Startups being made priority sector means nothing!

Last week, the Reserve Bank of India made a number of announcements. One announcement, however, caught the fancy of the press and the press friendly startup ecosystem. This was about bank lending to startups, now being categorized as priority sector. What surprised me was flurry of happy messages from the startup ecosystem and the investors.

Truth is, startups being made priority sector means nothing. Asking banks to lend to startups is like asking Amitabh Bachchan to sing Indian classical. Sounds interesting, but doesn't work.

While we need to wait till we see the details of the priority sector guidelines, here are a few thoughts and possible ways of getting to the goal of making flow of debt easier for startups:

1.) What delivery channel is the regulator going to encourage? We have to remember, we have not been able to fix the issues of access to credit for MSMEs as yet. And yes, they have been "priority sector" for a long time. Specialised NBFCs focussed on MSME sub-segments have done a much better job than banks.

2.) Lending to startups opens up a whole new risk paradigm. Even here, specialized entities have the ability to do a better job, not banks. Banks and traditional lenders thrive on productised lending models driven by standardized credit parameters and collateral. It is not possible to lend to startups using such standardisation or dependence on mortgage collateral. Most startups are asset light and hence no/low mortgage collateral. Secondly, startups bring innovations in products and delivery models which are new/evolving and hence no standardised credit parameters can evaluate.

3.) We must also note that banks hold deposits. It is the depositors money that gets deployed as loans. Would you want your deposit money to be lent to startups knowing well that 90% (or some such number) of startups die?

4.) If the bank NPAs go up suddenly due to loans made to startups, will it lead to a severe knee jerk reaction closing off the taps for startups for ever? (Yes, I know some of you are saying that banks are anyways sitting on big NPAs. The point is, the NPA mess that the banks are sitting on is due to poor processes and checks. The ability to have high quality processes for lending to startups in a bank environment (any environment) is significantly more difficult.)

So, what can be done?

5.) Banks are a key source of capital for most NBFCs in India and so banks will continue to play a key role but regulation should nudge towards a partnership between banks (bringing capital) and specialised entities (bringing expertise).

6.)In fact, NBFCs have not done a great job of lending to startups either! Partly because startup lending is a very new area and they are handcuffed by the expectation of banks and rating agencies to operate as per conventional metrics of NBFC evaluation. (Hence, funds. And funds have their own negatives.)

7.)If there is seriousness around creating appropriate flow of credit to startups, there is probably a need for a category of NBFCs that do startup lending or a category of "business correspondents" for startups. And, the need for special treatment given to them like NBFC-MFIs have enjoyed.

8.)Such NBFCs probably need stricter capital norms but relaxed period of recognition of non performing assets, etc. If that is bolstered with specific and large targets under priority sector guidelines, we will open up credit flow to startups at reasonable cost and through specialised channels (hopefully) without causing another credit crisis. The bank balance sheets will enjoy a layer of protection from the NBFCs capital and at the same time, the large balance sheet of the bank will be better able to absorb the losses than a smaller NBFC balance sheet enabling continues flow of debt capital to startups without hiccups.

9.) But, do we have enough startups that can borrow? Do we have enough professionally managed startups that are transparent about data? Are there ways in which the professional entrepreneur can share such data easily and are there ways in which the startup lenders can get access to such data so that, instead of mortgage collateral, they can lend based on data?

10.) We haven't even talked about legal recourse.

Yes, just a priority sector classification will NOT lead to lower cost of borrowing for startups. Devil, is in the details.

(One major announcement that skipped attention of the press completely does not have anything to do with startups per se. It is that priority sector criteria in future will be driven by the status of the credit penetration of the districts. This is massive!)