Lending to MSMEs by banks: Some bitter truths

Money life :  Vivek Sharma 9 Dec 2013

MSMEs being the backbone of economy have been in need of funds to grow themselves but banks have adopted an approach which has failed to meettheir needs

When it comes to lending for business activities, banks tend to prefer large business entities to small players. This bias comes from the fact that big businesses have better assets and the possibility of failure of these businesses is less compared to small business enterprises. In order to gauge this preference of banks conversations with a small business enterprise, often referred to as micro, small and medium enterprises (MSMEs) says it all. For a micro and small business, to get loan from a bank is nightmare. This has been happening in spite of dedicated MSME branches set up by various banks and MSME lending being a part of priority sector lending.

 

RBI data in this regard is an eye opener. More than 92% MSMEs run their business on self-finance and have no source of institutional finance. The chart below shows that:
 

It is obvious that small businesses require funds as they have limited source of self-financed capital. Idea of schemes such as Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) came from this but somehow could not acquire acceptance from the banks in general. Though loans were given under CGTMSE, the number has been very insignificant compared to the size and scale of MSME business operations.

But this is not all.

There has been always a demand and supply gap in lending to MSMEs. MSMEs being the backbone of economy have been in need of funds to grow themselves but banks have adopted an approach which has failed to meet their needs. The chart below shows the demand supply gap which seems to be narrowing in days to come but still very sizeable by any stretch of imagination:
 

What is extremely surprising is that MSMEs don’t perform badly compared to the big business houses when it comes to performance on the payment of loans. The data available in this regard shows that percentage of impaired assets have been rising for medium and large business while it has been relatively stable for micro and small business.
 

So, there is no apparent reason for banks to show preference for large businesses as their performance on impaired asset front has been growing bad to worse. What is it that is preventing banks from lending to MSMEs? Most apparent reason is that banks to play safe and don’t want to add to their non performing assets (NPAs). The unfounded fear comes again from the fact that small business will default. But this logic gets weakened in some cases. Even in cases when credit guarantee is available through CGTMSE, banks are wary of funding of MSMEs because of the fact they don’t want any hassle in claiming guarantee benefit in event of a default by a micro or small enterprise.

 Recently, while delivering a keynote address at the Training Workshop on Credit Scoring Model with support from IFC for MSE Lending in Mumbai on 29th November, Dr KC Chakrabarty, deputy governor, Reserve Bank of India (RBI) said that credit scoring modelwill go a long way in promoting credit facility to MSMEs. 

But the key question is can lack of will to fund MSMEs will addressed by a strong statistical model. There is a need to fix accountability for lack of funding of MSME business by banks. For instance every bank can be asked to offer collateral free lending first to MSMEs under CGTMSE before the bank asks for security for any lending.

Last but not the least, let MSMEs also understand their responsibility towards lending done by banks. They must act with full responsibility to ensure that loans are paid on time on them and wilful default does not become order of the day.
 

(Vivek Sharma  has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance.He writes on personal finance and economics and is invited as an expert on personal finance shows.)