IntroductionLet me start with an introduction of the SME Sector in India, its characteristics and needsDefinition: SMEIn India the Micro, Small and Medium Enterprises are defined by the size of ‘initial fixed assets investment’, i.e. the ‘plant and machinery (excluding land & building). Recently with the enactment of “The Micro Small and Medium Enterprises Development Act 2006 (MSMED Act 2006) , that came into effect from 2nd October 2006, MSMEs are classified as following –For Enterprises engaged in “Manufacturing or ProductionCategory Having ‘Plant & Machinery’ InvestmentMicroUpto Rs. 25 LakhsSmall Between Rs. 25 Lakhs and Rs. 5 CroresMedium Between Rs. 5 Crores and Rs. 10 CroresFor Enterprises engaged in providing or rendering “Services”Category Having ‘Plant & Machinery’ InvestmentMicroUpto Rs. 10 LakhsSmall Between Rs. 10 Lakhs and Rs. 2 CroresMedium Between Rs. 2 Crores and Rs. 5 CroresSource: http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=2502&Mode=0SMEs have traditionally been important to the economic progress of the developing countries in the world. In India, SMEs have emerged as a vibrant segment of the economy. This position is reflected in their substantial economic contribution in terms of employment, GDP, exports, technological innovations, besides social contribution made by developing the infrastructure and improving the standards of living. Small scale industries provide immediate large scale employment, offer a method of ensuing a more equitable distribution of national income and facilitate an effective mobilization of resources of capital and skill which might otherwise remain unutilised”.SMEs is the largest and fastest growing customer segment in India after agriculture.As per the Third All India Census of SSIs (2001-02), there were 10.52 million SSI units in the country, of which 1.37 million were registered and 9.15 million unregistered units. For the year ended March 2004, the number increased to 11.52 million, providing employment to 27.40 million persons and contributing an output of over Rs.3, 480 billion in FY04.But, SMEs lack adequate access to finance and capital markets. The high administrative and transaction costs associated with lending or investing small amounts don’t make SME financing a profitable business for commercial banks and the financial institutions.
The SME industry in India is structured as clusters of enterprises spread across India.India has approximately 400 modern small scale and 6000 rural and artisan based clusters. These clusters contribute to approximately 60 per cent of India’s manufactured exports.The size in terms of the number of units and the quantum of output of clusters may vary significantly. Some of them are so big that they produce upto 70 to 80% of the total volume of that particular product produced in India.Some successful examples of clusters are as underAuto ancillary industry near PuneICT Industry near BangaloreChemical and Pharmaceutical IndustryMost prominent in western region in states of Maharashtra and GujaratHigh Growth Industry with last year average growth of about 23%Export OrientedLack of Infrastructure and R&D SpendingTextile and Garment IndustryPrimarily located in Northern and Southern part of IndiaLong value chain involving Ginning, Spinning, Weaving, Knitting, Dyeing, Printing, Garmenting, etcExport OrientedCurrency Fluctuation and lack of institutional supportAuto AncillaryPresence in western and northern IndiaDomestic as well as Export OrientedFunding from Private banks as wellFairly Large Investment Requirements for further expansionEngineeringLargest overall industrial sector in IndiaDomestic as well as Export OrientedLarge FDI inflows in the past few yearsReported Easy availability of Capital
Most small and medium companies rely on extremely expensive funds sourced from the unorganized financial sector.As we know, banks have traditionally lent against the security of fixed assets. SMEs, in general and the service sector SMEs which form a significant emerging growth driver of the economy in particular, do not have high investment in fixed assets. This has resulted in the SMEs being under-financed or inadequately financed. Thus, the banks should take credit views beyond just financial parameters.
Small ticket sizes involving significant costs in terms of time and money make SME funding less attractive for banksThe risk associated with SME lending cannot be offloaded due to lack of significant secondary markets in India for such productsBulk of the SMEs are start-ups or do not have any credit history information and thus the funding decision becomes even more time consuming and complexThe SMEs in general and especially those in services industry do not have large proportion of fixed assets which could be used as a collateral for raising capital. The traditional approach and parameters must be done away with and new proxies for creditworthiness should be used to fund in such casesMost of the SMEs fail because the promoters lack experience when it comes to expanding beyond geographies, launching new products, etcAs the SMEs lack financial muscle, they are vulnerable to macro changes in the economy in general. The start-ups, especially in today’s IT era show a very high mortality rateThe clusters and individual enterprises are spread across geographies. Most of them are privately owned or partnership enterprises and thus there is a lack of availability of data to support and monitor the funding decisions
Term loan for acquisition of machinery and fixed assetsWorking Capital by way of funded Cash Credit LimitLetter of Credit is a document issues by a financial institution generally used in trade finance which provides payment undertaking to a beneficiary (counterparty to trade)
The new private sector bans have recently ventured into financing the high risk SME segment. Every bank is aggressively trying to tap new customers and serve the existing customers in the best possible way.
Management Support ServicesNPAs are sometimes the result of lack of knowledge about business reality. To reduce their number, it is advisable to offer SMEs the business support and development services in addition to credit. While lending to SMEs, the banks should know the customers, the market and the financial counterparts involved. SMEs should be guided and provided help in terms of management expertise and vertical knowledge. Support services can be a part of package deal alongside the credit.Communication regarding productsWithout marketing, even the finest services would never be sampled. Developing the right strategies for marketing, selecting the most suitable communication options and measuring the performance are vital for the banks and FIs to know their niche markets and offer packages tailor made to server them better.
Management Support ServicesNPAs are sometimes the result of lack of knowledge about business reality. To reduce their number, it is advisable to offer SMEs the business support and development services in addition to credit. While lending to SMEs, the banks should know the customers, the market and the financial counterparts involved. SMEs should be guided and provided help in terms of management expertise and vertical knowledge. Support services can be a part of package deal alongside the credit.Cluster Cross-SellingCluster presence of SME gives a lot of advantage to Banks as they can target customers with incurring small costs of customer acquisition. In case of Bank of Maharashtra, it has very good presence in State of Maharashtra and it service various clusters in Maharashtra some of them being Textile, chemical, leather, auto components, gems and jewellery so it would be advisable to venture geographically into cluster that has similar industry composition, and one such state is Punjab. We are emphasizing on this approach of expansion for the bank because as said earlier the need of SME are not only financial rather few non-financial (advisory to business). And non-financial services requires the expertise that are generally not available in banks domain of service and more so it is difficult to develop, therefore using its current strength and developing expertise in other industries simultaneously can be the road ahead for the bank.Triangle Funding ModelKeeping in the mind the various problems faced by SMEs and constraints on the side of the banks we have tried to come up with the model that creates a Win-Win-Win situation. In this model there are three parties involved, SME .. Banks and the VC Funds (the one that brings significant minority stake in the company say 15-20% and has a member on the board to look into the functions of SME and provide advisory services). Now how this model can be implemented:Say SME needs Rs.100 crores but based on the credit ratings and quality of assets bank has constraint and cannot give more than 60 crore of the loan to the SME, although bank feels that the business SME is into provides very good long-term opportunity but due to the conservative approach of the Indian Banking system it is tied and can’t give more money. Now here the issue arises SME are inadequately funded whereas Bank loses on the opportunity. For this we have introduced a new link into the system the VC fund, here if the bank is convinced it can tie-up with the VC fund who are into SME funding to provide funds for such SME..now the question arises … how will it help??To SME: It will get adequate as well as cheap funding. Also it gets the VC fund personnel on the board who helps SME in advising on various issues and also as there are lot of international tie-up between VC-funds and foreign companies it gives the opportunity for the SME to expand its market and get direct access to various good processes that are being followed by international counterparts.To VC: It gets the good business to invest in, usually VC funds like BTS Advisors are into such kind of financing where they pick up 10 -25% stake in the company for average 3.5 years and create value for the business as they are actively advising SMEs. Now the question arises here why SMEs don’t get fully funded from VC’s. The problem here is to get full funding SME won’t be able to give sufficient amount of stake in the business to such VC’s. Also many of the SME business started are family owned business and there is some amount of ego is involved in who controls the business therefore SMEs won’t be keen on getting fully funded by the VC’s.To Banks: This is where the bank needs to innovate, here when bank is advising VC to invest in certain business what banks can do is underwrite certain portion of loss of VC’s (say 20% in our case it would come out to be Rs. 8 crores) , what bank will get in return here is premium against this service, although looking at the financial statements it may seem that bank is holding Rs.8 Crore more as a liability in the balance sheet, but if we look at the overall process what has happened after the introduction of VC’s on SMEs board gives Banks the sense of security (assurance) of getting it originally funded money back. This happens as the business will be run in a more professional manner by taking calculated risks and generating max possible return. So this model can fetch extra underwriting premium as well as the security against the default.Viability of this model: Introduction of any model doesn’t make sense until there is a need in the market. And in one of the SME surveys conducted by CII , it was found that 58% of SMEs feel the growing importance of the non-conventional FIs for raising funds. Therefore the competition in SME financing sector is bound to increase and there won’t be only banks competing for the market share but also there will be various set of FIs that will be hunting for the share in the pie. Therefore the best approach would be to collaborate and develop a model that has long term viability and value creation for all the stakeholders involved.
Transcript of "Serving SMEs In India"
Serving SMEs in India Prasad Shahane Chetan GanatraNMIMS, Mumbai26th Oct 2008<br />
Introduction – SMEs in India<br />Growth Engine of Economy<br />Second largest employer<br />Significant contribution to Exports<br />Significant Contribution to GDP<br />Source: Ministry of Small Scale Industries website, India<br />
SME Industry in India - Profile<br />Features<br />400 modern and 6000 rural and artisan based clusters<br />Contribute 60 % of India’s manufactured exports<br />Examples: Pune, Bangalore<br />Prominent Sectors<br />Chemical and Pharmaceuticals (Maharashtra, Gujarat)<br />Textiles and Garments (North and South India)<br />Auto Ancillary (Maharashtra, Gujarat, Punjab)<br />Engineering (Spread Across India)<br />Source: D&B Emerging SME Series<br />
Needs of SMEs<br />Persistent requirement of Capital<br />Working Capital Facilities<br />Routine Business Needs<br />ForEx Services<br />Business Management guidance<br />Legal and Regulatory guidance<br />
Why not fund SMEs<br />High Transaction Costs for Small Volumes<br />No Secondary market for SME loan<br />Lack of Credit history information<br />Lack of Collateral<br />Inexperienced Promoters<br />Vulnerability and High Mortality Rate<br />High cost of Information Collection<br />
Portfolio – Bank of Maharashtra<br />Funded Facilities<br />Term Loans<br />Cash Credit<br />Bill Discounting<br />Non-funded Facilities<br />Letter of Credit<br />Letter of Guarantee<br />
Solutions<br />Disbursement of loan on need basis<br />Refinancing of Loan taken from unorganized lender<br />Awareness regarding products<br />Intensive use of technology, automation<br />Integrated Private and Business Banking<br />