By Shrikant Goyal
Credit and finance for MSMEs: SMEs are vital to India’s economy, contributing 40 per cent of the nation’s GDP and around 43% of its exports. However, these businesses face significant financial management challenges, compounded by their need for funds. Although various funding sources are available for SMEs in India, secured and unsecured bank loans remain the most widely used option.
The International Finance Corporation (IFC) reported that 87 per cent of SMEs in India rely on bank loans for funding. With the implementation of GST in most sectors, the role of bank loans is expected to increase, especially for SMEs. However, a significant drawback of using traditional banking channels is the lack of flexibility. Banks in India often impose foreclosure charges ranging from 1 per cent to 4 per cent when customers seek to pre-close their loans before the end of their tenures.
Imposing foreclosure charges makes it challenging for SMEs to switch lenders, effectively locking them into their current financing arrangements. It significantly burdens SMEs, who may need to change lenders due to unfavourable terms, higher exposure needs, or unsatisfactory service from the existing lender. The most critical reason remains service-related issues.
Removing foreclosure charges from SME loans can benefit not only the SME borrowers but also banks and the government.
Benefits to SMEs
The fund requirement is a long-term journey for SMEs. There may be times when the bank’s terms and conditions are not aligned with the SME’s long-term goals, resulting in dissatisfaction on the part of the SME. With the removal of foreclosure charges, SMEs can shift to banks with terms and conditions aligned with their growth journey and long-term goals. It will give SMEs access to financing better suited to their needs, ultimately leading to a more prosperous and sustainable business.
Also read: Banks’ GNPAs in MSME loans decline to Rs 1.54 lakh crore: MSME ministry
Often, SME companies are unhappy with the existing banker due to service-related issues. If they have options to switch over without additional cost, that will help them go to the lender with the desired bandwidth and intentions to serve them, making it a happy and rewarding relationship and instilling greater confidence in the SME. We had observed the same trend in other service-related industries as well.
Benefits to Banks
Enhancing reputation and goodwill: By offering more flexible loan arrangements and eliminating foreclosure charges, banks can position themselves as being customer-centric, leading to increased business and profitability.
According to the Australian Securities and Investments Commission’s (ASIC) review of mortgage broker remuneration, which was published in 2017, “Around 53 per cent of surveyed borrowers who had made additional repayments to their loans in the previous 12 months agreed that they would be more likely to recommend their lender as a result.”. This is an example to illustrate how the imposition of charges such as the foreclosure charge impacts customer relationships.
Healthy competition: This move could be instrumental in promoting healthy competition amongst the banks among the banks, egging them to improve their service standards, operational efficiency and productivity. Currently, a few large banks hold a significant market share of the lending market, making it difficult for new-age banks to compete. By removing foreclosure charges, new players in the banking industry can emerge, increasing overall competition and driving innovation.
Improved service standards: Suppose an SME moves its business from one bank to another – likely to be easy with no foreclosure charges. In that case, it will force the bank to revisit its terms and conditions, service standards and area of improvement to up their delivery, thereby making growth and development an integral part of the banking culture. It will result in a more efficient, customer-oriented, competitive, and efficient banking system. In a nutshell, the market will be open to all banks, and one who delivers the best services will gain the market share.
Benefits to Government
The removal of foreclosure charges shall lead to an increase in stamp duty collection for the government. Currently, the government collects stamp duty on the mortgage deed and the hypothecation deed of the loan amount. The charges of these stamp duties vary from one state to another. With the removal of foreclosure charges, SMEs can freely change their lending banks, creating subsequent deeds, resulting in higher stamp duty collection for the government.
Also read: Bank credit to micro, small enterprises up 14% YoY in March: RBI data
Other than increased revenue, removing foreclosure charges will allow the government to create a conducive environment for SMEs, existing banks, and new-age banks, leading to increased economic activity and employment opportunities resulting in higher tax revenues and a more robust economy. The same has always been the key priority for the government.
Why has it not been done if it’s such a win-win situation? Like every yin, this, too, has a yang. Most of the banks argue that the primary obstacle to removing foreclosure charges is the ALM mismatch, where banks’ liabilities from fixed deposits with defined interest rates and maturity become a limitation for lending.
The good news is that every challenge has a solution, and so does this. It requires a collaborative effort by RBI and banks, employing new-age AI technologies and innovative treasury offerings to mitigate the challenge. Considering it has been successfully implemented for home loans which is also a long-term asset for the banks, and floating linked interest loans for individuals, they should be able to find a solution for SME loans.
To summarise, one cannot argue with SMEs’ crucial role in India’s growth. Hence, improving the ease of doing business is imperative. A World Bank report published in 2020 ranked India 63 out of 190 countries in ease of doing business. Removing foreclosure charges from SME loans is one step in this direction. Given that this reform benefits all stakeholders, SMEs, banks, and the government, leading to increased economic activity and revenues, it is time to take the bull by the horns.
Shrikant Goyal is the Managing Partner and Co-founder of GetFive. Views expressed are the author’s own.