A common complaint of the MSME sector is its inability to access structured credit from financial institutions, the high rate of interest of credit along with and the requirement of substantial collateral for availing of loans. While these points are true from the MSME point, it needs to be appreciated that banks and financial institutions deal with public money, are governed by very stringent laws of the Reserve Bank of India and are answerable to their shareholders and investors. There are certain features of MSMEs that make it intrinsically complicated for banks and financial institutions to extend credit easily.
Accurate information about the borrower—a critical input for decision-making by banks in the lending process—is not easily forthcoming in the case of MSMEs, as the sheer ticket size of SME lending makes it non-viable for banks to invest in developing information systems about MSME borrowers. This leads to banks curtailing the extent of lending even when MSMEs are willing to pay a fair risk-adjusted cost of capital.
Another issue is that of granularity. Granularity arises from a situation where the risk grading system at banks does not have the requisite capability to discriminate between good and bad risks.
The consequence is a tightening of credit terms, or an increase in prices, or both. From the borrower’s perspective, this leads to an outcome where the bank is over-pricing good risks and under-pricing bad risks. It is difficult for individual banks to develop adequate expertise in MSME lending-risk assessment exercises, which leads to problem of granularity. Thus, access to adequate and timely credit at a reasonable cost remains an issue for MSMEs as there is a high risk perception among the banks about this sector and the transaction costs for loan appraisal is high.
So how can this Catch 22 situation be solved? This problem can only be solved through institutional reforms aimed at reducing the inherent risk of the sector, thereby making them more attractive for banks and financial institutions to lend.
Making MSMEs more competitive and less risky
To ensure the competitiveness of MSMEs, it is essential that the availability of infrastructure, technology and skilled manpower are in tune with the global trends. Currently, the state of infrastructure, including power, water, roads, etc. in most areas where MSMEs are set up is poor and unreliable.
Although the central and state governments have set up a number of special economic zones, industrial areas and parks, industrial townships etc.,