Govt’s subordinate debt scheme for MSMEs a welcome move but success depends on due diligence process

February 26, 2020 11:41 AM

Credit and Finance for MSMEs: Finance Minister Nirmala Sitharaman in Budget 2020 has proposed to launch a scheme for giving subordinate debt to MSMEs stressing on the working capital challenge faced by them.

The government has asked the RBI to extend the debt restructuring window for MSMEs.
  • By Vidisha Krishan

Credit and Finance for MSMEs: One of the major causes for low availability of bank finance to MSME sector is the high-risk perception of the banks in lending to MSMEs and consequent insistence on collaterals that are not easily available with these enterprises. Finance Minister Nirmala Sitharaman in Budget 2020 has proposed to launch a scheme for giving subordinate debt to MSMEs stressing on the working capital challenge faced by them.

Subordinated debt (also known as a subordinated debenture) is an unsecured loan or bond that ranks below other more senior loans or securities with respect to claims on assets or earnings. Subordinated debentures are thus also known as junior securities. In the case of borrower default, creditors who own subordinated debt will not be paid out until after senior bondholders are paid in full.

The government has asked the Reserve Bank of India to extend the debt restructuring window for micro, small and medium enterprises by a year to March 31, 2021, in measures aimed at imparting thrust to the MSME sector. It is proposed to introduce a scheme to provide subordinate debt for entrepreneurs of MSMEs. This subordinate debt to be provided by banks would count as quasi-equity and would be fully guaranteed through the Credit Guarantee Trust for the Medium and Small Entrepreneurs (CGTMSE).

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The MSME Ministry and Small Industries Development Bank of India (SIDBI) established the CGTMSE in 2000 to implement the Credit Guarantee Fund Scheme. The corpus of CGTMSE is contributed by the GoI and SIDBI in the ratio of 4:1 respectively. An app-based invoice financing loans product will be launched. This will obviate the problem of delayed payments and consequential cash flow mismatches for the MSMEs.

Further, necessary amendments will be made to the Factor Regulation Act 2011 to enable non-banking financial companies (NBFCs) to extend invoice financing to the MSMEs through TReDS thereby enhancing the economic and financial sustainability. TReDS is an institutional mechanism to facilitate the trade receivable financing of MSMEs from corporate buyers through multiple financiers.

This move is beneficial and will boost the financial health of MSMEs. Compared to other alternatives the subordinate debt will be less expensive. So surely this is a welcome move and will enhance the economic and financial sustainability of MSMEs. However, the success of the model will hinge on the quality of the due diligence done prior to the lending. Even within the MSME sector, albeit it is crucial, the quality of the borrower will have to be maintained for this to be a long term model which can be supported by lenders notwithstanding the government of India’s support.

Vidisha Krishan is the Partner at MV Kini & Co. Views expressed are the author’s own.

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