Getting money to the SMEs: Banks have replaced the development finance institutions, but without the necessary skill sets

July 03, 2020 6:20 AM

The banking sector urgently needs to build and train a separate cadre which specialises in manufacturing-sector loan appraisals. Banks have replaced the development finance institutions, but without the necessary skill sets.

RBI must urgently review criteria for declaring a borrower as NPA if he was regular up to the cutoff date; bring in a scheme to convert the overdrawing due to Covid up to September 30.

By KS Mehta

In the background of a core sector output shrinkage of 23% in May, a huge fall in employment, Rs 8 trillion loans under moratorium, and the urgent need to revive employment through economic activity regeneration, the monetary and credit policy measures announced need faster delivery. While these are targeted at the revival of the SME sector, policies for large borrowers are under design and need to be issued quickly. There is also a need to formulate measures for borrowers who had a good track record up to March 2019, but not on the cutoff date of February 1. Business cycles do not convert you into a bad manager. The national objective is to recharge the animal spirits, and, the government should energise such managers also.

The new SME credit flow measures urgently need five supportive pillars:

  • Fast implementation of a liberal fund of funds under proactive professional management, with skin in the game.
  • The government-guaranteed debt of 20% should be considered as quasi-equity, and not debt. RBI can issue a diktat for this, valid up to March 31, 2023, for calculating ratios for internal credit appraisal
  • Urgent review of NPA criteria as also a temporary reduction in core capital requirement both for working capital and fixed assets
  • Liberalisation of the criteria for internal credit rating up to March 31, 2023.
  • A monitoring officer in each city to review delay in credit sanction or refusal, and passing of interest reduction.

RBI must expeditiously design measures for special situations or authorise the banks to do so. If, say, a company with a good track record gets a spike in orders due to a large new EPC contract or an export supply contract. It has adequate net worth for existing business, but not for the new opportunity. Here, the cash flow combined with past performance and not capital contribution alone should be the criteria. Different sections of large plants, road construction, building construction, are excellent examples of EPC work. Funds are tied up in bid bonds guarantees, etc. Such measures will create growth tigers and turnaround the nations idle assets.

The first pillar, viz the fund of funds (FOF) can be a long-term game-changer as a source of equity or quasi-equity for growth of the SME sector. Immediate attention needs to be given for its effective result-oriented functioning in a short time. The government can persuade, at least four successful VC funds (preferably promoted by banks) to contribute capital directly or indirectly, and, more importantly, to take part in the operations committee. Each bank should effectively identify their SME clients with a good track record prior to Covid and encourage them to turnaround or grow with FOF support. And, in turn, lend more credit! A win-win situation for all and especially the nation. The FOF should also seek out investees on its own. The officers of FOF should not be tied down to government pay scales but incentivised on results even if they are on bank deputation or are laterally appointed. Only professionalism will make it succeed.

Innovation in investment instruments will be the key, including non-voting equity, participating preference shares, convertible loans. Many promoters may not be in a position to dilute equity initially. RBI should consider these as core equity for ratio calculations for three years. They would also have to address the design of fund instruments for the partnership firms and sole proprietary concerns.

The second pillar is recreating SMEs capacity to borrow. The large sector has lost Rs 2,600 crore in March quarter. The SME losses will be at least double of this by the September quarter; cash flow will suffer heavily from delayed customer payments.

RBI deserves full praise for progressively imposing financial discipline in the past. Two major limbs were that borrowers should contribute 25% of working capital and 40% of term loans from net worth funds. The March to September losses will sharply reduce the net worth funds, negativate ratio compliances, thus, impacting capacity to utilise sanctioned loans resulting in lower production capacity utilisation. The financial ratios of March 31, 2021, will also reflect fall in performance. The situation will worsen, especially if the government guaranteed loans are counted as debt. Revision in measures needs to be planned now so that borrowers know compliance targets.

As per the third and fourth pillars, RBI must urgently review criteria for declaring a borrower as NPA if he was regular up to the cutoff date; bring in a scheme to convert the overdrawing due to Covid up to September 30, into a working capital term loan with moratorium up to March 31, 2021. For regular loans, it must liberalise its stringent criteria for internal loans for the periods from FY20 to FY23, and thereafter restore status quo ante.

Where the central government has guaranteed loan repayment, for four years such loans should be counted as quasi-equity and not as debt by an RBI diktat. They are more secure than mortgages on co-assets. It must reduce the net worth contribution of working capital from 25% to 15% by the end of FY21, and then to 20% by FY22. Purchase of modernisation or balancing plant contribution should be reduced to 15% with a higher debt-equity ratio of 2:1 for investments up to FY23. This will lead to better productivity and quality up-gradation. Most importantly, these ratio adjustments will keep the borrowers in the lower interest bracket on their existing loans. Also, these will be crucial contributors to export competitiveness and lower inflation.

The fifth pillar is aimed at efficacious implementation of the new policy and of interest rate cuts. We now have five large public sector banks whose staff, at branch levels, will deliver better if monitored. An effective senior officer with industrial credit background should be appointed in each city only to review cases of refusal or of delay beyond thirty days in loans sanction or in passing down rate cut benefits. He should also act as an ombudsman for the borrower.
Lastly, the banking sector urgently needs to build and train a separate cadre which specialises in manufacturing sector loan appraisals. These banks have replaced the DFI, ie, development finance institutions, but without the necessary skill sets.

I sincerely believe the above pillars, together with a revival of demand, will lead to faster turnaround and most importantly build the “Asian Tigers”. Agriculture has been a saving grace, good monsoons are predicted. Hence, thrust on the revival of manufacturing together with a policy thrust on special sectors like trade, tourism, travel hotels, construction and real estate will be the key.

The author is Partner, SS Kothari Mehta and co. Views are personal

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