Ensuring adequate and timely credit to Micro & Small Enterprises (MSEs) by banks – Identifying a success strategy.
By Dr S Santhanam PhD(Eco), General Manager (Retd), NABARD and Consultant-Development Finance, Pune.
Remove the foot from the brake pedal, Change gears and Accelerate the Growth of MSE’s
MICRO AND SMALL ENTERPRISES (MSE’S) IN INDIA
Micro and Small Enterprises (MSE’s) have been widely accepted as being vital to the Indian economy given their role in job creation and their ability to foster entrepreneurship. At present, the three classifications of enterprises are clubbed into a single sector viz., Micro, Small and Medium Enterprises (MSME’s). It also includes Khadi, village and coir industries (Table:1).
This paper discusses issues relating to bank finance with regard to the first two classifications viz., Micro and Small among the MSMEs. It analyses the status and characteristics of MSEs, factors, both internal and external, affecting the flow of bank finance to this sector and lays down strategies for accelerating the pace of bank finance for its development.
Table:1. Classification of MSEs – Investment ceiling in Plant, Machinery/Equipment
|Micro||Up to Rs 25 lakh||Up to Rs 10 lakh|
|Small||Above Rs 25 lakh & up to Rs 5 crore||Above Rs 10 lakh & up to Rs 2 crore|
Status and Characteristics
i. Heterogeneity of MSE sector
The MSE sector in India is highly heterogeneous in terms of the size of the enterprises, location, variety of products and services, people employed, coverage of the social sector, and leveraging information, communication and technology (ICT) in running their enterprises. Of the total number of MSMEs estimated at 214.38 lakh, as many as 214.35 lakh indicating that almost all the units were MSEs. These two categories of enterprises have contributed to employment of 497.61 lakh people (Tables:2&3).
Table:2. Number of MSEs- Type-wise
|Total – MSMEs||15.64||198.74||214.38|
|Total – MSEs||15.61||198.74||214.35|
Table:3. MSEs- Employment-wise
|Category (Number- lakh)||Regd||%||Unregd||Total|
ii. Industry-wise distribution of enterprises
Among various types of industries classified under the MSE sector, the top three positions were held by industries relating to manufacturing of food products (62.99 lakh), wearing apparels (35.91 lakh), and the textiles (35.91 lakh) sector. Among the services sector, the top three positions were held by the industries in sale and maintenance and repair of motor vehicles (30.03 lakh), education (27.26 lakh), and health and social work (16.07 lakh). Computer and related activities, a new entrant to this sector, were also found to be contributing significantly by providing employment to 10.52 lakh people (MSME Annual Report, 2012-13).
iii. Ownership of enterprises – Social Group-wise
Analysis of the MSE sector in terms of the social group reveals that the enterprises owned by Scheduled Caste (SC), Scheduled Tribes (ST) formed just 13.59% of the total number of units in the country. The enterprises owned by OBCs showed a significantly higher level at 41.94% (Table:4). In the context of the national policy for supporting MSEs of those owned by such disadvantaged groups like SCs/STs/OBCs, low coverage of bank finance poses a challenge for banks.
TABLE:4. OWNERSHIP OF ENTERPRISES – SOCIAL GROUP-WISE
|Sch Caste (SC)||7.6||7.84||7.83|
|Sch Tribe (ST)||2.87||5.89||5.76|
|Other Backward Classes (OBC)||38.28||42.11||41.94|
iv. Banks’ concerns in lending to MSEs
The Fourth Census of MSME sector revealed that only 5.18% of the units had availed of finance through institutional sources. While 2.05% had finance from non-institutional sources, the majority of units i.e. 92.77%, had no finance or depended on self-finance.
There are concerns that banks face while lending to smaller enterprises. Credit information about a small enterprise is not as easily available, as it is for a larger firm, and it is not cost-effective for the lender to collect information on all small enterprises. Nor have the small enterprises adequate collaterals to offer. The lenders, therefore, either refrain from lending or load the cost of information asymmetry into the lending rates. Another important factor is that risk assessment of smaller enterprises requires a separate set of tools as against the conventional tools, the absence of which is likely to dissuade banks from such lending.
v. Priority Sector Lending and MSEs
There is no sub-target fixed for MSE lending for banks though it forms part of priority sector lending, which means that even if a bank does not make any lending under MSE segment, it can fully achieve all priority sector stipulations by lending to other priority sector segments.
vi. Usage of Credit Guarantee Scheme for MSEs
The Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) set up in 2000 operates a Credit Guarantee Scheme (CGS) which guarantees grant of collateral-free and /or third-party guarantee-free-credit facilities to MSEs by Member Lending Institutions (MLIs).
Although the CGS is in operation since 2000-01, out of a total number of MSE accounts of 21,80,036 with the banks, the accounts covered under the CGS were just 57,552 (31 March 2009) which constituted only 2.64% of total accounts. Further, only about 10% accounts representing collateral-free bank loans up to Rs 25 lakh were covered under the CGS.
The Working Group on MSEs set by the RBI in 2009 reviewed the working of the CGS and suggested measures to enhance its usage by banks. However, as observed above, a number of challenges in the implementation of CGS such as poor coverage of loans under CGS, low settlement rate by the agency to banks etc., still remain unresolved.
vii. Areas of divergence in guidelines
The Bank of Baroda had undertaken a study of its select branches in Kerala in financing MSE sector and implementation of guidelines of CGTMSE and RBI concerning this sector. The study analysed various aspects governing financing of MSE sector by banks. These are classified in the following matrix (Table:5)
Table:5. Divergence in Guidelines of CGTMSE and RBI
|The maximum amount of collateral-free loan.||Rs 100 lakh||Rs 10 lakh|
|Mandatory nature of lending.||Non-mandatory||Mandatory|
|The quickness of sanction.||Delayed||Quick|
|Reason for delay.||Sanction needs approval from CGTMSE before disbursement||No delay, since sanction is at the bank level|
|Cost to borrower||Borrower to bear guarantee fee. For MEs up to ` 10 lakh is borne by CGTMSE.||No additional charges both to MSEs|
|Recovery of dues in case of default||i. Lock-in period of 18 months
iii. Guarantee to be invoked within one year (now 2 years) of account classifying as NPA.
iv. Final claim is paid by the Trust to the MLIs after three years of obtaining of the decree of recovery.
|i. No such lock-in period
iii. No such condition
iv. No such condition.
The study concluded that divergence in guidelines issued by CGTMSE and RBI had contributed to poor growth of CGTMSE lending in Bank of Baroda, in Kerala. This is another challenge banks would be facing in financing MSEs.
As mentioned above, the MSE sector is heterogeneous in character and so, one size fits all approach of providing one standard bank product or a set of financial products would not address the issues being faced by the sector. So, it is attempted to look at the sector slightly moving away from the conventional bank finance approach being followed by banks under the extant guidelines of the RBI.
At present, banks finance MSEs using conventional finance products such as composite loans (combining working capital and investment credit), separate term loans and working capital loans for large size MSEs.
Under conventional financing, investment credit to an MSE is provided by way of a term loan with an appropriate rate of interest charged on the loan amount sanctioned. For example, if a loan of Rs 50,000 is issued to an MSE carrying an interest of about 15% to be repaid over a period of 4 years, the principal compounded with interest would reach a level of Rs 77,240 at the end of the stipulated period. In other words, the borrower would be required to pay an interest of Rs 27,240 on a loan of Rs 50,000 which would be more than 50% of the principal amount borrowed by it from the bank. Though, with the interest rate compounded increase the loan burden of the borrower considerably, it will be less than the interest rate charged by the informal system. However, compounding of interest has its own demerits.
The power of compound interest will result in unpaid loans leaving the lender and the borrower in distress. The result is a vicious cycle that sets up a domino effect of defaulters. Compounding interest grows so fast and the borrower would not be able to pay his bank dues making the economy to pay the price. So, charging interest may not be a solution for financing MSEs at least for those disadvantaged (SC/ST/OBCs) and those at the lower end of the spectrum.
According to experts in finance, conventional finance creates artificial money supply not being backed by real assets leading to high inflation, rich becoming richer. So, what is the solution available for financing such assets of MSEs which are run by those who do not have means to offer even collaterals, particularly the enterprises set up by SC/ST/OBCs? Therefore, the strategy proposed will be a combination of providing investment finance by way of ‘finance lease’ in lieu of term loan and /or using ‘participative financing’. In addition, an outline on the idea of introduction of ‘Referral Programmes for MSE customers’ is also given in the paper.
The guiding principles
The bank finance to the MSE sector would be guided by the following principles:
- Partnership finance
- Collateral free finance
- Low-cost finance
- Target financially disadvantaged
- Provision of non-financial services
Keeping the above guiding principles, the product features and mode of providing such products to MSEs are discussed and presented below:
i. Finance lease
Procuring an asset by way of leasing has emerged as a popular funding option among the business enterprises. But, this facility is available generally, for corporate borrowers. It is time that this is extended to the MSEs also, particularly for those enterprises run by SCs/STs/OBCs which need encouragement and hand-holding support.
The lease transaction involving acquisition of capital equipment to be used by the actual use for a fairly long period of time (over the economic life of the assets) is popularly known as ‘finance lease’, where the lessor is the legal owner and the lessee enjoys the ‘usufructs’ of the leased asset.
There are certain merits of finance lease which may include, no margin money, customised cash flow for the lessee, avoidance of loan covenants and fast and flexible financing, and hedge against risks of inflation and obsolescence.
Of course, lease financing has certain demerits as well. Leasing is considered as not suitable for project financing as asset leasing requires rentals to be paid in advance, while in project financing, a long gestation period is normally required. Leasing arrangement would prove costlier than other funding arrangements where the residual value of the asset is substantial and in a finance lease.
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i. MFIs as financial intermediaries
Over the last two decades, a large number of microfinance institutions (MFIs) have contributed to the growth of microenterprises(MEs). Since 2011-12, a special class of for-profit institution viz., NBFC-MFI has also been allowed to operate by the RBI. It is estimated that more than 800 MFIs served 26.8 million customers in 2011-12 with an outstanding loan portfolio of Rs 209.1 billion.
NBFC-MFIs served about 87% of the total customer base of MFIs. MFIs have more than 60,000 loan officers spread across 12,000 branches. They introduced the concept of financing MEs adopting Joint Liability Group (JLG) model which banks also started using for financing their small-ticket borrowers. They are tech-savvy and some of them having their Core Banking Solutions (CBS) for their own microfinance business. Over 0.195 million
Business Correspondents / Customer Service Points (BC/CSPs) have been deployed to provide ‘the last mile’ banking services to the unbanked people and the role of MFIs is significant in this regard. So, leveraging the MFIs and particularly the NBFC-MFIs would help to increase the credit flow to MSEs particularly for their investment credit needs.
As regards NBFCs/ MFIs that may be allowed to undertake participative financing and/or any other non-interest-based financing, the RBI may issue suitable directions for compliance by banks and other agencies allowed in this regard.
ii. Make use of ICT mandatory
Information technology has annihilated time and distance. The research by global management consulting firm BCG for Microsoft revealed that about 90% of small and medium enterprises (SMEs) in India have no access to the internet and leveraging latest IT tools and techniques can help India’s small businesses boost revenues by $56 billion and help create over a million jobs. So, as part of financing an MSE, cost of setting up of an internet facility should be taken into account and support provided on softer terms (grant + subsidy). RBI may issue suitable guidelines to banks in this regard. As this measure would incentivize the MSEs and bring them in contact with the outside world, the GOI may also consider providing grant/subsidy for defraying the investment cost for the purpose.
iii. Use specialized institutions for financing MSEs
Setting up of ‘small local banks ’ is one of the ideas proposed by the RBI which can play an important role in the supply of credit to small enterprises and agriculture and banking services in unbanked and under-banked regions in the country.
There are specialized branches (Example: Microsite branches of Indian Bank finance only through SHGs) for financing MSEs, particularly of those disadvantaged groups. These branches should be strengthened in terms of capacity building, awareness creation etc., to provide bank finance to MSEs.
SIDBI has set up a ‘loan facilitation and syndication service’. This may be strengthened. Organisations like Bhatiya Yuva Seva Trust (BYST) which provide mentoring services for youth willing to set up MSEs are working with banks like Indian Bank. Similar initiatives may be encouraged.
iv. Address divergence in guidelines on CGS
It would be necessary to address the issues of divergence on the guidelines of CGTMSE and RBI as discussed and make the directions uniform for banks to follow without any ambiguity in implementation of CGS.
v. Provision of Tax incentives for financing MSEs
The GOI may consider providing tax incentives for banks to the extent of their financing MSE sector during a particular year. Modalities with regard to the extent of coverage of such loans to MSEs and the level of tax incentives to be offered to the banks may need to be worked out by the GOI in consultation with the RBI.
vi.Provide factoring services to Small Enterprises
“For small and medium firms, we intend to facilitate Electronic Bill Factoring Exchanges whereby MSME bills against large companies can be accepted electronically and auctioned so that MSMEs are paid promptly,” Dr Raghuram Rajan, Governor, RBI had mentioned in his report on ‘Financial sector reforms — A Hundred Small Steps’. Though there are divergent views on this from various quarters, it would be necessary to consider this proposal for the growth of small enterprises.
Some of the guidelines of the RBI such as collateral-free loan up to a particular level, coverage of bank finance under the CGS etc., are found to be observed more in breach by banks. Since collateralized loans may not be eligible for the CGS cover, banks should not in their own wisdom collect collaterals for issuing loans to MSEs thus depriving such enterprises the scope for coverage under the scheme of the CGTMSE. These conditions should be made ‘non-negotiable’ for banks.
Keeping the above principle in view, the following matrix attempts to summarise the strategy for financing MSEs.
|Category of MSE||Type of MSE||Strategy|
|Investment up to `5 lakh||MSEs-Manufacturing and services.||1. Focus SC/ST/OBC entrepreneurs.
2. Provide collateral-free bank finance through a combination of ‘finance lease’ and deferred loan facilities.
3. Compulsory coverage under the CGS
4. Banks should be the nodal agency for coordination and getting all subsidies and financial support from various agencies.
5. Encourage microenterprises showing promise of graduating out to the next stage.
6. Adopt JLG mode and intensify bank finance through BCs and through MFIs.
|Investment range > `5- `25 lakh||Same as above||As above from a. to e.
1. Start large pilots by providing bulk finance to MFIs including NBFC-MFIs for on-lending to microenterprises on an agency mode thus outsourcing the bank branch functions. The MFIs would follow the same guidelines as that of the principal banker in appraisal, documentation etc.
|Investment range >`25 – `1 crore||Same as above||As above from a. to e.
1. Entire finance can be given by the bank directly instead of using MFI mode.
|Investment range > `1 crore||Same as above||Bank to follow norms as per guidelines of RBI. Consider providing factor services to Small Enterprises.|
Introduce Referral Programmes
‘Referral Programmes’ are popular among a number of new generation industries, particularly the IT sector. On similar lines, banks may consider introducing ‘Referral Programmes’ for getting new MSE customers. They can use their existing customers running an MSE as ‘Referral Ambassadors’ by providing suitable incentives/ rewards to them.
Running an incentive programme to reward such ‘ambassadors for referrals’ is a time tested method of dramatically increasing ‘word of mouth’ (WOM) success. The referral/ reward structure taps into an innate desire to help others. Such programmes present a lot of room for creativity in the structure, cost and development of referral incentives.
In developing a suitable reward structure for referral ambassadors, banks should keep in view that the incentive should be enough to interest the customers to participate and it should not erase the profit of the new revenue generated. So, the first step in determining the ‘optimum incentive value cost’ is to analyse the ‘Customer Lifetime Value’ (CLV) and ‘Customer Acquisition Cost’ (CAC). These two concepts are extremely important for banks looking to get a good ROI on their marketing investment. Rewards can be either monetary or non-monetary or a combination of both.
The idea of introducing referral programmes among banks for promoting MSEs needs policy support from the RBI. Hence, details and modalities of a suitable incentive/reward structure have not been attempted in this paper.
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This was the way Apple marketed its products to the people around the world. As they say, rest is history. This is true for financing the MSE sector also. New thinking, a small strategic step would do the magic. Focus on disadvantaged groups (SC/ST/OBCs) and provide customer-centric financial products. These would be small but strategic steps for banks in achieving their objective of providing timely and adequate credit to MSEs.