Tuesday, May 24, 2016

Tweak the laws and rules to prevent NPAs in MSMEs

The micro, small and medium enterprises (MSMEs) are the largest vendors for the Union and State governments in defence, aeronautics, electronics, safe drinking water equipment and services, medical and pharmaceuticals, solar equipment and servicing. The MSME Development Act (MSMED) also provided for MSME Facilitation Council, a quasi-judiciary institution serving as an arbitration and conciliation mechanism for disputes relating to the delayed payments for the goods supplied or services rendered by the supplier at little cost. Jurisdiction is restricted to units functioning within the State, although their dues can be with any undertaking or government outside the State. 

Only 10 out of 29 States have such councils functioning with the most efficient among them in Tamil Nadu, Karnataka, Telangana, and Kerala. Gujarat and Uttar Pradesh (UP), although have a large number of sick MSMEs, but have not reported the number of cases resolved through the Council. Neither the Ministry website nor the Development Commissioner for MSME (DC-MSME) has put out information on the functioning of the Council in various States.  
Section 18 of the MSMED Act does not cover the intending buyer’s places from where the order is placed for certain goods and the enterprise manufactures, according to specifications. For its own reasons the vendee can cancel the order. The SME suffers the loss until it finds a buyer requiring goods of the same specifications. It is unlikely the alternate buyer may be available as well. 
The units requiring facilitation for recovery of their bills against goods and services supplied represent their cases both by themselves and/ or through their advocates. The Council chaired by the Commissioner of Industries has on board representatives from the accredited Industry associations and State Level Bankers' Committee (SLBC). 
This alternate dispute resolution mechanism however, works well when the dues are with public sector units (PSUs) or buyers other than government agencies and the government itself. Government departments rarely honour the arbitration proceedings and that leaves many MSMEs as non-performing assets (NPAs).
The Courts also do not entertain appeals against the decision of the Council unless 75% of the disputed amount is paid into the Court. If the MSME unit were to approach Debt Recovery Tribunal (DRT), it has to up-front remit 25% of the claim amount without being sure of a decision in its favour, as the DRT is meant mainly to ensure that the banks do not suffer from bad debts. 
On the other hand, units that approach the Council have to deposit admission fees of just Rs500 and small administrative fees for arbitration as decided by the respective state government.
The advantage of approaching this Council is the specific timeline for settlement of the cases. Here every claim gets acknowledged on the same day with the respondent getting a notice to respond within 15 days. Most cases get settled within three months. The units get breathing time from banks to pay dues following the Award of the Council.
However, several public–private partnerships (PPPs) involving specific commitments from the government, when not honoured by the government, the SME units end up in huge losses. For example, SMAAT India Pvt Ltd, SME unit in Hyderabad receiving 158 national and international innovation awards installed water purification plants in Karnataka through PPP with government having to supply raw water and electricity after installation. About 240 plants installed three years back were not supplied raw water and power that denied them the user charges. Government of Karnataka did not even pay for the equipment and installation charges within a week of installation as required under PPP. The amount of loss is a whopping Rs220 crore. 
The losses arising on both the counts however, land up in terminal NPA status of the related units in Banks’ books. The Bank feels that the unit has sovereign risk domestically. The provisions of the MSMED Act need refinement. Several units have become victims of prejudice of either of the Branch Manager or the Controlling Authority. The units do not have the option to swap their collateralised account with another bank willing to take the account on merits, either at incipient stage or at NPA stage without impacting on their provisions relating to that account. 
RBI rules are no reprieve
The latest circular instructions of the Reserve Bank of India (RBI) only compound the problems and defy solutions to the actual problems faced by the units eligible for capital restructuring or revival but denied that opportunity. Instances of prejudicial view of some of the well-run MSME units by the managers concerned also contributed to the NPAs in the sector. 
Some alternatives that deserve a look, as the roll out of instructions in RBI circular 338 dated 17 March 2016 take effect from 1st June.
Swapping the Account: 
a) If any unit is aggrieved with a particular bank over the management of the loan accounts or over the inadequate limits sanctioned confining to the discretionary powers of the sanctioning authority, such unit having adequate collateral security should be enabled to migrate to another willing Bank either on as-is-where-is basis or for enhanced limits.
b) In respect of units where decision to restructure has been taken with a set of conditions, such conditions should be within certain rational boundaries – in terms of additional margin money or equity or additional collateral security or all the three simultaneously. If such conditions are too onerous they should be subject to redress by the Banking Ombudsman. It may be necessary to enlarge the scope of working of the Banking Ombudsman for this purpose.
No additional costs for migration shall be imposed on the units in such cases.
Zonal Committees: There is thus far no trace of the banks acting on the constitution of these committees although even the MSME Ministry circular dated 2 June 2015.  Bank-wise Zonal Committees also seem to pose difficulties in as much as each such committee has to have a specialist, a nominee of the government, representative of the financing bank from zonal or head office to be the convenor with the ZM as chairperson. A calibrated solution needs to be put in place.
a) Restructuring or revival as suggested by the TEV study should also be made mandatory if the CAP fails. If the TEV study were to opine that it is not economically feasible to revive the unit there would be no option but to reject the proposal and such rejection should invariably be recommended to the appropriate authority by the Zonal Committee.
b) The Committee should not otherwise have the option to reject the proposition of any running unit. Once rejected by the Zonal Committee, the unit’s option to revive ceases permanently.
c) If the proposal does not merit consideration due to malfeasance or fraud, legal proceedings could be instituted as mentioned in the circular and such disqualification should be recorded and communicated in writing to the unit with copy to the government so that the government can also take appropriate call on the statutory dues. 
d) Extant instructions specify closing the door for rehabilitation permanently if a fraud or malfeasance is noticed. This instruction is absolutely in order for all proprietary units. The instruction needs a review where one of the partners or directors indulges in fraud and even the unit is itself a victim of such action. Just because frauds are occurring in a bank, the bank is not dubbed as a fraudulent bank. As long as the unit changes the partner or director who indulges in such fraudulent act and institutes legal action, if the existing collateral securities sans those of the fraudulent partner or director, the reconstituted unit should be allowed to continue its manufacturing activity. 
Incentivising Banks: Banks should be incentivised for taking up restructuring. In as much as such action is taken up on well validated proposals that have reasonable scope for moving away from NPAs the period of transition should be viewed for lesser provisioning by the Banks concerned. 
Uniform treatment for all accounts between Rs10 lakh and Rs25 crore may not be in order for the following reasons:
a) Up to Rs1 crore Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) cover is available.
b) The bandwidth between Rs10 lakh and Rs25 crore is too large as the sanctioning authorities for the intermediary layers of limits will be different and so would be for taking a decision on restructuring/revival. By bifurcating the limits between Rs1 crore -Rs5 crore; Rs5 crore-Rs10 crore and Rs10 crore-Rs25 crore, the zonal committees will be able to involve the appropriate sanctioning authorities as members depending on the cases under consideration. 
It is appropriate for the RBI to tweak the prudential norms to the advantage of the banks that take a positive action in ensuring that the units do not turn sick in the first place and in cases where they find it worthwhile to rehabilitate in the second place so that asset loss and job loss can be avoided.
Published in www.moneylife.in on 23rd May 2016.