Working capital funding for MSME’s during the Covid19 Pandemic

A few months ago, no one knew that SARS-CoV-2 existed but now, we are faced with an unprecedented situation on account of the spread of novel Corona Virus (COVID- 19) that has been declared a pandemic by WHO. The spread of this virus cannot be controlled since we do not have a vaccine for it & our hope for a vaccine maybe 18 months away.

The present 21-day lockdown is basically for buying more time and simultaneously educating our citizens about social distancing. The underlying objective is to ‘flatten the curve’ i.e. to keep the number of #Covid19 infected cases lower than the number that our health infrastructure can handle. 

In my earlier article, I had emphasized the need for the MSME’s to have a 12 to 18 months Action Plan.

Meanwhile, on March 27, 2020, the Monetary Policy Committee (MPC) Reserve Bank of India in its Seventh Bi-monthly Monetary Policy Statement, 2019-20 Resolution stated that ‘Global economic activity has come to a near standstill as COVID-19 related lockdowns and social distancing are imposed across a widening swathe of affected countries. Expectations of a shallow recovery in 2020 from 2019’s decade low in global growth have been dashed. The outlook is now heavily contingent upon the intensity, spread and duration of the pandemic.’

MPC was of the view that macroeconomic risks, both on the demand and supply sides, brought on by the pandemic could be severe. It also noted that ‘the Reserve Bank has decided to undertake several measures to further improve liquidity, monetary transmission and credit flows to the economy and provide relief on debt servicing.’

It also said that ‘Banks and other financial institutions should do all they can to keep credit flowing to economic agents facing financial stress on account of the isolation that the virus has imposed.’

COVID-19 – Regulatory Package

Reserve Bank of India vide its circular RBI/2019-20/ DOR.No.BP.BC. 47/21.04.048/2019-20 dated March 27, 2020, issued detailed instructions in regards to the Statement of Development and Regulatory Policies released on March 27, 2020, wherein certain regulatory measures were announced to mitigate the burden of debt servicing on account of COVID-19 pandemic and to ensure the continuity of viable businesses.

The areas covered included:

(i)           Rescheduling of Payments – Term Loans and Working Capital Facilities

In respect of all term loans, all commercial banks are permitted to grant a moratorium of three months on payment of all instalments falling due between March 1, 2020, and May 31, 2020. Also, the residual tenor will be shifted across the board by three months after the moratorium period. However, interest shall continue to accrue on the outstanding portion of the term loans during the moratorium period.

In respect of working capital facilities sanctioned in the form of cash credit/overdraft (“CC/OD”), lending institutions are permitted to defer the recovery of interest applied in respect of all such facilities during the period from March 1, 2020, up to May 31, 2020. The accumulated accrued interest shall be recovered immediately after the completion of this period.

(ii)         Easing of Working Capital Financing

In respect of working capital facilities sanctioned in the form of CC/OD, lending institutions may recalculate the ‘drawing power’ by reducing the margins and/or by reassessing the working capital cycle. This relief shall be available in respect of all such changes effected up to May 31, 2020, and shall be contingent on the lending institutions satisfying themselves that the same is necessitated on account of the economic fallout from COVID-19.

Classification as Special Mention Account (SMA) and Non-Performing Asset (NPA)

Since the moratorium/deferment/recalculation of the ‘drawing power’ is being provided specifically to enable the borrowers to tide over economic fallout from COVID-19, consequently, such a measure, by itself, shall not result in asset classification downgrade.

The rescheduling of payments, including interest, will not qualify as a default for the purposes of supervisory reporting and reporting to Credit Information Companies (CICs) by the lending institutions. CICs shall ensure that the actions taken by lending institutions pursuant to the above announcements do not adversely impact the credit history of the beneficiaries.

Observation

While the above-referred COVID-19 package by RBI was for immediate relief to individuals & MSME’s facing a challenge due to the locked-down:

1)   It allowed rescheduling of payments by granting a moratorium of three months on payment of all instalments of Term Loan and defers the recovery of interest on Working Capital OD/ CC.

But a 3-month deferment is insufficient for a pandemic that may not have a vaccine for 12 to 18 months and where the effects of the disruption on the business will linger for much longer than 3 months.

2)   The package is based on the presumption that normal economic activity will resume after the 21 days lockdown and sufficient liquidity will be generated for payment of the entire accumulated accrued interest of the previous three months.

It is unrealistic for the entire accumulated accrued interest of three months to be paid immediately after the completion of the 90 day deferment period?

3)   Lending institutions are allowed to recalculate the ‘drawing power’ by reducing the margins and/or by reassessing the working capital cycle and shall be contingent on the lending institutions satisfying themselves that the same is necessitated on account of the economic fallout from COVID-19.

For the industry that was already under stress on account of mounting Debtors due to tight liquidity, March was a critical month, being the last month of the financial year. Pending sales orders, outstanding collections and payment obligations in relation to the financial year including statutory dues were to be settled. Under this scenario, it is impossible for any lending institution to determine & come to a conclusion that the need for recalculating DP is necessitated purely on account of the economic fallout from COVID-19.

Opportunities in the evolving scenarios

It is obvious to all that this is a long fight against COVID-19. While it has thrown us into a quandary, it has a potential for medium and long term upside for India and the Indian Industry. There existed overdependence on China as a manufacturing hub for the global supply chain which has got exposed and is hurting US & Europe. The world is looking for alternatives and India has an opportunity to be a credible alternative.

Many drugs like hydroxychloroquine sulphate which are being tried in combination by doctors globally to treat coronavirus patients are manufactured in China and in India. India has some of the world’s largest manufacturers of the finished drug as well as its component ingredients. There exists immediate demand for standard protective gear like gloves, mask, gown, face protection, goggles, face shields, gloves, coverall, headcover and rubber boots etc.

Meanwhile, on 27th March 2020, SIDBI has launched SAFE (SIDBI Assistance to Facilitate Emergency response against Corona Virus), a financial assistance program for MSMEs which are engaged in the manufacturing of products like hand sanitizers, masks, gloves, headgear, bodysuits, overalls, shoe-covers, protective goggles, ventilators or offers services like testing labs, clinics etc related to fighting the novel coronavirus. (refer to my post for details)

 Indian manufacturers including many MSME’s will have an opportunity to market India; they will have to upgrade their technology, manufacturing capabilities & capacities. There is a tremendous scope to realign the global supply chain & move a large part of that manufacturing activity to India.

MSME’s should accept for a fact that there may not be a return to normalcy as they knew it and will have to have the courage to take bold steps in order to take advantage of the opportunity. They will face small issues & difficulties in the next 12 to 18 months with regard to reassessing working capital, realigning manufacturing process based on social distancing requirements, use technology to enable remote working using VPN or migrating data to the cloud, use team working suits. These niggles will get resolved, but India and its MSME’s will have to think big and behave like a world power. The focus of all stakeholders and the government has to be on aiming higher as a nation and winning this battle. To come out and grab a share of the global trade from China.

While I have already covered the ‘needs emphasized due to this crisis’ in my earlier article and employee protection is definitely the topmost amongst them. Social Distancing will have to be immediately implemented for businesses. This can be achieved as follows:

• Ensure employees maintain 3 feet distance between themselves or more whenever possible.
• Workers working in close proximity may have to wear safety masks for personal protection.
• All non-critical services may be performed during off-peak hours.
• Staggering of shifts to reduce the total attendance at any given time.
• Sanitization of the workplace will be of paramount importance with a need to provide employees with access to sanitizers, gloves and disinfectant wipes depending on the type of job function.

The funding of the above needs and raising debt from banks is a major source that most industries including MSME’s will look for.

The COVID 19 package released by RBI is definitely not the whole story to overcome this challenge. It is clear that no one has any idea of how bad the effect can be on the economy. Therefore RBI too is assessing the size of the situation. The opportunity that this crisis presents to India is surely not missed both by Government of India and RBI. Therefore, both are having a calibrated approach to a financial package and therefore MSME’s should stay focused on having their plan ready during the lockdown period to traverse the next 2 to 3 years.

The pointers for preparing a Revised Business Plan and Estimating Working Capital requirements have been shared by me in my earlier article. A well-made business plan will enable the banker in properly assessing the additional working capital funding requirement quickly if presented in the Credit Monitoring Arrangement (CMA) format.

Meanwhile, State Bank of India and other PSU Banks, have with a view to providing some degree of relief to their existing borrowers whose operations are impacted by COVID 19, decided to make available additional credit facilities by way of ad-hoc facilities to tide over the current crisis situation.

 The brief highlights are as under:

However, business & MSME customers of Private Sector Banks and Co-operative Banks are still awaiting a similar package to be declared by their Bank. Waiting is a luxury MSME’s cannot afford and may have to proactively approach their bank for the relief.

Interestingly, there is RBI’s Master Circular, and that is what the MSME’s can use to seek additional working capital requirement from their bank.

Putting the above in perspective

You will be pleased to know that RBI has vide RBI/FIDD/2017-2018/55 Master Direction FIDD.CO.FSD.BC No.8/05.10.001/2017-18 dated July 03, 2017, Master directions incorporating guidelines issued to banks in regard to matters relating to relief measures to be provided in areas affected by natural calamity.

Master Direction - Reserve Bank of India (Relief Measures by Banks in Areas Affected by Natural Calamities) Directions, 2017 were issued in exercise of the powers conferred under Sections 21 and 35A of the Banking Regulation Act, 1949 and has laid down the guidelines to banks for dealing with relief measures in case of natural disasters

The National Disaster Management Framework recognizes 12 types of natural calamities viz. cyclone, drought, earthquake, fire, flood, tsunami, hailstorm, landslide, avalanche, cloud burst, pest attack and cold wave/frost.

The present Covid19 pandemic is also one such calamity brought about by nature and the government has decided to treat it as a notified disaster. The finance ministry too has clarified that the Coronavirus can be classified as a natural calamity and the Force Majeure clause may also be invoked. Therefore, I suggest that industry & especially MSME’s may use the guiding principles of the above Master Directions and the various COVID 19 emergency packages declared by PSU banks as the basis for structuring their request to their respective Banks.

The directive states that the developmental role assigned to the commercial banks including Small Finance Banks warrant their active support in reviving the economic activities of those affected by the occurrence of a natural calamity. Their role is to provide relief measure through rescheduling existing loans and sanctioning fresh loans as per the emerging requirement of the borrowers.

Chapter III of the directive covers Institutional framework:

The Divisional/Zonal Managers of scheduled commercial/SF banks must be vested with certain discretionary powers to avoid the need to seek fresh approval from their Central Office regarding the line of action. Some of the areas, among others where such discretionary powers are vital may be the adoption of scale of finance, extension of loan period, margin, security, sanction of new loan keeping in view the total liability of the borrower.

 Chapter IV of the directive covers Restructuring of existing Loans

The Master Directive predominantly covers Agricultural Loans both Short Term and Loan Term.

With regards to Non-Agricultural Loans, it says that a view needs to be taken by State Level Bankers’ Committee (SLBC)/District Consultative Committee (DCC) depending on the severity of the calamity as to whether a general reschedulement of all other loans (i.e. including loans given to MSE units or in case of extreme situations, medium enterprises). If such a decision is taken, while recovery of all the loans be postponed by the specified period, banks will have to assess the requirement of the individual borrowers in each such case and depending on the nature of his account, repayment capacity and the need for the fresh loans, appropriate decisions shall be taken by the individual banks. The primary consideration for extending credit to any unit for its rehabilitation should be based on the viability of the venture after the rehabilitation program is implemented.

 The direction covers following structures for Agricultural Loans, however, in the present COVID 19 disaster, the Business borrowers need identical structures to make the lending & restructuring exercise viable and not result in an unrealistic expectation of servicing the additional debt along with their existing loans in an unreasonably short period.

Therefore, the suggested structures for Business/ MSME Loans would ideally to be as under:

 Short Term

1)   The principal amount of the short-term loan, as well as interest due for repayment in the year of occurrence of the natural calamity, may be converted into a term loan.

2)   A maximum repayment period of up to 3 years (including the moratorium period of 1 year) should be allowed if the loss of Sales is between 33% and 50%. If the loss of Sales is 50% or more, the repayment period may be extended up to a maximum of 5 years (including the 1 year moratorium period).

3)   In all restructured loan accounts, moratorium period of at least one year should be considered. Banks should also not insist on additional collateral security for such restructured loans.

 Long Term

The banks may reschedule the payment of instalment during the year of natural calamity and extend the loan period by one year.

 Asset Classification

 The restructured portion of the short term as well as long-term loans may be treated as current dues and need not be classified as NPA.

 Terms and Conditions

Guarantee, Security and Margin

     I.       Credit should not be denied for want of personal guarantees.

   II.       The fresh loan shall be granted even if the value of the security (existing as well as the asset to be acquired from the new loan) is less than the loan amount.

  III.       For fresh loans, a sympathetic view will have to be taken.

 IV.       Margin requirements may be waived or the grant/subsidy given by the concerned State Government may be considered as margin.

Rate of Interest

a.   Banks are expected to take a sympathetic view of the difficulties of the borrowers and extend a concessional treatment to calamity-affected people.

b.   In respect of current dues in default, no penal interest to be charged.

c.   The banks should also suitably defer the compounding of interest charges.

d.   Banks should not levy any penal interest and consider waiving penal interest

e.   Depending on the nature and severity of natural calamity, the SLBC/ DCC shall take a view on the interest rate concession that could be extended to borrowers so that there is uniformity in approach among banks in providing relief.

Follow up action

The government and RBI may extend further relaxation of lending norms, however, they will have to seriously look at reviewing the NPA norms too including the concept of SMA and recalibrate them back to present levels over the next 3 to 5 years. Without this, a large number of MSME’s will be heading for closure and a tremendous number of job losses. MPC has already stated that macroeconomic risks both on the demand and supply sides, brought on by the pandemic could be severe.

Present disaster puts an onus on MSME’s to ensure that they have a long term vision and in the changing business environment globally, they are making smart choices by taking outside professional help to manage their finance, banking relationships and most of all for preparing Business Plan, generate MIS Report and closely monitor the progress and chart out the variance every month to ensure that they have a grip and are focused on all important business indicators. The right way to win is to recognize that winning isn’t the end game, but the beginning of new opportunities (Meghan Daum).

Banks should recommend their MSME clients to hire professional firms for financial monitoring and to provide timely guidance to reduce the chances of failure. CFO Services LLP has been helping numerous MSME clients not only to overcome the business challenges but also to provide the tools required by business owners to help navigate the choppy waters and achieve success in the long term.