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Banks are missing out on the big opportunity of funding small enterprises

Banks are missing out on the big opportunity of funding small enterprises

Despite a push by the government, banks are still shying away from lending to small and medium enterprises. A recent study says that as much as 78 per cent of funding for MSMEs comes from informal sources or is self-financed while only the remaining is met by banks and other institutions. Special: Best SMEs

The beleaguered Kingfisher Airlines currently has a staggering debt of Rs 7,500 crore. One of its many lenders is the state-run Bank of Baroda (BOB), whose share of the amount is Rs 550 crore.

Compare this to the bad loans given by BOB to all the micro, small and medium enterprises (MSMEs) in the country put together. BOB's gross bad loans to MSMEs amounted to Rs 1,100 crore, or 3.2 per cent of its total loan of Rs 34,500 crore to the entire sector. Thus BOB's bad loans with just one big company Kingfisher Airlines, are half its non-performing assets with thousands of MSMES.

Nor is Kingfisher the sole example - there have been several instances in recent years of large companies defaulting on bank loans of vast amounts. It gives the lie to a view still widely prevalent among bankers - that doing business with micro, small and medium companies is inherently more risky than funding big companies.

A recent survey by consulting firm McKinsey covering 29 banks across emerging economies in Asia, Africa, Latin America and Eastern Europe, which focus on MSMEs, showed that only two of them had a return on equity (ROE) - a measure of company profitability - of less than 15 per cent from their MSME business.

About a dozen reported ROEs of 30 per cent or more. "Taking a 10-year view, a good bank should have made more money from dealings with SMEs than with large companies," says Renny Thomas, Partner at McKinsey. The report also says that worldwide, banking revenue from MSMEs in emerging economies is likely to double from $150 billion in 2010 to $367 billion in 2015. In South Asia, which comprises India and its neighbours, banking revenue from MSMEs is estimated to more than triple during the same period, from $20 billion to $64 billion.

R.K. Bansal, General Manager, SME and Wealth Management, Bank of Baroda
MSMEs are risky but the risk is diversified as you are lending to small businesses in different sectors: R.K. Bansal Photo: Rachit Goswami/
The Ministry of MSMEs defines micro enterprises in manufacturing as businesses with an investment of less than Rs 25 lakh in plant and machinery; correspondingly, the investment cap for small enterprises is set at Rs 5 crore and for medium ones, at Rs 10 crore. The investment threshold is lower for service enterprises in all categories.

Some bankers are indeed realising the opportunity MSMEs could provide. "MSMEs are risky but the risk is diversified as you are lending to small businesses in different sectors across different geographies," says R.K. Bansal, General Manager, SME and Wealth Management, BOB. K.S. Chandramouli, General Manager in charge of MSMEs at Canara Bank, agrees. "Our experience with small businesses is better than that with large companies," he says.

Reserve Bank of India (RBI) data show that bank lending to MSMEs was Rs 5.4 trillion (one trillion equals 100,000 crore) as of January 2013. In March 2012, it was Rs 5.1 trillion.

It is not enough, though. A recent study by the International Finance Corporation, in partnership with the Japanese government, said that MSMEs in India require Rs 32.5 trillion in financing. Of this, as much as 78 per cent comes from informal sources or is self-financed while only the remaining is met by banks and other institutions. This is because bankers such as Bansal and Chandramouli are in a minority.

"The problem is that banks do not look at MSMEs as a business proposition," says Deep Kapuria, Chairman of the Confederation of Indian Industry's National MSME Council. A report by rival industry lobby, the Federation of Indian Chambers of Commerce and Industry, echoes his view. It says that, in 2011, 55 of the 77 commercial banks operating in the country failed to meet the RBI's target of 20 per cent growth in loans to MSMEs. Within the MSME segment, RBI guidelines prescribe 60 per cent of bank loans should go to micro enterprises. Data as of June 2012 show only four banks met that target. "While overall lending to the sector grew about 33 per cent in 2011/12, most banks are not growing their MSME portfolios," says C.K. Mishra, Joint Secretary, Ministry of MSME.

Why do many bankers have the impression that loans to MSMEs are risky? Some point to statistics. Comparing BOB's bad loans to MSMEs against what it is owed by Kingfisher alone is just one way of looking at the picture. BOB officials note that while bad loans to MSMEs amount to 3.2 per cent, gross bad loans as a percentage of total advances are much lower, 1.53 per cent. Similarly, at Punjab National Bank (PNB) bad loans to MSMEs were 4.9 per cent of total loans to the sector, while its overall bad loans amounted to 4.6 per cent of total advances.

The counter-argument? Percentages are one thing, gross amounts another. Since MSMEs hardly get bank loans, the total volume of bad loans to this sector was just Rs 19,500 crore across all banks in March 2012, while bad loans overall added up to Rs 1.37 trillion.

Small scale entrepreneurs say many banks invariably demand collateral from them though there is no such mandatory requirement. On the contrary, RBI norms direct banks to give loans up to Rs 10 lakh to MSMEs without collateral. "Traditionally, the banker's mentality is to seek collateral," says S.S. Bhatia, General Manager, SME, PNB. "Even entrepreneurs are not aware they can demand loans without it."

Many manage without bank help. J.S. Dua, founder of Pyramid Control Systems, is one such. Dua set up Pyramid, which makes electrical control panels, in Faridabad, Haryana, almost 20 years ago using his own savings. His company's revenue has risen from Rs 1.25 lakh in the first year to Rs 3 crore in 2012/13, but Dua feels it could have been 10 times higher if he had more funds to execute all the orders that came his way.

He had to forgo hundreds, he says. "I get many phone calls from banks, offering me loans. But when I say I have no collateral, the call is disconnected," he says.

Even MSMEs rated by credit rating firms such as CRISIL do not get loans easily. Ratings firms have suggested that top-rated SMEs should get interest concession of up to one per cent. But Joint Secretary Mishra says that no more than Rs 300 crore in loans have been sanctioned in the past four years to MSMEs with this concession.

Again, when MSMEs do get loans, they are charged interest rates higher than large companies, because the latter are in a position to negotiate. "Unlike large companies, MSMEs do not pressure us to negotiate interest rates," says PNB's Bhatia. "They are ready to take loans at any rate."

Themselves to blame?
A number of bankers claim MSMEs are themselves to blame for being denied loans as they do not maintain accounts properly and are often family businesses lacking professional management. They are unable to convince banks of their cash flow and the feasibility of their business.

Still, the government has been trying to push banks to lend more to MSMEs. It has launched schemes that seek to lower the risk lenders face. The Credit Guarantee Trust for Micro and Small Enterprises scheme is one such. Under it, the Small Industries Development Bank of India (SIDBI), which has initiated the scheme across 132 banks, provides a guarantee to bear up to 85 per cent of the loss if an MSME defaults. As of January 31, 2013, about a million MSME units had availed of Rs 48,000 crore in loans under the scheme.

Both the number of participants and the amount loaned have almost doubled from a year earlier. In this year's Budget, Finance Minister Palaniappan Chidambaram took another step to boost funding to MSMEs when he announced the setting up of a 'credit guarantee fund' for factoring by SIDBI, providing it a corpus of Rs 500 crore. 'Factoring' is an arrangement under which an organisation such as SIDBI pays the amount due to an MSME immediately after the order is shipped. This allows the MSME to maintain a steady working capital flow during the period it takes for the client to receive the shipment and pay the amount.

SIDBI is also working with 10 banks to open specialised small branches to give loans to high-tech start-ups that have received angel funding. Banks including PNB, Corporation Bank, Dena Bank and Oriental Bank of Commerce, among others, have started one such branch each. "It is an experiment. Let's see if it works," says Sushil Muhnot, Chairman and Managing Director of SIDBI. Overall, there are just 1,618 branches of state-run banks that cater specially to MSMEs, compared with a total of 89,000 bank branches in the country.

The road ahead is still not easy. Joint Secretary Mishra admits many bank managers are not aware of the government-backed SIDBI schemes. "Outside state capitals, bank branches are totally unaware of MSME schemes," he says, recalling an earlier stint as principal secretary in the Bihar government, when he often noticed this. "At the block or district level, I have myself seen entrepreneurs bringing RBI circulars with them to show managers the schemes under which they can get loans."