Traditionally, lending to small businesses has always been fraught with risk for financiers. Around the turn of the millennium, banks and finance companies started aggressively pushing retail and SME lending, recording annual growth rates as high as 30%. As a result, many small businesses, which were previously beyond the ambit of financing, could now avail loans relatively easily. This trend was helped along by an increasing number of direct-selling agents, who acted as intermediaries in the process. These developments, however, haven’t quite resulted in the win-win situation that one would have hoped for.
Data by TransUnion CIBIL suggests that non-performing assets (NPAs) in the MSME space have been increasing year on year, and are up to almost 10% of the entire sector’s current outstanding, with the potential of another `55,000 crore to slip into the NPA zone. In addition, a significant increase in leverage has been witnessed amongst borrowers—taking on as many as 10 or 12 loans at the same time.
While such behaviour benefits the individual or the business in question, it is detrimental for the system. It presents an inordinate increase in risk for the lender who provided the first loan—something that’s almost certainly not factored in the interest rate. There’s also the fact that much of small-business lending is carried out without collateral. When such loans go sour, between 50% and 60% of the loan value is effectively written off. The finance industry needs to act fast, before such loans reach damagingly high proportions.
Data from various credit bureaus and the reported earnings of different companies reveal a prevalence of stressed loans to small businesses. One might be tempted to attribute this to the continuing effects of demonetisation and the complications in the implementation of GST, but these factors are only a part of the explanation, not the whole. The root issue exists at a far more fundamental level—it, in fact, exists in the borrower-lender relationship.
Many borrowers today resort to intermediaries, in the hope that the latter’s knowledge of the credit policies of various companies will help them find a financial solution that’s best suited to their specific requirement. The benefits of engaging with intermediaries are, however, greatly overestimated. In truth, any business owner can just as easily connect with 4-5 lenders personally, understand how they work, and arrive at a decision themselves as to whom to do business with. Intermediaries, while they play an important part in system, deprive the borrower-lender relationship of the personal touch.
Living in a digitalised age as we do, it is easy to underestimate the importance of personal interactions in business relationships. This is a mistake, especially in the small business space. The strongest relationships are built on trust, and trust comes from being ‘human’ and personal, starting with something as simple as visiting the financing company’s branch and interacting with their staff.
Direct contact between loan officers and their client yields subtle yet important information about the borrower’s type, competence, quality of business and even personal integrity. Moreover, studies suggest that borrowers have a lower likelihood of being delinquent if they receive more personalised guidance from the bank or know their loan officer long enough. In fact, JP Morgan rightly stated a hundred years ago that character was what he looked for first in a borrower.
Even in developed, technologically advanced markets like the US, consumers and small businesses show a strong demand for the personal touch. A 2017 study by JD Power revealed that 71% of all bank customers visit a branch an average of 14 times during a year. Even the tech-savvy millennials visit a branch as many as 11 times. Consumers continue to prefer branch visits to open an account, conduct major transactions, or get financial advice.
Small businesses, owing to their nature or size, can sometimes go through difficult times, during which they sorely need the assured support of a financier. This realisation, if nothing else, should encourage them to develop long-term relationships with trusted lenders.
The MSME sector is expected to employ a considerable share of India’s large and growing workforce. The recent Budget announcement—to extend the reduced tax rate of 25% to those companies with a turnover of over `250 crore—is extremely positive for the sector and has re-emphasised the government’s intent to boost this sector. Given these changes, it is imperative for these companies to solidify their financial position. One would strongly urge these to directly reach out to lenders in an as open and transparent manner as possible.
By Govind Sankaranarayanan, Chief operating officer, Retail Business & Housing Finance, Tata Capital