, the Government of India and SIDBI set up the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE).  When a borrower is not in a position to offer collateral security and third party guarantee, the CGTMSE would provide guarantee to financial institutions for credit facility up to Rs.100 lakh extended to MSE borrower without collateral security and third party guarantees. Under the scheme, if the borrower fails to discharge his liability, CGTMSE would make good of 85 percent of the outstanding amount in default to the lender. However, the guarantee fee and annual service charges of CGTMSE to be borne by the borrower.

Protection against delayed payment from Corporates:

The MSMED Act 2006 provides that the goods and service supplied by a MSME unit, the buyer shall make the payment within 45 days. The agreement between the buyer and seller may be in writing or oral or even without agreement, the buyer shall not delay the payment beyond 45 days. The buyer is liable to pay interest at the rate of three times of the Bank Rate notified by the Reserve Bank at monthly rest. Any dispute with regard to amount due shall be referred to MSE facilitation council constituted by the State Government. Further, as per RBI guidelines, banks are required to fix a sub-limit for payments to SMEs, within the overall limit sanctioned to large corporate borrowers.

Then what’s stopping MSEs from the growth trajectory?

Regardless of Government investing huge amount of money in the form of Capital assistance, skill development programmes and enacting various laws for protection of the MSEs, the environment for growths of MSEs are not fast enough. The sector has been primarily depending upon debt financing as source of equity funding remain elusive in our country. The various studies disclose that MSEs are ambling down for years, despite of government assistance for their all-round developments. Most of these units are currently struggling due to inadequate assets, inadequate long source funds/capital and susceptibility to market fluctuation. Excessive informal borrowings at higher rate of interest by the micro and small enterprises found to be another prominent factor of bank loan defaults which stops further flow of credit to such enterprises. The other glitches are non-availability of skilled man power, low technology, high administrative/ transaction costs, lack of professionalism, delay in receiving payments, not getting finance for job work, difficulties in marketing and product branding etc. The 4^th annual employment-unemployment survey (2013-14) of Labour Bureau released (in 2015) reveals that 14.50 percent end-up without work after Government sponsored skill upgrade training.  The recent survey found that except for a handful of trades like leather work, plumbing, motor driving and tour/travel operations, all other categories of skilled persons exhibited double digit unemployment.  Therefore many researchers of Indian employment scenario opine that spending Government money on imparting skills is impractical without creation of new jobs to accommodate those trained under Government sponsorship.

Why MSEs do not get adequate finance from financial institutions?

Although, the commercial banks and other financial institutions have been making steady strides to increase their share of credits to MSE sector, but they have certain difficulties in sanctioning limits to SME borrowers.  In an environment of NPA numbers in banking sector alarmingly swelling, banks themselves are under the stress and facing challenge to raise capital.  The banks and financial institutions look for safety measures of money financed by them like security, guarantee, and insurance etc. Usually, six factors called ‘CAMELS’ (Capital adequacy, Asset quality, Management quality, Earnings, Liquidity and Sensitivity to market risk) are considered for evaluation of a credit proposal.  In the cases of MSEs, the majority of borrowers fail to submit the information called for by the banks, as they do not hold adequate financial statements or business plans.  Therefore, in the absence of financial information and track record of credit worthiness of the borrower, the banks are unable to sanction the requisite loans. Adding to the above qualms, MSEs are regarded as high-risk sector for lending on account of numerous instances of quick mortality, as well cases of diverting and siphoning off funds by unscrupulous promoters that are found to be prominent factor of default in MSE sector.

How can we achieve the better balance?

Financial facilitation to the MSEs is critical for job creation, export growth and development of a manufacturing base in India. Therefore, there is a dire need to accelerate adequate finance to this sector in a resolute way. However, this job cannot be simply passed on to the commercial banks without ensuring fair recovery finance released by the lenders. Many researchers spell out their advice, advocating the intervention of the Government in the following areas for a progressive role in expanding financial access to the MSE sector.

1. The setting up of TReDS, which are expected to commence their operation shortly, is expected to solve the problems of delayed payments from corporates. It will also ensure quicker financial flow to the MSEs, that too at a cheaper rate of interest. TReDS (Trade Receivables Discounting System) is an institutional set up for flow of finance to micro, small and medium enterprises (MSMEs) would start the activities as authorised payment system under the Payment and Settlement Systems (PSS) Act, 2007 under the supervision of RBI. The model outlined for TReDS in the paper, envisages its operation both in primary market segment as well as a secondary market segment. The MSME trade receivables discounted by banks and other financial institutions on TReDS are essentially in the form of a reverse factoring system. In reverse factoring, the seller (supplier) trades his duly converted factoring units of invoices/bills of exchange, to the financier at the behest of the buyer corporate. The financier (bank or Non-banking financial institution) who buys these factoring units, steps into the shoes of the supplier to receive payment from the corporate buyer on due date. Once the invoice/bills of exchange is discounted by the financier, the onus of collecting payment from corporate buyer rests with the financier without recourse to the seller (supplier who sold the invoices/bills of exchange to the financer is discharged from liabilities to the financer on account of discounted invoice). The advantage to the supplier is that the rate of interest decided by the financer while discounting the invoice (factoring units) is based on the rating of buyer corporate and not on the rating of the seller. He therefore gets the better pricing in the competitive bidding due to good credit rating of his clients. For more details on TReDS, log on to https://bankingschool.co.in/loans-and-advances/do-you-know-how-treds-helps-msme-finance/
2. The Government should also support the MSEs to raise funds through venture capital or incentivize market capital/equity investment by providing seed equity and also set up an institution to assist them in the process of introductions to investors, professional service providers.
3. The Government may think of providing tax rebate on income earned by the micro and small enterprises if they plough back the same in the business. This is in view of many people believed that a section of micro and small entrepreneurs hide their profits to avoid taxes and thereby showing the units under loss. It is presumed that such tax break on income earned by SMEs would encourage them to come out with clean records on their real profit and gain access to bank finance on the basis of their financial strength.
4. Banks should help the genuine cases of sick enterprises for reviving their operations. The experts are of the opine that it is a necessary risk a bank must be prepared to take if it allows more units to be set on the track of recovery. The banking regulator shall explore the ways to allow more flexibility in restructuring micro and small enterprises in distress. The Government can also have a scheme of incentivizing financial institutions who participate in the revival process.
5. There is a need of educating entrepreneurs at regular intervals, on financial products and services, advancing innovation, enhancing productivity and improving business mode etc., more importantly in building financial awareness among rural and semi urban entrepreneurs.
6. The common complaint against banks is that the MSE borrowers continue to pay them higher rate of interests compared to large borrowers on the basis of their ratings. There is an urgent need to provide differential rate of interest rates for MSEs whose loans are covered under credit guarantee scheme of CGTMSE. Banks need to consider scoring models in their evaluation of loan to ensure that interest rates are lower for the units who achieved higher scores. The reduction of interest rates for healthy units is necessary to ensure fair and transparent credit pricing.

Besides implementing suitable action plans for all round developments of MSEs, the Government and the Central bank should also chalk out a plan on the basis of various suggestions given by the experts to weed out pitfalls stemming from bad loans in Banks. We must remember that any super-rapid implementation of corrective action plan without addressing the lacunae may end up negating the intended benefits to all concerned.