Why MSMEs are Not Darling of the Lenders
Banks remain cautious lenders to MSMEs and remain focused on the retail segment, the reason is obvious
There is no second opinion that the Micro, Small and Medium Enterprises (MSME) sector is the backbone for developing nations across the globe. In a burgeoning economy like India, this dynamic sector drives the spirit of entrepreneurship and generates employment opportunities. MSMEs in India are currently striving to strengthen their presence across sectors while expanding their footprint globally. The progress of the MSME sector is closely entwined with India's pursuit of becoming a global economic power. However, the sector is facing plenty of challenges, with access to affordable credit is most crucial. The government's latest initiative of loan approval in 59 minutes, although a novel move, may not be a game changer as a large number of small and medium enterprises will remain out of its ambit. What we need is a vibrant financial sector that caters to the entire MSME spectrum and understands the special circumstances in which they operate.
Credit Paucity in the MSME Sector
Governments and banks are well aware of the scarcity of credit in the sector and the former has even taken steps to increase credit flow to the MSME segment. However, banks remain cautious lenders to MSMEs and remain focused on the retail segment. The reason is obvious- Bankers are wary of defaults. The default in retail loan segment is much lower than that of the MSME segment. To address the issue, Govt launched CGTMSE scheme where banks are protected against default. However, overall credit flow to the MSME sector refused to take off. A couple of years back, RBI issued licenses for establishing specialised Small Finance Banks, which are expected to exclusively lend to MSME segment but this too has been a non-starter. The current situation has been further aggravated by the failure of ILFS, which had a huge impact on the liquidity of NBFCs.
Issues and Challenges:
The basic role of the banks is to lend money and earn enough to generate returns for their promoters, depositors, investors etc. In doing so, banks have to bear the risk of default by the borrowers. This makes them cautious lenders and ensures that any default remains within manageable limits. The MSME segment is traditionally seen as a riskier lending option vis-à-vis other options available to the banks. The reasons are many. Some critical issues (listed below), if addressed can help the sector gain confidence of banks and financial institutions.
The MSMED Act 2006, Chapter V, para 15 and 16 states that bills/ invoices of MSMEs must be settled in 45 days. This has not been enforced by PSUs or Private Sector. As a result, it puts extreme pressure on MSMEs to meet their payment commitments on time. Consequently, it affects their credit rating and ability to raise fresh loans from banks. MSMEs are always at the receiving end and seldom demand payments from large companies as they fear to lose lucrative business. Finding a viable solution to this issue would hugely benefit the sector.
The MSMEs are highly vulnerable to the volatility of the market conditions. Therefore, they genuinely need the support of the banks for extension of time for repayment of the loans. But the banks are reluctant to restructure the loans because it will then be immediately classified as a sub-standard asset and subjected to provisioning requirement. The data on the restructuring of loans of the past 3 years, available on the RBI website, will confirm this hypothesis. Therefore, what the sector needs is a more flexible approach towards MSME loan restructuring and in fact, some incentive to the lenders to encourage them to take up the process promptly. Not a one-time policy intervention (as has been done recently). RBI's reluctance to formulate such a policy emanates from its lack of trust in the lenders that they will misuse such a policy to hide real NPAs. This issue can be resolved with mutual involvement of the RBI and banks.
Another critical area where MSMEs are vulnerable is the lack of basic financial understanding. More often than not their financial decisions revolve around "tax avoidance'. Since lenders and credit rating agencies closely analyse financials of a company to determine their creditworthiness, MSMEs must be careful of maintaining their financial position while exercising "tax management'. A bad rating impacts both their ability to raise funds and the price at which funds can be raised.
A similar issue is the use of working capital. Despite the increase in turnover, MSMEs still end up defaulting on their payment obligation. Why so? In the pursuit of growing their business, they often end up diverting the working capital to buy fixed assets without tying up long term funds. They fail to understand the importance of liquidity and this also hurts their credit rating. MSMEs, therefore, must be given some "Basic Financial Education" to make them understand the nuance of the finances.
At the same time, RBI's Asset Classification norms are applicable mutatis-mutandis across all segments i.e Large Corporates, Mid-Corporates, and MSMEs. However, it is unfair to expect the same kind of financial discipline from SMEs vis-a-vis Large/ Medium Corporates. It is a well-known fact that SMEs largely depend on their larger counterparts for sales of goods and timely realisations of their dues. Therefore, they generally end up providing credit period against their sales to these entities in the range of 60 to 120 days. On the other hand, they do not easily get the raw material on credit. Overall, the cash cycle for the MSMEs works out to be anything between 3 and 6 months. Therefore, they find it extremely difficult to manage their working capital requirement and thus end up delaying payment towards their commitments.
Increasingly, digital lending is gaining prominence in tackling such issues by digitising the entire process of SME financing and increasing efficiency manifold. In an endeavour to transform India into a cashless economy, various Government initiatives have shifted focus on digital alternatives for financial transactions. The MSME sector is no different. These programs have created a more favourable environment for financial technology or Fin-tech models to emerge as a credible alternate lending mechanism in the MSME space. With automated underwriting process and risk management, it has lower operational cost, faster turnaround time and smoother loan processing.
Despite these developments, there still exists credit demand-supply disparity in the sector. In such a scenario, it is desirable that this highly vulnerable yet growing segment with tremendous potential be treated differently as far as credit disbursement and asset classification norms are concerned.