Credit and Finance for MSMEs: Bank managers who were earlier eager and able to sanction legitimate loans are now afraid of an impending inquiry if a creditworthy enterprise they lend to ends up going kaput, for good reasons or bad.
- By Utkarsh Sinha
Credit and Finance for MSMEs: India has an MSME problem: our economy is credit hungry but our banks are credit shy. We have historically been a nation built upon bank lending. Barring a few marquee examples, when a small company needed capital to grow: be it Capex for acquiring new machinery, trade financing for fulfilling an order, or bill discounting for paying suppliers, the preferred pathway had been bank lending. The credit slowdown forebodes a wider drop in output which a competitive economy can ill afford. The banking sector cleanup under Dr Rajan’s RBI was a critical course correction for bank balance sheets to reflect a true position of their lending books, and will doubtless prove beneficial in the long run. It did however have an unintended side-effect: public sector banks, which constitute 65 per cent of corporate lending in India and have traditionally been risk-averse to start with, became ever more so.
Slowdown in Lending
There’s an old adage whispered in the corridors of bureaucracy: you don’t get into trouble for not acting. This pithy truism has started to hold true in public sector banks too. Managers who were earlier eager and able to sanction legitimate loans are now afraid of an impending inquiry if a creditworthy enterprise they lend to ends up going kaput, for good reasons or bad. It is easy to malign PSU employees, but the simple fact is that India’s banking employees are a true success story. Some of the sharpest and shrewdest minds sit behind those desks, and for decades, they have played their silent part in ensuring a flow of credit to fuel growth in India. But a spurious enquiry – that they often must defend out of pocket – for a legitimate lending decision gone bad serves as a death sentence. This has led to a significant slowdown in lending that predates even the banking sector reforms. A similar risk aversion is also causing delays in bid acceptance under IBC, where bankers are forced to wonder how they would justify a big haircut that makes business sense during a vigilance inquiry.
In an economy where the effects of fiscal and monetary policy are notoriously slow to trickle down to the real economy, agility in credit markets is necessary. India has one of the slowest transmission rates of reserve rate changes to the main street amongst the developing economies. Furthermore, the reluctance to lend by the banks gave rise to a plethora of NBFCs, which borrows from the same banks and lend to the main street after applying a fee on top, that has made real interest rates dearer for the average borrower. This NBFC layer also further slows central bank transmission rates.
Combine this with the fact that the market for commercial paper in India is wafer-thin (despite some enabling measures taken by SEBI and RBI), we may potentially be confronting a significant gap in growth capital in the country. The advent of Covid-19 will serve to make these effects more dire. Just this month, sovereign bonds in India fell to a three month low, with the yield on 10-year debt rising 14 b.p., which has spooked the markets and further eroded the market for commercial paper.
The Equity Way
The path out of this comes by way of equity. India’s MSME equity market – both private and public – is anemic compared to the size of our GDP. While we have relative overrepresentation in the tech sector (which mostly falls in the MSME category), there is scant private growth capital for non-tech enterprises. Similarly, very few companies make it public before achieving scale; and when they do, they receive scant analyst coverage and consequently, are sparsely traded.
There are no short-cuts out of this, but three prescriptions will serve us well in the long term. The first would be the establishment of a growth equity fund-of-fund (FoF) under SIDBI that is focused on non-tech sectors. There is tremendous leverage that the FoF model achieves by multiplying the amount of capital available to entrepreneurs. It spurs an engine that creates scale, jobs and exports. No developing economy has become a world-class economy without adequate access to growth capital, and India needs a long and sturdy bridge to the other side.
Further, we need to enable policies – particularly around capital gains and repatriation of capital – that encourage the flight of capital to India. We are in the fortunate position of being one of the few economies that will emerge out of the crisis with significant headroom for growth, and therefore an inherent attractiveness for foreign capital. We must marry this with enabling policy measures to ensure this capital flow occurs.
Finally, we need to create market mechanisms that enable transactions. Investment banks in India are (quite naturally) shy of low-value deals. It takes the same amount of effort whether you work on a $2 billion deal or a $20 million deal; and when your fee is a function of the transaction size, a firm is naturally incentivized to chase the whales. But there are enough small deals out there, that collectively can generate a lot of fees. A policy incentive would be a big boost. Transactions, unlike marriages, are not made in heaven. They are cooked by seasoned professionals who shop ideas around, often for long periods of time, before they finally fructify. And almost always, deals lead to wealth creation, jobs and growth in scale. It is well noted that the richest fishing waters are located off the shallow seas abutting deserts. You won’t bag a whale there, but you will leave with a rich catch. We need to create a new class of investment banks that make chasing the smaller fish their bread and butter.
Utkarsh Sinha is the Managing Director of boutique investment bank Bexley Advisors. Views expressed are the author’s own.