Financing SMEs

Katie Hill of Acumen Fund highlights an interesting point regarding the lack of adequate and relevant financing options for SMEs in India:

"From there, we initiated conversations with a number of commercial banks and knew from the get-go that this would be tough—especially after one banker told me that they define “small businesses” as companies with revenues of R.50-150 crore (that is USD $10-100 million)! The commercial banks look at SMEs and see high transaction costs and high risk. Maybe I think about risk too much like a venture capitalist and not enough like a banker. So far, the Indian commercial banks that we talk to want a 100% guarantee, usually as company cash reserve or personal promoter guarantee. This may be the only option for getting commercial banks comfortable with the credit-worthiness of a company like GEWP. It is far from an ideal option. We have not given up on the mainstream banks. We will continue our current conversations and push for innovative thinking. "

There was a recent article ( I cannot recollect where) that hinted the role of micro-finance in robbing credit from the more "efficient" employment-generating SMEs in India. It was interesting to note this insight, especially in the light of the eternal debate on the relevance of micro-finance in alleviating poverty. My own view is that most Indian banks tend to follow a "lazy banking" model of business. Granted that the prudence and regulations have a place, but they have adopted a radical form of risk-aversiveness. The credit managers are hesitant to fund new-age business ideas, and definitely not without the guarantee of an asset that is 100% of the value of the asset. Moreover, most of this credit centers around one-time term loans that are expected to work as seed-funding for these enterprises. As Katie points out, working capital credit options are absent. I assume this is so owing to the higher degree of involvement required by the banker to understand the underlying cash flows of the business.

Since banks are mandated to maintain 40% of their total credit outlay for priority-sector lending (i.e. agricultural, rural, SME and micro-lending), most banks have now shifted to lending to MFIs at not-so-competitive rates, who in turn, transfer some of the high interest costs to the end-borrowers. Banks, themselves, are insulated from the risks of the business and so far, large-scale defaults by MFIs have been rare. It is also interesting to note that within the 40% target, there are no minimum targets for the SSI/SME sector itself. So, there might be merit in the argument that micro-finance is tending to replace credit to SMEs. The reason though, is not micro-finance itself, but the deep-rooted reluctance of Indian bankers and lenders to assume more risks.