Unlocking the Greenfield SME Finance Potential: A Call to Action for Private Sector Banks

Indian entrepreneurs transitioning from trading to manufacturing is a significant trend towards industrialization. Recent disruptions in global supply chains, such as the COVID-19 pandemic, have highlighted the vulnerabilities of relying on imports. This has prompted many entrepreneurs to consider domestic manufacturing as a more reliable option.

The Indian government has launched various financial incentives, subsidies and tax benefits to promote manufacturing under the "Make in India" campaign. Also, the Indian government wants to reduce its dependency on China and therefore banning imports of many products by strictly applying BIS guidelines and heavy import duties.

This inexorable wave of entrepreneurship has not only reshaped the industries but also presented an opportunity for the Indian Banking sector to reinvent itself and adopt innovative structuring in its lending policies.

BUT

Here is the reality.

Meet Rohan—a young, ambitious engineer with a degree from one of India’s top engineering colleges. Armed with passion and a vision for the future, he decides to set up a semiconductor or renewable energy parts factory in Gujarat, aligning with India’s push towards technological innovation and sustainability.

Now, Rohan is no ordinary dreamer. His father, Mr Pannalal Verma , is a successful textile businessman who has built immense wealth over decades. Their family’s net worth is robust, backed by liquid assets and real estate holdings. To sweeten the deal for the bank, Rohan is ready to offer more than 100% collateral - a security that most lenders would dream of having.

Yet, when Rohan approaches a private sector bank for funding, his proposal is politely declined.

Rohan wonders:

• “Why does my father’s success and our family’s wealth not count?”
• “If I can pledge more than 100% collateral, why can’t the bank trust me?”

It feels unfair that despite having a solid financial background and securing the bank’s exposure, the ‘lack of experience’ argument overshadows everything else.

This article is a compelling argument for private sector banks to reimagine their roles in financing greenfield MSME manufacturing units.

Setting up a greenfield (New) manufacturing unit is a complex and multifaceted process that requires careful planning and execution. Before diving into this venture, an entrepreneur typically engages in a series of essential steps and preparations:

?? Market Research and Analysis: Identifying a viable Product/Product line, Analyzing market trends-demand-competition-potential customer base, Evaluation of feasibility and profitability of manufacturing the chosen product.

?? Business Plan Development: Making Manufacturing strategies, Designing business model, target market, Pricing Strategy, Sales and Marketing channels

?? Legal and Regulatory Compliance: Register the business entity, obtain necessary permits, comply with health/safety/environmental norms

?? Location and facility: Selecting appropriate location for the manufacturing unit considering factors like proximity to suppliers, distribution channels and availability of labour, Determining the layout of the manufacturing facility.

?? Supply Chain Management: Establishing relationships with Suppliers of Raw materials, obtaining letter of intent from them and fixing broad terms with labour contractors.

?? Factory construction and Equipment planning: Negotiation with various vendors of core machinery and estimation of construction cost of the factory building and other costs such as electric installations, Power connection, pollution control equipment, testing equipment’s, material handling equipment’s etc

?? Securing finance: Securing funding for the unit through sources like promoter’s equity, Loans from Banks, Investors, Government grants etc.

?? Hiring & Training: Recruitment of Production, Admin, Sales staff etc.

?? Logistics and Distribution: Plan the logistics for product distribution including transportation and warehousing.

?? Compliance & Reporting: Stay informed about changing regulations and ensure ongoing compliance with all legal and industry standards.

Out of all above steps, securing timely finance for setting up the manufacturing project is crucial for several reasons, and failing to do so in a timely manner can have significant negative impacts on the project's success.

Turnaround Time (TAT) in greenfield funding is an important aspect which if not met reasonably, then entire dynamics and projections of the project would get disturbed.

• Machine Vendors may refuse to supply the machine or increase the price in case of delay in payment.
• Construction cost of building may increase if prices of steel/cement go high. This can quickly erode your budget if you don't have adequate funding in place.
• Delaying the launch of your manufacturing unit or product can put you at a competitive disadvantage. The identified suppliers of raw material and customers for finished goods may be approached by new players in market or by existing competitors.
• Failing to meet these timelines can damage Entrepreneur’s reputation and lead to contract breaches.
• If you resort to high-interest loans or financing options due to funding delays, it can significantly increase the overall cost of your project.
• In some cases, regulatory approvals and permits may be contingent on demonstrating financial stability and the ability to meet financial obligations. Failing to secure funding in a timely manner can lead to regulatory compliance issues.

It is observed that majorly Public Sector Banks in India are currently financing greenfield MSME manufacturing projects while this generally doesn’t come under the lending policies of Private Banks. Said proposals with a PSU bank eventually happen but it takes lot of time & process and ultimately doesn’t serve justice to the time of an entrepreneur and his projections.

Though public sector banks try matching the speed of private banks, there is still a gap.

This happens due to various limitations at the end of PSU banks in terms of employee productivity, less focus on digitalization as assessment tools,? lack of frequent business review system, limited employees in loan factories, no exclusive person for lending and same person has to serve asset & liability customer both, frequent transferrable jobs, internal processes and various other reasons.

On the other hand, Private sector banks are usually known for their highly competitive outlook and technological superiority. On occasion, they also provide tailored loan solutions to meet the requirements of the borrowers after carefully assessing their financial condition and repayment habits.

Private banks on the other hand with a higher employee productivity rate, continuous team review system, System driven Turn-around-time (TAT) management, Doorstep service and no requirement to frequently visit the branch, defined and reachable escalation matrix, use of data processing technology in processing the proposal and simplified internal processes can play a big role in funding greenfield MSME units within reasonable time.

The current generation MSME entrepreneurs always prefer private banks whereas their parents would always guide them to get it from a public sector bank. However as far as setting up a new MSME manufacturing unit where the entrepreneur doesn’t have a previous manufacturing experience raising finance from private sector banks is a tough task.

Why Private banks are currently not aggressively entertaining greenfield MSME funding:

• Lack of Industry knowledge with a new entrepreneur, Loan repayment risk, Collateral limitations, Cash Flow Constraints and Economic factors are the key risks associated with lending money to a new entrepreneur with no previous manufacturing experience. Private sector Banks are more interested in funding a vintage customer who either requires working capital in existing business or an existing set up which is looking for Capital expansion.
• There is no strict mandate to Private Banks from ministry of MSME and central office of particular bank to enter into greenfield MSME unit finance.
• The overall profitability can be achieved from brownfield MSME finance and other business also like Mortgage loans, Home Loan, Credit cards, Insurance, unsecured business loans, auto loans and various other low risk businesses and products. ??
• Not having a vintage team within the bank which can understand the dynamics of a greenfield manufacturing project and can simultaneously monitor it.

At the most, the private sector banks are funding those new set ups where there is an existing associate concern in same line of business which is generating sufficient cash flows as per books of accounts and ready to provide its corporate guarantee for the newly established entity where the finance is sought.

For example, XYZ Pvt Ltd is engaged in manufacturing stainless steel bars under a Hot Rolling Mill generating sound cash flows annually. If said company goes for a backward integration plant under a new entity called ABC Pvt Ltd for melting of metal scrap which will be used as a raw material in stainless steel bar manufacturing process, a private bank may fund the Capex and working capital to ABC Pvt Ltd if XYZ Pvt Ltd provides its corporate guarantee to said bank against finance to ABC Pvt Ltd.

If the financing system demands existing cash flows for financing a new venture, how will India ever encourage greenfield MSME projects in emerging industries like semiconductors or renewable energy?

How a program can be structured by Private Sector Banks for financing greenfield manufacturing units

Private Banks can take various initiatives to fund new borrowers, often referred to as "Start-ups" or "emerging entrepreneurs." These initiatives aim to reduce the inherent risks associated with lending to such borrowers while promoting economic growth and innovation.

Here is an indicative list of initiatives:

?? Initially, A fund say Rs 500 Crores for a financial year can be allocated at bank level for greenfield MSME finance. Advances under this fund can be booked under separate head for special monitoring.

?? Instead of allowing this open ended for entire country, location specific funds can be allocated. Let’s say if Gujarat or Maharashtra has delivered more success in Greenfield MSMEs, a pilot model can be started from any of these states considering the facts that entrepreneurs there have more sound repayment conduct and eligibility as compared to other locations in the country. ?

?? Bank can only go ahead with particular decided Industries which are growing as per economic reports and where the product is having regular demand. Thus, during the initial phase of launching a greenfield finance scheme only regular or tested profiles can be funded. Example: Pharmaceuticals, General Engineering, Plastic and Polymer, Food Processing etc. Moreover, initially Banks can prefer those business profiles where a deep technical experience is not required. For example, a furniture manufacturing business simply focuses on principles of cutting, bending, welding, shaping, jointing, and finishing unlike industries that require complex chemical reactions or complicated assembly lines.

?? Bank can ask for third party TEV reports to evaluate the proposal and viability of project. Also, a reference check of the customer can be done from existing portfolio customers of the bank in the same industry.

?? Small Industries Development Bank of India (SIDBI) has done tie up with OEM vendors who are standard companies manufacturing standard machines. From experience it is observed that Industries which procure these machines for further manufacturing of various products are generally successful in business and delivering results and therefore chances of defaults are very low in those industries. Also, since these machines are good quality machines manufactured by reputed vendors, the resale price at the time of enforcement of security is also not very low. For example, Injection molding machines play a crucial role in the plastic industry and are considered the workhorses of plastic manufacturing. Injection molding machine made by Fanuc, Toshiba, Milacron, Haitian etc. companies are standard quality machines which has a longer life cycle. Also, from salability view point there is no major challenge as many small MSMEs buy refurbished machines for starting their operations.

?? Where SIDBI and Public Sector banks are funding Capex at lower security ratio say 50-60%, Private Banks can start funding greenfield proposals at minimum 100% immovable security coverage and total 125% to 150% coverage including the primary security against the loan.

?? In some cases, Bank may conservatively decide to fund only Machinery cost in a project and may ask the promoter to construct the factory building from own funds. Thus, where bank has reservation for constructed collateral, this way the same can be mitigated. Also, where banks want a shorter period for Date of commencement of commercial operations (DCCO) they may decide to fund only machinery part in a project and ask the borrower to construct the factory building from own funds which can bank consider in promoter’s margin.

?? Along with immovable security coverage they may take 3 to 6 EMIs in advance as fixed deposit (DSRA FD) so that if project operations are delayed, they can secure the repayment with advance EMIs.

?? Repayment ballooning can be done so that in the initial period the borrowing unit need not to outflow major portion of cash flows towards debt repayment. Gradually when the unit get set up and operations are smooth, a higher repayment can be scheduled in ending years of term loan.

Conclusion:

In conclusion, the untapped potential within the greenfield MSME manufacturing sector presents a significant growth opportunity for private sector banks. By recognizing the inherent advantages and possibilities within this segment, banks can not only expand their business portfolios but also play a pivotal role in nurturing the aspirations of young entrepreneurs. It is a symbiotic relationship where banks stand to benefit from a diversified portfolio while entrepreneurs gain access to the necessary capital within reasonable timeframes.