We are living in a financially critical time cycle. Global growth outlook remains positive for the year 2018 despite threats from an expansionary US fiscal policy, rising oil prices, protectionism etc. On the domestic front, while the economy is firming up with GDP growth rate scaling to 7.7% in the last quarter of FY18, developments in the global market and a sensitive inflation rate warrant a cautious approach in dealing. Historically, economic growth, especially corporate expansions in the country, had remained highly dependent on bank finance. Structural shifts in the financial market by introduction of Asset Quality Review (AQR), followed by Insolvency & Bankruptcy Code, has brought greater transparency and superior governance levels in functioning of banks for a sustainable credit culture, which is altering the rules of credit intermediation. This resulted in higher NPA numbers, which led to higher provision costs and affected the profitability of banks, causing pressure on them.
Corporate credit, by and large, has been a major driver of bank credit growth after the liberalisation of the Indian economy in the early 1990s. In recent times, when the noose is being tightened on defaulting borrowers and the easy money regime has been put to end with welcome moves by RBI in terms of AQR, tighter exposure caps and other directives on lending and provisioning practices by banks, the corporate sector has also lost its appetite and ability to grow. As a result, the credit growth in the large corporate segment has slowed down. On a year-on-year basis, though the non-food bank credit increased by 11.1% in May 2018 as compared with 4.1% in May 2017, credit growth in the large industries segment has remained muted in the last few years. Also, MSMEs are drawing the attention of the lenders, with high credit growth in the segment.
Now that has affected banks’ growth and income is not visible due to higher dependence on corporate credit. Banks need to look for new segments that can drive growth the same way retail did in the past. The MSME sector, which is the second largest employer after agriculture, is emerging as a lending sweet spot. The role played by MSMEs in the Indian economy cannot be overstated, whether it is GDP, manufacturing output, exports and employment generation. MSMEs also help address geographic disparities through dispersal of entrepreneurial activities. Historically, MSMEs have a smaller share in available bank credit in proportion to their contribution to GDP. Information asymmetry, lack of collateral and higher lending costs deter desired credit flow to the sector. Moreover, the gap in overall available non-food credit and credit to MSMEs has increased over the years. Credit flow to this segment has been mainly owing to the priority sector lending targets, despite of the low NPA percentage and higher margins for lenders. The contribution of MSMEs towards GDP is not reflected in the available credit to the sector through formal channel. Banks argue the cost of serving customers is high, but seeing better asset quality and higher growth it is even stronger argument to lend to this sector.
The stress in the banking sector continues as gross non-performing advances (GNPA) ratio rises further. As per the Financial Stability Report released by RBI in June 2018, GNPA ratio of scheduled commercial banks (SCB) rose sharply from 10.2% in September 2017 to 11.6% in March 2018. The performance of the industry sector was even worse, with a GNPA ratio at 22.8%. In view of the increasing stress, tighter exposure caps and diminishing scope in lending to large corporates, banks and other financial intermediaries have initiated course corrections to shift their focus to MSMEs. At the same time, smaller loans are evolving as a new growth engine for the financial sector, which is also indicated in the latest MSME Pulse report, a quarterly by SIDBI and TransUnion CIBIL. The report gives meaningful insights about the MSME sector, based on analysis of credit data of more than 5 million borrower accounts, which are divided into four categories as per credit exposure:
Micro: Exposure less than Rs 1 crore;
SME: Exposure between Rs 1 crore and Rs 25 crore;
Mid: Exposure between Rs 25 crore and Rs 100 crore;
Large: Exposure above Rs 100 crore.
As per the report, while asset quality deterioration in the large segment continued, the MSME space portrayed a relatively stable and range-bound asset quality. Within the MSME segment, the NPA rates are higher for larger sized exposures. GNPA for loans below Rs 25 crore has actually declined.
Although the segment brings new opportunity for banks, it becomes extremely critical for banks to avoid any irrational exuberance if they aim towards building a sustainable MSME portfolio. Overall, the recognised NPA exposure for MSMEs was Rs 81,000 crore as of March 2018. There was another Rs 11,000 crore of non-NPA exposure, whose other exposures are tagged as NPA by at least one other bank and exposure of Rs 1,20,000 crore belonged to entities that are high risk category. Banks need to be proactive but cautious. New private sector banks have a superior acquisition profile in the MSME space in terms of credit growth and targeting less risky enterprises. Even their riskier loan acquisitions are asset backed in nature, which partially mitigates lending risk to the segment. At the same time, public sector banks do not exhibit the same acquisition skills in the segment as they are extending plain working capital and term loan structures in the high-risk segment. It is a great opportunity for PSBs.
The appetite of banks and financial intermediaries for lending in the MSME space has been increasing gradually, though a huge gap still remains in MSME financing. There is a clear shift in focus towards smaller loans as credit growth rate in loans up to Rs 1 crore was 22.2% and credit growth rate in loans in the segment of Rs 1 crore to Rs 25 crore was 12.8% on a year-on-year basis, as of March 2018, which are the highest among all segments in the commercial lending space. The report analyses that credit growth in the very small segment (less than Rs 10 lakh) has been around 35%.
Entering the small loan segment is not a cakewalk for banks. Besides NBFCs, banks have new competitors in the form of digital banks, fintechs and even e-commerce firms. Markets are getting innovative and new models of lending are emerging every now and then. While high-tech models are targeting a segment that has primary or surrogate data as a proof of creditworthiness, banks are required to adopt a high touch model to serve the MSME segment, which needs a lot of hand holding and mentoring for entering a formal credit channel. At the same time, banks are also required to remain competitive by reducing the cost of running a high touch model and need to adopt to complementary technologies to serve with a blend of high-tech and high-touch model.
MSMEs were temporarily affected by structural reforms such as demonetisation and GST but are back in business, which is evident from the level of utilisation of working capital facilities availed by them from banks. Working capital facilities of MSMEs, which are closely associated with the levels of economic activity reflected in production, trade, revenue etc, have surpassed the pre-demonetisation level of activity in all segments. Specifically, MSMEs with exposures from Rs 10 lakh to Rs 10 crore had recovered business activity to pre-demonetisation levels of September 2017. Formalisation of business and push for cashless transaction are encouraging informal sectors to transit into the formal economy. This is expected to add around 10 lakh new-to-credit (NTC) MSME borrowers to the system annually. A recent NTC portfolio study suggests 60% first-time borrowers sustain or increase their credit exposures, in the two-year period following their first formal loan. The gap between the formal credit available and the economic activity exhibited by the MSME is still huge. Banks can achieve more priority sector lending targets by lending to MSMEs, which means lesser investment in the low-yielding Rural Infrastructure Development Fund and high profitability.
Banks and NBFCs have used retail lending as a tool for growth and profitability during the period 2012-16. MSME is the only category that offers hope in terms of demand and asset quality. It is the new retail.
(Mohammad Mustafa is Chairman & Managing Director, Small Industries Development Bank of India)