Creating a bankable future for MSMEs

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Rana Kapoor: Nov 09 2012, 01:52 IST

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.

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