Ensuring Debt Finance for All Professionally-run MSMEs.

For several years, a number of policy initiatives have been taken to address the financing gaps for MSMEs. Of course, we have improved over the years. However, a lot still needs to be done. Here is a set of views, that I have, on how to go about doing it. Some of it is about approach and some of it is about actual implementation. Of course, this is a complex problem and I am not denying that genuine efforts have been made in the past. My argument is that those efforts have fallen short and it may be a time for policy makers to do a few things differently (to the extent that some of the suggestions may seem impractical but I am taking the liberty to list them out here.)

Note: Unsecured, small ticket lending to MSMEs based on credit of the individual promoter is largely (on the How to aspect) a solved problem (in India) and has got/getting a lot of attention. (We are miles to go for universal access to finance for MSMEs even in the small ticket, individual credit led lending.) The focus of this write-up is on corporate SMEs with high growth aspirations, where the funding requirements is in crores (individual promoters credit is not a good alternative for company credit) and is generally not done by traditional lenders without mortgage collateral. For new age, asset light but professionally run businesses, it is a key gap, that remains unsolved at scale. Hence, the focus on that segment in this write-up.This write-up is addressed to those shaping policy and regulation. This write-up is specific to the Indian context.

Do NOT broad brush: The MSME segment includes not just the local tea shop, or the puffed rice making factory but also includes the SME corporate with turnover upto INR 250 Cr (as per the recommended Budget 2018 classification) with some of them having raised institutional venture capital. Hence, the funding requirement, credit evaluation process and lending model will not be the same. If we don't separate out the sub-segments and find specific solutions for each segment based on loan size, security and nature of entity, we will not have a comprehensive solution.

It may make sense to break down MSMEs into categories based on legal structure i.e. individual, proprietorship, partnership and OPC or private limited and have priority sector or lending target setting done separately for them. Have caps on loan amounts for each type of legal structure. The reason why I say this is, I am not sure why a firm with several crores of rupees in turnover, borrowing from banks, etc in crores should have the legal structure of a partnership/proprietorship. It should be a private limited company. The regulators have to make it easier for people to set up companies and be compliant. This will enable access to additional sources of data which can be leverage to take lending decisions.

(A note for SMEs seeking larger loans: If you don't have mortgage or collateral security AND you haven't put in much of your money as equity because you don't have much AND you don't have reasonable size of operations AND you don't want to be compliant with additional regulations or provide verifiable data on various aspects of your business AND you still expect funding in crores - time to get some coffee. The purpose of adding compliance and improving access to different sources of data from the SME is to deal with the lack of security. Please note that unlike equity investors, lenders do not get a share on your upside but they do get a share of your downside for sure and hence they need to ensure that downside is limited. )

Accept that only Banks will NOT be able to help us in ensuring complete access to finance for MSMEs: Banks hold public/retail deposits and it is natural that they will have less risk appetite than NBFCs or specialised funds who are typically funded by entities that have the ability to manage risk unlike the retail depositor of a bank. By design, NBFCs or specialised funds will take more risk through sectoral specialisations. Historically, banks have been treated as the favoured child by regulators. If there is genuine interest in enabling access to finance for all segments of MSMEs, it has to be recognised that banks, NBFCs, specialised funds will together be able to address the funding needs of MSMEs.

How about allowing specialised MSME lenders partial access to the payments and settlements system? This will allow them to set up basic escrow accounts and current accounts with zero or close to zero EOD balance and ability to receive funds ONLY from corporates. NO cheques, NO savings or other deposits. This will enable specialised MSME lenders/NBFCs to offer payments, set up escrows to do a cash flow traping arrangements to deduct repayments without having to depend upon banks who create severe roadblocks in letting specialised lenders access to these simple operations. Sounds, kind of, like payment banks but I am talking about larger value transactions. Say, those who offer loans in INR crores to corporate SMEs and need to transact in several lakhs and crores and not in thousands.

Use Govt backed DFIs as market developers: India needs to find a way to use Govt backed DFIs in a market development role and not in competitor role. Their role should be to find ways to encourage other commercial lenders/investors (Banks, NBFCs, specialised funds) to do the job of lending to MSMEs instead of competing with them by trying to reach the MSMEs directly. I understand that there was a time when DFIs had to "show the way" because the commercial lenders/investors were not interested. However, over the past 8-10 years, it has been shown that private entities have been trying to find different ways of reaching out to the lucrative MSME finance gap. Frankly, if all the banks and NBFCs together are not able to directly reach all MSMEs, it is good reason to introspect and accept that one or two DFIs with limited geographic presence can reach out to all MSMEs.

Policy makers should encourage the use DFI funds to act as market developers through guarantees/credit enhancements for institutional investors to invest into NBFCs/specialised funds that are trying to fund MSMEs in India. This opens up a much larger tap of borrowings for the NBFCs and specialised funds (beyond banks) and also enables them to raise funding at a cheaper cost (assuming credit enhancement by DFI will lead to better rating of the transaction.). Oddly enough, I have seen multiple instances where Indian DFIs offer funding to NBFCs/specialised funds at a cost that is signifcantly higher than what the commercial banks or offshore commercial and DFI lenders are ready to offer at.

Consider Bank, NBFCs and specialised funds as partners and not adversaries: Banks in India (DFIs included) do not like sharing of pari-passu or second charge with NBFCs or specialised funds, as a practice, when lending to SMEs. Even though nothing in the regulation or law disallows it. This is a version of caste system propagated within our financial services industry under the excuse of lack of sufficient assets. Interestingly, I have seen multiple cases of companies that are profitable for more than 3 years with INR 50 Cr+ revenues (and fixed and current assets worth atleast INR 15-20 Cr) having INR 2 Cr worth short term facilities from banks backed by 75% cash deposits and security over entire current and future assets of the company (and possibly even the kidney's of the promoters) NOT willing to share pari-passu charge over receivables (not on cash, not on fixed assets, just receivables) for NBFCs willing to lend higher amount than the bank and under more flexible terms. Since, forced regulation and orders will not solve this "social" problem, a better way is to encourage banks i.e. say that for the MSME loan accounts that the bank has, if the banks are able to demonstrate another non-bank lender on-board, they will be awarded 1.5x the value of their loans as priority sector.

Over-leverage of SMEs has to be addressed differently: Initiatives like the central credit registry is necessary to give a clear idea about over-leverage.(This is already being done.) It should be made compulsory to have all types of financial lenders (not just banks) add the details of the loans on the platform.

Data, data, data: Enable electronic access to data for all types of statutory, regulatory and transaction compliance done by companies. Eg: Specialised lenders or even banks should have access to data on taxes, electricity payments, EPFO, ESI, salary, bank transactions, etc. Security and privacy concerns are paramount but given that they are solvable issues, we need to find ways in which access to all that data is made extremely convenient, if we were to expand access to finance for MSMEs.