Recent policy initiatives indicate the state is focusing on an orderly growth of the unorganised sector, with the spotlight on micro and small enterprises. As pointed out by the National Commission for Enterprises in the Unorganised Sector, in its final report to the Prime Minister last April, technology and innovation are central to the growth of these enterprises. Two vital components of innovation and technology are: research & development (R&D) and fund availability.

But can R&D activity be left to the initiatives of micro and small enterprises? Given the financial implications, doing R&D is a near-impossible task for these enterprises. So, stressing on R&D in this sector could be a ?footloose? approach. Instead, the burden of R&D should be placed on large enterprises. It does not mean that the micro and small enterprises should not reap the benefits of innovation. Nor should they remain least innovation-oriented.

The spillover effects of innovation have been well documented. As a strategic option, and induced by tax and other benefits, large Indian and foreign firms here engage in R&D activities. Micro and small enterprises should be able to enjoy the positive externalities of innovation of these large firms.

To evolve appropriate policy intervention, it is important know how technology acquisition & upgradation (TAU) works. Availability of funds often gets highlighted as a key inducing factor. It is not the lack of funds; rather it?s cumbersome procedure in getting loans from financial institutions that is seen as the inhibiting factor. The problem has been compounded by the weakened focus on priority sector lending, in the wake of banking sector reforms. Since non-performing assets have mostly been linked to default risks of small units, micro and small enterprises face several procedural bottlenecks in getting bank credit.

Banks? reluctance to advance loans to micro and small enterprises is also founded on the inability of these enterprises to fulfill documentation needs. It is the perceived risk that influences lending decisions of banks. While banks view non-compliance seriously, the micro and small enterprises are helpless given their lack of expertise. Sources say lending agencies are not supportive here. Small firms are forced to take the help of so-called ?documentation experts?, who charge 3 to 5% of the loan as fees.

Several government schemes promote technology adaptation by small firms. For instance, the Credit Linked Capital Subsidy Scheme was designed to technology upgradation of micro & small enterprises. This scheme provides up to 15% capital subsidy for induction of proven technologies.

The scheme covers about 14 major identified products/sub-sectors, and provides subsidy based on the purchase price of plant & machinery. The Small Industries Development Bank of India (Sidbi) and the National Bank for Agriculture & Rural Development (Nabard) are the primary nodal agencies for the scheme. A few public sector banks and state-level financial corporations are also co-opted as nodal agencies for the implementation and release of capital subsidy under the scheme. But the grant of benefits under the scheme is subject to fulfilling various conditions, including documentation. Freelance experts who help with documentation take a handsome commission of close to 7.5% of the benefits availed of by the applicant.

Collateral requirement is yet another hindrance. It should be appreciated that micro and small businesses are started mostly by first generation entrepreneurs, with bare minimum resources. They bring in the initial capital from own savings or by pooling savings of their family and friends. An insistence on collaterals, as is often done by lending agencies, will drive them out of the organised credit market.

While the demand for collaterals inhibits TAU amongst micro and small enterprises, such requirements cannot be wished away. So the problem remains. A way out is to encourage mutual credit guarantee schemes (MCGS). Such an arrangement should be a tripartite agreement involving commercial banks, industry association and borrower. To this end, a commercial bank need to be identified as a lead bank for a given geographical jurisdiction, working in consortium with other banks in the same region and in liaison with industry associations.

The idea behind involving the industry association is that collateral requirements are imposed to avoid adverse selection problem that a credit provider often faces. Industry associations have members with sufficient knowledge of value of assets and have the potential to monitor fund utilisation. It facilitates peer monitoring that reduces the probability of adverse selection and moral hazard associated with possible default.

Sidbi should promote the idea of MCGS with commercial banks that have a prominent presence in a given locality. Of late, Unido is an active promoter of the idea of MCGS.

The writer is a faculty at the ICFAI Business School, Bangalore