Why do small and medium enterprises not get adequate bank finance?

Although, commercial banks and other financial institutions have been making steady strides to increase their share of credits to the MSE sector, but they have certain difficulties in sanctioning limits to SME borrowers.  In an environment of NPA numbers in the banking sector alarmingly swelling, banks themselves are under stress and facing challenges to raise capital.  The banks and financial institutions look for safety measures for money financed by them like security, guarantee, insurance, etc. Usually, six factors called ‘CAMELS’ (Capital adequacy, Asset quality, Management quality, Earnings, Liquidity, and Sensitivity to market risk) are considered for the 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 a track record of the creditworthiness of the borrower, the banks are unable to sanction the requisite loans. Adding to the above qualms, MSEs are regarded as a high-risk sector for lending on account of numerous instances of quick mortality, as well as cases of diverting and siphoning off funds by unscrupulous promoters that are found to be prominent factors of default in the MSE sector.

How can we achieve a better balance?

Financial facilitation to the MSEs is critical for job creation, export growth, and the development of a manufacturing base in India. Therefore, there is a dire need to accelerate adequate finance to this sector resolutely. However, this job cannot be simply passed on to 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 is expected to commence its 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 setup for the 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 a 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 the due date. Once the invoice/bills of exchange are discounted by the financier, the onus of collecting payment from the 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 the buyer corporate and not on the rating of the seller. He therefore gets the better pricing in the competitive bidding due to the good credit rating of his clients.
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, and professional service providers.
3. The Government may think of providing tax rebates on income earned by the micro and small enterprises if they plough back the same in the business. This is because many people believe that a section of micro and small entrepreneurs hide their profits to avoid taxes thereby showing the units under loss. It is presumed that such a tax break on income earned by SMEs would encourage them to come out with clean records of their real profit and gain access to bank finance based on their financial strength.
4. Banks should help the genuine cases of sick enterprises to revive their operations. The experts 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 ways to allow more flexibility in restructuring micro and small enterprises in distress. The Government can also have a scheme of incentivizing financial institutions that participate in the revival process.
5. There is a need to educate entrepreneurs at regular intervals, on financial products and services, advancing innovation, enhancing productivity 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 rates of interest compared to large borrowers based on their ratings. There is an urgent need to provide differential rate of interest rates for SMEs whose loans are covered under the credit guarantee scheme of CGTMSE. Banks need to consider scoring models in their evaluation of loans to ensure that interest rates are lower for the units that 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 based on 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 a corrective action plan without addressing the lacunae may end up negating the intended benefits to all concerned.