Collateral damage

The proprietor of a Bangalore-based smallscale telecom equipments company, Raj Lakshmi was greatly relieved when the economic downturn ended. The year 2008 was the first one in the 20 years she had been running FON-ESS India, in which her account books showed a loss. And indeed, by end-2009, she had been inundated with orders, and all she needed was a modest Rs 10 lakh in bank credit to execute them. But in the eyes of the local bank she approached, one loss-making year had tainted her record. Her request was turned down. "You have been unprofitable for a year. You will take seven years to return to profitability and become creditworthy," she was told.

Credit squeeze

Lakshmi managed the credit from other sources. But millions of others who constitute the vast small and medium enterprises universe - lately expanded and called the micro, small and medium enterprises, or MSMEs - are not so lucky. In India, MSMEs are defined as industrial units in which the investment in plant and machinery, barring a few specified sectors, does not exceed Rs 10 crore. At last count in 2006/07, there were 2.61 crore MSME units in the country. Absence of timely and sufficient credit is the biggest hurdle they face.

It is not as if there are no institutions to address their credit needs. Banks have been directed by the Reserve Bank of India to increase their lending to MSMEs by 20 per cent every year, and they have been doing so. In 2010, credit disbursed to the MSME sector grew by 42 per cent to a whopping Rs 3.62 lakh crore.

However, those running these enterprises claim that banks are unresponsive and consider them less creditworthy than large enterprises, frequently seeking so much collateral that they are unable to take advantage of the credit schemes. Curiously banks also charge them higher interest rates than they do big companies.

Delhi-based Swati Prasad's experience is typical. She set up Creemos International a year ago, exporting leather accessories to Europe. "My current orders stand at Rs 32 lakh. I have projected orders of Rs 80 lakh by March-end," she says. But her attempts to get a bank loan have proved futile. "I am a merchant exporter.

I don't make the accessories I export. The bank did not seem to understand this. It wanted to see my balance sheets for at least three years to consider my loan application. It even wanted collateral," she says. In 2000, the Small Industries Development Bank of India, or SIDBI, the apex lender to this sector, launched the Credit Guarantee Fund Trust for Micro and Small Enterprises, or CGTMSE, which would stand guarantee for loans up to Rs 1 crore.

But only around 400,000 MSMEs have taken advantage of it so far. Entrepreneur Neeraj Singhal, who runs one such unit, Karshni Aluminium Company, in Ghaziabad, puts it down to low awareness. "There are more than 10,000 such enterprises in Ghaziabad, but not more than 10 per cent of their owners know about the scheme," he says.

He adds that three people he personally knows, who applied for loans under this scheme, were all turned down on various pretexts."The scheme has become active only in the last six to nine months," admits M.K. Nag, Chief General Manager (SMEs), State Bank of India, or SBI.

SIDBI, too, has realised it needs to do more. "Bank officials have to be trained on how to lend on a cash flow basis instead of the conventional collateral basis," says R.K. Das, General Manager, SIDBI. "We have already started a training programme for bankers."

Even more galling for this sector is the high interest charged on loans when they are fortunate enough to get them. Rates vary from 11 to 15 per cent, while large enterprises are usually charged around nine per cent. "I'm borrowing at a much higher rate than the big companies and grappling with high input costs," says Uma Reddy, owner of HiTech Magnetics, a Bangalorebased manufacturer of transformers and coils. "Yet I need to price my products cheaper than the big guys, who have brand power, if I expect to sell." According to CRISIL, every one per cent increase in the interest rate reduces SME profits by an average of 14 per cent.

But banks have no intention of reducing the rates. "There isn't any scope for lowering interest rates further," says Nag of SBI. "We have to consider each loan application as a business proposal and see the impact on our bottom line. We are not giving out subsidies."

Some feel the high interest rates could be managed if credit came in regularly and on time. "If banks ensure efficient and timely delivery of credit, interest rates would only be of secondary importance," says Anil Sinha, General Manager, Advisory Services at International Finance Corporation. "There should be better information flow between the bank and the SME unit."

What US does

In the US, for instance, credit bureaus play a key role in facilitating this, collecting all information on companies applying for loans and sending it online to the banks considering the applications. Using this data - augmented from other sources - the bank accords a "credit score" to the company, and then decides whether to lend or not. "Implementing such a model in India should not be very difficult," says IFC's Sinha.

Mathew Titus, Executive Director of Sa-Dhan, a network of microfinance institutions, had another suggestion. "MSME development institutes should come up with a viable business model for them, which they can present to banks," he said. Some small steps to redress this sector's credit woes are already underway.

The Indian Bankers Association is working on an electronic registry of movable assets of companies against which loans could be given by banks. SIDBI is working on an Italian group guarantee model for securing small loans. In this, a group of SME owners and a bank come together to form a new company owned collectively by them, which then stands guarantee for loans taken by each entrepreneur.

India's growth story depends heavily on the health of its MSME sector, which accounts for nearly half of its manufacturing output, 40 per cent of its exports, and is a source of much innovation. It must get easy access to credit if it has to move.

Reproduced From Business Today. © 2011. LMIL. All rights reserved.