1 Apr 2019, 13:23 — 5 min read
Background: Access to affordable and timely credit is vital for the unhindered growth of an SME (small & medium enterprise). GlobalLinker member Gopal Kansal shares his thoughts on why lenders are cautious in lending money to SMEs.
The basic role of banks is to lend money and earn enough to generate returns for their promoters, depositors, investors etc. In doing so, these lenders have to bear the risk of default by the borrowers. This makes them cautious to make sure any default remains within manageable limits. The MSME segment is traditionally seen as a riskier lending option vis-à-vis other options available to the banks. The reasons are many.
1. The MSMED Act 2006, Chapter V, para 15 and 16 states that bills/invoices of MSMEs must be settled within 45 days. This has not been enforced by PSUs or Private Sectors. This puts extreme pressure on MSMEs to meet their payment commitments on time. Consequently, it affects their credit rating and ability to raise fresh loans from banks. MSMEs are always at the receiving end and seldom demand payments from large companies as they fear losing lucrative business.
2. MSMEs are highly vulnerable to the volatility of the market conditions. Therefore, they genuinely need support of the lenders for extension of time for repayment of the loans. But they’re are often reluctant to restructure the loans because it will then be immediately classified as sub-standard asset and subjected to provisioning requirement. The sector needs a more flexible approach towards MSME loan restructuring and not a one-time policy intervention. RBI’s reluctance to formulate such a policy emanates from its lack of confidence in the lenders that they will misuse such a policy to hide real Non-performing assets (NPAs).
3. Another critical area where MSMEs are vulnerable is lack of basic financial understanding. More often than not their financial decisions revolve around ‘tax avoidance’. Since lenders and credit rating agencies closely analyse financials of a company to determine their credit worthiness, MSMEs must be careful of maintaining their financial position while exercising ‘tax management’. A bad rating impacts both their ability to raise funds and the price at which funds can be raised.
4. A similar issue is the management of working capital. Despite the increase in turnover, MSMEs still end up defaulting on their payment obligation. Why so? In the pursuit of growing their business, they often end up diverting the working capital to buy fixed assets without tying up long term funds. They fail to understand the importance of liquidity and this also hurts their credit rating. MSMEs, therefore, must be given some ‘Basic Financial Education’ to make them understand the nuance of the finances.
5. At the same time, RBI’s Asset Classification norms are applicable mutatis-mutandis across all segments i.e. large corporates, mid-corporates, and MSMEs. However, it is unfair to expect same kind of financial discipline from SMEs vis-a-vis large/ medium corporates. It is a well-known fact that SMEs largely depend on their larger counterparts for sale of goods and timely realisation of their dues. Therefore, they generally end up providing credit period against their sales to these entities in the range of 60 to 120 days. On the other hand, they do not easily get the raw material on credit.
Overall, the cash cycle for the MSMEs works out to be anything between three and six months. Therefore, they find it extremely difficult to manage their working capital requirement and thus end up delaying payment towards their commitments.
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Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views, official policy or position of GlobalLinker.
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