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., there remains a lot still to be done. On the technology front, government and industry need to invest more in R&D. The government needs to enhance its support to the MSME sector for development, innovation and adaption of technology, without which these units stand no chance of survival on a global platform. Although India has the advantage of a large pool of human resources, the industry continues to face deficiencies in manpower, especially in the skill-set for areas like manufacturing, service, marketing, etc.
So skill development is a key area that needs to be addressed, both by government and industry, in order to ensure a steady supply of human resources with skill-sets for the MSME sector. Establishing ITIs, private skill training institutes and industry-academia tie-ups are the need of the hour.
India continues to be a growing market for cheap exports, which has a direct impact on the MSMEs and their survival. The world over, governments provide supportive measures to their MSME sector through targetted benefits and facilities. In line with this international practice, a wider public procurement policy for MSMEs is essential to ensure a stable market for the MSMEs.
Currently, institutional entitlements like fiscal incentives, power connection, purchase preference, technology support etc are available only to the registered units, which constitute a mere 6% of the total MSMEs. Policy and institutional reforms are needed that would allow unregistered industrial units in the MSME sector to join the mainstream and enjoy all the entitlements.
The government should also undertake measures to implement all recommendations of the Prime Ministers Task Force that include supporting the district industries centres, ensuring enhanced raw material supply and facilitating product marketing support, thereby, giving the sector a stronger platform to operate from, which would eventually reduce their inherent risks and make them more competitive.
PPP and policy support
To address the issues of infrastructure, technology and skilled manpower, a tool that definitely should be considered is public-private partnership. PPPs are arrangements between government and private sector entities for providing public services and related infrastructure. PPPs are characterised by the sharing of investment, risk, responsibility and reward between the partners.
The idea is to induce the investment and enhanced capabilities of each participant to strengthen the delivery and reach of the service already being extended by the government. Even industry chambers need to join hands with the government in a joint effort to build and provide the needed support to the MSME sector.
MSMEs to become more banking friendly
A customised credit risk assessment system is required to make enterprises more competitive and creditworthy. Not only will it bridge the gap between an institutional lender and the MSME borrower, but it will also help develop the much-needed information database on the MSMEs, enabling easy future referrals and wiping out the problem of information asymmetry.
The SMEs need to do their management planning and make the processes more formal, so as to have the documentations ready for financing opportunities. Accounting policies and consistency in book information will lead to better reliability from the bankers. Institutionally, provisions need to be included in the rules governing the MSME sector so that periodically the enterprises are evaluated on a five-year basis and re-certified so that they can graduate from MSME to mid-size companies.
Given the importance of the sector, the government, industry chambers, think-tanks and policy-makers need to come together to create an environment conducive for MSMEs to flourish. This would in turn make MSMEs banking-friendly. Adequate RBI and Sebi support and institutional reforms are also necessary to take the sector to the next level of global competitiveness.
The author is founder, MD & CEO, YES Bank