Customise funding

Updated: Jan 18 2013, 07:17am hrs
Banks have to tweak lending norms and loan products to suit MSME needs

Ramnath Pradeep

Despite playing a vital role in the economy, the micro, small and medium enterprises (MSME) sector is gasping for timely and adequate funding from the banking sector. A government survey indicates that 90% micro units in India still procure funding from relatives, friends and private money lenders. Micro-sized units constitute 95% of the MSME sector, with small units making up under 5% and medium-sized units forming hardly 0.21% of the registered enterprises.

The primary challenges the MSMEs face while obtaining funds from banks are delays in clearing the proposals, follow-up with various executives, inability to provide collateral security and insufficient knowledge of financial management.

The financing constraints faced by Indian MSMEs are attributed to a combination of factors. These include policy, legal/regulatory framework, institutional weaknesses and lack of reliable credit information on SMEs. Banks have a traditional methodology of lending to this segment (against collateral and with a linkage to net worth as judged through tax returns) leading to MSMEs ending up being under-financed. Thus, the sector lacks a wide range of financing options and other services crucial to creating a sustainable business model.

The deteriorating global economic conditions leading to liquidity constraints have also affected the growth of MSMEs.

The sector inherently faces some critical issues, like shortage of skilled manpower, lack of capabilities in terms of product and process innovation, inability to compete with bigger players for market share, absence of infrastructure and scope and opportunities for expansion, inability to take advantage of economies of scale, etc. These problems are compounded by the low-cost production centres in China and corruption and red-tapism in the India.

MSMEs can overcome such debilitating factors through enhanced research and information on market dynamics, policy changes, buyers and sellers, and effectiveness of promotional activities. Thinking beyond conventional market practices and adopting emerging mediums like social networks, tie-ups with business-2-business (B2B) portals, business and marketing networks, and exploring marketing channels such as e-business, e-mail and mobile-based platforms would rein in costs and add muscle to the MSME business.

The development of new entrepreneurs is critical to Indias growth and development. Though there has been a burst of entrepreneurial activity across the country, spanning rural, semi-urban and urban areas, the majority of new entrepreneurs are self-financed.

There is a widely held perception among entrepreneurs that it is difficult to get bank loans at the start-up stage, while it becomes comparatively easier at the growth stage.

It is a challenging task for the banks to finance MSMEs. This arises from several issues: accounting practices of MSMEs; limited reach of banks in rural areas; limited risk appraisal due to lack of local knowledge, etc. The ease of fund procurement from the unorganised sector, like from money lenders, adds to the challenge.

To address these challenges, banks should start lending to SMEs in small buckets at rates that are more remunerative than the industrial sector, but competitive than the unorganised sector. Use of other delivery channels like post offices, regional rural banks and NGOs will give banks access to non-urban areas and provide them information about the SMEs. Besides, conducting knowledge and training sessions for MSMEs to help them understand the importance of financial and business planning and skill development, and providing them special receivable finance schemes and factoring services would improve the MSME environment.

There is no substitute for self-help. The MSME entrepreneurs must educate themselves on optimum utilisation of resources, develop a strong technological base, perceive innovation as a core competency for success, and understand and relate international developments to the business.

To assist the MSME sector, the government has set up the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), offering a cover of 75% of the default amount under the scheme. Setting up of the first rating agency for the SME segment, SMERA (SME Rating Agency), and enacting the MSME Act to meet the specific needs of the sector are some of the other steps taken by the government to aid the sector. Regulatory guidelines for lending to the sector also helped improve the fund flow to the sector to an extent.

Failures and successes in business is a given, and banks need to understand that the same applies to the MSME sector. Banks will have to tone up their risk assessment and risk management capacities, and provide for failures. Despite the risks involved, financing of first-time entrepreneurs is essential for financial inclusion and the countrys growth.

The banking sector has to device appropriate strategies and products for each of the MSME segment. While funding the micro segment may require tapping the financial inclusion projects, the small and medium enterprises may be capable of being provided support through the regular products, albeit with some tweaking in terms of the funding norms and financial criteria used to judge their credit worthiness.

The author is chief advisor, banking law, PDS & Associates, and former CMD of Corporation Bank. Views are personal. Email: