12-point Agenda for the RBI Committee on MSMEs

Pain points for the MSME sector

MSMEs Credit woes in stock

The RBI has its task cut out as it sets about addressing the sector’s credit and viability concerns.

A debate on MSMEs has come alive due to the Centre’s insistence on a regulatory reprieve for the beleaguered sector post GST and post demonetisation. The RBI at its last Board meeting that Urjit Patel chaired, promised to set up a Committee on the MSME sector by the end of this month.

There is an estimate, authenticated by the Centre, that there are around 50 million MSMEs, both registered and unregistered, employing 120 million, second only to agriculture.

Credit crunch

MSMEs contribute 6.11 per cent of manufacturing GDP and 24.6 per cent of services GDP. They also account for 16 per cent of bank lending. Around 8 per cent of credit to manufacturing micro and small enterprises and 13 per cent to medium enterprises are estimated to be gross NPAs.

MUDRA (Micro Units Development and Refinance Ageny) and the ‘59-minute loan sanction’ promises enhanced credit reach to the sector with SIDBI in the lead for both. MUDRA helped banks to push the services sector lending below Rs. 5 lakh significantly.

Field studies reveal that MUDRA loans have been used by several banks to swap a good number of failing micro service sector loans. There is also evidence of moral hazard following adverse selection as several enterprises are non-traceable at the location mentioned in the applications.

In the band of Rs. 5-10 lakh the percentage of loans is less than 20 per cent, indicating preference for a risk free portfolio and lack of interest in the manufacturing sector.

The government has put in place e-Invoice, TReDX, Samadhan, GeM to ensure prompt payment of bills from public sector undertakings and central government departments. Even so, the State PSUs and state government departments continue to delay the bills of MSMEs, leading to NPAs.

A procurement policy has been put in place to provide for preferential purchase from MSMEs, without sacrificing the conditions of quality of goods and services supplied to the buyer.

The process of loan disbursal is also cumbersome. Quite a few banks follow a multi-layered approach to lend to the sector and as a result due diligence suffers. The branch that disburses is also expected to monitor and supervise the credit but does not have the time or manpower for that.

There is hardly any communication between the entrepreneur and the credit authority until an irregularity in the account surfaces.

So given declining credit and growing NPAs, the following 12-point Agenda is a way ahead for the RBI panel:

* Thresholds in priority sector portfolio.

* Credit risk assessment of the MSMEs

* Thresholds for declaring the MSMEs as NPAs — 98 per cent of the portfolio in the fold of proprietors/family owned enterprises in the shape of partnerships, have no exit route of the sort facilitated under the IBC code or the Industrial Disputes Act.

* Revival and restructuring of sick enterprises — Innovative institutional interventions like the Industrial Health Clinics in States that carry the highest numbers of enterprises in this category.

* Cluster Development — Additional lending incentives.

* SIDBI’s Role — Review and Redefine for assuming real leadership role.

* The guarantee mechanism in the shape of the Credit Guarantee Fund Trust for Micro and Small Enterprise (CGTMSE) needs to be reviewed and redefined.

It has a role conflict with SIDBI as the latter is its promoter and at the same time secures its guarantee for the enterprises financed directly by it. CGTMSE premia rates were found to be high by their primary lending institutions and the claim settlement process unacceptably late.

* Role of credit rating agencies and effectiveness of internal credit rating tools.

* Recommendations to the Centre on policy initiatives.

* Digitisation of MSME lending and managing its transition.

* Setting up of Movable Asset Registry — Operational issues and directions.

* Setting up of Public Credit Registry — Roadmap for data integration without sacrificing data

privacy and data security.

Given the cascading effect of the large corporate manufacturing and services enterprises on the MSMEs, their healthy growth is crucial for employment and growth of the manufacturing sector as a whole.

Since MSMEs are still largely debt driven and not equity driven, it is important that access to credit should be easier, cleaner, and faster.

The writer is Adviser, Government of Telangana on Micro and Small Enterprises

Published on December 27, 2018, The Hindu Business Line

Making MSMEs buzz again

Making MSMEs buzz again

The RBI’s decision to set up a high-level MSME Committee to resolve issues facing the sector gives some hope

Not all has been well with the micro, small and medium enterprises (MSMEs) since demonetisation and introduction of the Goods and Services Tax (GST). Credit declined. Debtors are mounting pressure. Labour is on the exit following aggressive online sales as a recent Trade Body report revealed.

But the intentions of the governments can’t be faulted. The Government of India (GoI) has put in place a robust public procurement policy. The GST led to the creation of Government eMarketplace (GeMs) and trade exchange (Tradex), which are making some inroads to resolve the delayed payments problems.

However, access to credit is still a problem. This has been flagged as an insurmountable problem by the GoI to the Reserve Bank of India (RBI). It is one of the problems that the RBI looked at with a six-month horizon through a high-level committee expected to be announced by the end of December 2018. New Year seems to start with a look at the Christmas Star!!

Defining MSMEs

The sector has multiple regulators but a single law: MSME Development Act 2006. The definition of the MSMEs based on investment was set to move to another single parameter – turnover — but was whittled down by Parliament. The ideal would be a combination of turnover and employment as this sector employs the largest number of people next only to agriculture. But most of the firms falling under the unregistered category mask actual employment. Developed economies like Germany and Malaysia having a large SME sector define them on these two parameters.

Only 16% of the MSMEs is estimated to have access to institutional credit. MSMEs that are self-funded account for 20% and include proprietary firms, private cooperatives, private self-help groups, khadi and village industries, coir industries and artisans providing huge employment opportunities. They also ensure regional balance through industrialisation of rural remote and less developed areas.

Some 98% is still owner-driven – proprietary or family driven partnerships — and a few alone are in the private limited category. Having included services in the defined category of the sector since 2006, manufacturing has suffered heavily.

Looking at the global SME sector one would notice that India does not stand in isolation. While a few countries like Germany, Malaysia, Netherlands and China stand out in resolving problems affecting this sector, India is still in the melting pot striving to create an ecosystem congenial for the growth of MSMEs and providing easy access to credit.

Many Challenges

New schemes like Make in India, Start Up and Stand Up India, Mudra and the latest 59Minute sanctions have not altered the scenario significantly. The services sector crowds out the manufacturing sector. Around 95% of Mudra loans has also gone in favour of the services sector below the credit limit of Rs 5 lakh per enterprise.

Nearly a lakh of enterprises are estimated to be sick or non-functional. Banks that lent to them earlier hardly showed interest in their revival or restructuring despite clear guidelines from both the RBI and the GoI, going by the fact that only 7% are considered potentially viable and just around 2% revived with an average of less than Rs 14-15 lakh per enterprise. Though Industrial Health Clinics provide a ready answer as proved by the Telangana government, there are few takers among banks.

Several studies have brought out that access to credit is a major area that requires reforms. Several banks have been distancing themselves from both entrepreneurs and enterprises due to the multi-layered approach they follow — one markets the loans; the other scrutinises the application and processes; the third sanctions and the fourth at the branch-level finally disburses the loan. In the end, due to inadequate staff and limited knowledge, due diligence, monitoring and supervision suffer. Information asymmetry and adverse selection are the outcomes.

Simple Steps

Informal or unorganised enterprises still dominate the sector and formalising them requires simple documentation and extension of flexible terms of credit based on cash flows. High process costs and turnaround time; demand for excessive collateral; conflict between social objective and profitability; geographical disparities; high cost of funds; low scale-up capabilities; single product lines; and complex product regulation orders are major challenges to provide easy access to credit.

Inconvenient provisioning norms and non-performing loan threshold on a par with their elder brothers followed by poor intent and low ability to pay back the loans compound the challenges. Banks that debit inspection charges to the unit’s accounts can hardly agree to this deficiency in public. The regulator knows the position but has no solution.

Banks invariably insure machinery while extending credit to the MSMEs. However, there is no evidence that there are any claims that are settled save fire accident out of this insurance mechanism although premium is debited to the accounts. The Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) guarantees are issued in large measure for loans up to Rs 10 lakh mandatorily although such guarantee can be extended for loans up to Rs 2 crore.
Sidbi as an umbrella institution for the CGTMSE has a conflict of interest as the latter also extends guarantee to the loans sanctioned even by Sidbi directly. Sidbi even after 27 years of existence is yet to provide leadership in lending to the sector. Its schemes are thinly spread on the refinance window.

Data Integration

The Public Credit Registry that provides scope for better information flow across credit agencies requires digitisation of the sector that is estimated to have only 27% as digitally literate. If reliable data exists, integration challenges can be addressed when a data beehive is set up. In RBI Empowered Committees of MSMEs and SLBCs, data presented have no coherence. Integrity of data has been questioned many times.

Udyog Aadhaar of the Ministry of MSMEs – the enterprise registration data — does not capture data in full. If systems are to perform, data is crucial. Cleaning up existing data is the first step before new sets of data are put in place for integration of data across clientele bases and institutions with diverse capabilities.

The KC Chakrabarty Committee appointed by the RBI in 2007 and PMO Committee of 2009 were the last two committees that examined the issues in great depth and offered a few solutions. Credit to MSMEs in general, and MSEs in particular, has been looking southwards almost for seven years in a row. Cascading effect of the corporate sector NPAs still hangs on the vendors, viz, MSMEs. Challenges mentioned above still remain. At its November 2018 board meeting, the last of Urjit Patel as Governor, the RBI decided to set up a high-level MSME Committee to resolve several issues facing the sector. The sector as usual lives on hope.

(The author is an economist and senior banker. The views are personal)

Values are the Elixir of Life

Values are the elixir of life

Most countries which are less spiritual than India are less corrupt than us and they suffer from less poverty. Why should we have any spirituality at all in our country? Sadguru Jaggi Vasudev responded to this nicely. I thought of starting my discussion today with his thought.

Centuries ago, the whole world, far smaller than the one we are living today, no doubt, was looking to ancient India because India was very much in tune with both the outer and inner laws. Several tried to travel to India to learn and enjoy visiting the country. Columbus wanted to travel to India but landed in a different place; so was Vasco De Gama who landed in Panaji; it was Robert Clive who made to Calcutta. What was it that attracted them to this place? Only riches?  Jaggi Vasudev attributes it to spirituality.

Spirituality is something within of everyone and not one that you organize on the street, according to him. But we are doing too much outside and call it spirituality. “The physical existence is ruled by physical laws. If you are not in tune with them you suffer. Various cultures in the world have done far better than us in the world because they are in tune with the physical world.” However, their suffering within is untold, because they are not in tune with their inner laws. These inner laws teach us to be ambitious and not greedy; to have character with competence and not jealousy and incompetence and to live by values and culture but not by ego and extravaganza. Where are we after 71 years of independence? Why do we see greed everywhere? Why do we want to appear different from what we actually are? Politics and religion have some umbilical cord and this relationship whether Pope and the Church, Mohammad and Islam, Buddha and Peace, have all moved from the Court Halls of the then Kings or Monarchs.

Why Merger of PSBs not a good idea?

Human resource and cultural issues apart, most mergers in the past haven’t led to improvement in profits

Emboldened by the apparently frictionless merger of the associate banks with SBI, the Ministry of Finance has decided to merge two weak banks with one strong bank, namely, Bank of Baroda, Dena Bank and Vijaya Bank, in the PSB (public sector bank) space. That this should happen exactly 10 years after the Great Recession of 2008, which was triggered by big banks, indicates a certain overconfidence about financial stability in India.

Since nationalisation, Indian banking has grown and exhibited much diversity in size, content and structure, represented by PSBs, regional rural banks, new generation private banks, old private banks, foreign banks, cooperative urban banks, cooperative rural banks, small payments banks, small finance banks, and NBFCs.

Business correspondents support the financial inclusion efforts of banks. Such diversity and effective regulatory oversight contained the contagion effect of the decade-old global recession on the Indian economy. The Narasimham Committee (1994), while arguing for six large globally competitive banks, preferred closing the weak banks to merging them with strong ones.

 

There have been 39 mergers and takeovers during the post-nationalisation period, which includes the SBI merger. It is important to draw lessons from all these mergers. While all banks reduced their presence in rural and semi-urban, non-profitable centres post-liberalisation, SBI, post-merger, closed 5,000 branches, thus effectively guillotining the plan to reach the unbanked poor.

Regulator-driven financial inclusion efforts of 2005, board-monitored measures, and Jan Dhan have supplemented the financial inclusion agenda. India Post Bank is the new institution aimed at taking banking services to the doorsteps of the least banked.

Against this backdrop, the latest merger is enigmatic.

Former RBI Governors YV Reddy, D Subba Rao and Raghuram Rajan have, on one occasion or the other, cautioned the government against seeing consolidation as a panacea for the ills of the banking system.

Though the RBI’s Financial Stability Report has estimated healthy economic growth of over 7.5 per cent for 2018, it has warned against complacency. And, this comes despite legal and regulatory measures to stem the NPA (non-performing asset) rot in banking through ‘market-based resolution plan for insolvency’ (IBC), putting 11 banks under surveillance via prompt corrective action plan, and continuing efforts to de-stress the sector.

The government, however, has put together another merger, even before the results of the PCA were known.

Of the three banks — Bank of Baroda, Vijaya Bank and Dena Bank — slated for merger, BoB is on the plate for the second time in the merger exercise. As at the end of 2017-18, BoB was the biggest with a total income of ₹50,306 crore, a net loss of ₹2,432 crore and net NPA of 5.5 per cent. Vijaya Bank comes next, with a total income of ₹14,190 crore, a net profit of ₹727 crore, and net NPA of 4.4 per cent. And, Dena Bank recorded a total income of ₹10,096 crore, a net loss of ₹1,923 crore, and a net NPA of 11.95 per cent.

Profitability ratios

Results of a study by Jagadeeswaran et al on the pre- and post-merger comparisons of profitability — with the year of merger as base year — in the case of SBI, IOB, BoB, PNB, IDBI and OBC reveal that net profit to total income, net profit to interest income, net profit to total assets and net profit to net worth declined for all except PNB and BoB. The exception was partly due to the period of merger, when the capital regulations post-Basel did not hit them. Banking is all about financial intermediation. People are at the epicentre, both in front and behind the counters. The culture of the institutions is intertwined with the culture of the regions. Human resource and cultural issues have impeded the success of mergers across periods and nations.

It is, therefore, important that the big banks think twice before turning into unwieldy conglomerates. Basic banking and customer services cannot be compromised.

The government would do well to start development banks to fund infrastructure projects and, thereby, relieve PSBs of this task. Experience has demonstrated that PSBs are not right channel for the job as it involves their funding long-term projects with short term resources.

Universal banking did enough damage with banks selling more third-party products, eyeing hefty commissions, instead of focussing on core banking operations. Hopefully, thanks to the latest directive from the Finance Ministry, this damage will be minimal, where banks alone will stand to gain, and not the officials selling such products.

Looking ahead

While past accomplishments are no guarantee to future success, past failures can serve as good foundation for enduring success. To improve its own stock, the government would do well to concentrate on improving governance in PSBs, pledge not to interfere in loan sanctions, and move a resolution in Parliament that no party would indulge in loan write-offs either for the farm or other sectors unless the areas are affected by severe natural calamities.

Further, higher capital allocation with or without Basel-III cannot prevent bank failures triggered by systems, people and processes. Both demonetisation and GST had hit not just the MSMEs but also resulted in the lengthening of processing time. Even politically speaking, with elections round the corner, toying with the financial sector with mergers looks faulty, unwise and untimely.

Bet Big on MSMEs in Telangana

Bet big on MSMEs in Telangana

Low NPAs in the sector should drive financial institutions for proactive interventions rather than waiting for things to happen

The Telangana government has created efficient policy instruments around TS-iPASS, T-PRIDE, T-IDEA, RICH (Research and Innovation Circle of Hyderabad), TASK (Telangana Academy for Skill and Knowledge) and TIHCL (Telangana Industrial Health Clinic Limited) for the MSME ecosystem. The micro, small and medium enterprises (MSMEs) in the State today do not face power outages, voltage fluctuations and scarcity of industrial water. Tolerance to pollution is going down slowly but surely.

Digital technologies, particularly artificial intelligence and man-machine learning, are changing the way businesses are moving. Large enterprises are also making a beeline to industrial parks and clusters like never before. Credit institutions, however, are yet to match these efforts.
The questions that arise now are: Where are the entrepreneurs? Why are they not crowding in? What to do to make the ecosystem deliver?

Copability and Capability

Risk profile of the MSME sector indicates the copability and capability of the financial sector. Business risks surrounding industry, markets, operational efficiency, management risks and financial risks impact credit quality and infringe on standalone credit risks. Low NPAs in the sector should drive financial institutions for proactive interventions and not wait for things to happen. Enhanced CGTMSE (Credit Guarantee Fund Trust for Micro and Small Enterprises) threshold to Rs 2 crore is again an opportunity for the banks to move to trust-based lending from the balance sheet and ratio-based template lending platforms.

Both MSMEs and entrepreneurs are also changing the way they run their businesses. The other day I noticed as many as 60 young men and women at Cherlapally in the shoes of their parents or grandparents. The aspirations today for most of them are moving from legacy and archaic systems to newer ways of doing things; catching up with emerging technologies; setting up new systems and moving to global markets as well.

Banks should view such enterprises differently and wherever such change has been occurring; human assets should be valued and embedded into their risk profiles. This should enable better credit scoring and higher volume of credit to meet the challenges.

Cross-holding Risks

Going forward, industrial clusters should provide lenders a risk mitigation platform and for borrowers, scope for moving to value chain from supply chain management. But such clusters should have an interdependence between large enterprises and MSMEs in a seamless manner cross-holding the risks. All shall be on ERP platforms enabling easy data-based monitoring.

According to a recent report by the Planning Department, Adilabad, Gadwal, Rajanna Siricilla, Siddipet and Warangal districts require skill adaptation, promotion and skill building in textile technologies (handlooms, powerlooms, technical textiles, fabrics, apparel and readymade garments).

All other districts in Telangana, except Wanaparthy, require skills related to food processing machining, chemicals, and heat treatment. Wanaparthy district requires skillsets related to solar technology. TASK should also encompass providing for industry association interface and incubation centres in at least four key districts – Warangal, Nizamabad, Adilabad (around IIT) and scaling up the VTIs, ITI and polytechnics both in regard to technologies and faculty.

Mudra-enabled banks show more performance in the MSME sector but lending lags for manufacturing ones. Textile Mudra has extended the threshold to Rs 20 lakh at the extreme and this also provides a great opportunity for banks and NBFCs to lend for manufacturing MSMEs since the State is set to emerge as a major operator in the sector both in domestic and foreign markets. The future of MSMEs rests on embracing digital technology.

Declining growth in lending to the sector from commercial banks provided a great window of opportunity to the NBFCs. The latter are devising credit products based on GST data driven by the latest relaxations in thresholds and submission of returns and take very limited recourse to the credit rating agencies. CRAs have not been able to come up with a rating tool for new enterprises that the lenders can latch upon readily. Banks would do well to look at their lost loan book during the last five years. They should extend credit without cross-selling products like insurance and MF that led to the shortage of working capital upfront.

Competitiveness of future MSMEs comes from knowledge-based enterprises and global markets. Entrepreneur development centres in the DICs, NIMSME, and MSME-DI should work in collaboration to identify and train entrepreneurs and develop shelf of projects around the prospects within the shortest possible time. Lending institutions should tweak their products to cater to such situation providing environment for growth.

Disciplined Accounting

The MSMEs’ rate of vertical growth has not much to cheer as micro and small tended to remain in that status for decades. Product differentiation and price differentiation continue to be drawing less attention. Organisation of their sales books needs the willpower to move on disciplined accounting track. This would mean a change in the mindset of most of them. Digital training of both bank staff and MSMEs needs tools for kick-starting learning appetite within optimal costs for such initiatives.

Banks should consider failure as integral to the development. The GoI in its draft industrial policy has recognised Industrial Health Clinic modelled on TIHCL as a key intervention. Revival of a viable enterprise revives dormant fixed assets and sustains employment in the sector.

The government is also committed to seeing the MSMEs in good health. Seventy-five MSMEs through TIHCL are set to join the recently turned around Rajarajeswari Spinning Mills, Sirpur Kagaz Mills and the likes, with special support from the government.

Opportunity mapping as indicated in the infograph unfolds a large canvas for those who can take the risks and manage them well. Time and tide wait for none. Banks and NBFCs would do well to seize the emerging opportunities in the sector.

https://telanganatoday.com/bet-big-on-msmes-in-telangana

India Did Well: Needs More Reforms

The political economy of India enters the 72nd Independence Day with a sense of pride, no doubt, with the third largest economy of the world on an uptick of 7.5% growth rate. What is more, there is hope of consistency in such growth. GST, a showpiece of cooperative federalism, is the major indirect tax reform on the road to stabilization after the recent rate modifications and relaxed quarterly return submission. All it now needs is bringing fuel prices under its ambit. Yet, the nation cries for more reforms to ensure equity and social justice to all.

The Worries:

Core Consumer Price Index inflation accelerated to a 3-year high in July 2018 at 5.7%, while Wholesale Price Index moved to a six year high. Inflation is set to breach 5% in 2018, crossing the benchmark rate of 4%. Fiscal policy will be under severe pressure during the current year with States’ contribution to the widening deficit as warned by a recent Study of State Finances by the RBI. Impending General Elections 2019 to Lok Sabha would add more fuel to this fire.

The rise in stock-market indices driven by more domestic investment of about Rs.66666cr in the backdrop of foreign portfolio investors pulling out Rs.4,583cr in 2018 thus far, has little to cheer as the balance of payments position continues to be weak. IMF in its Annual External Sector Report cautioned India against relying on global financial markets to fund current account deficit of 3% of GDP.  The over-valued US dollar in the wake of increasing oil prices is enough cause for our future worry. A few economists have already predicted a burst of the bubble sooner than later with the exodus of FIIs.

Developed India:

70 reforms during the last 71 years have led to the present status of development. The nation has a large unfinished agenda on education and health reforms. I would add one more: water security in the country.

National Water Commission’s (2012) recommendation for establishing Water Regulatory Authority in each State to ensure use and allocation of water as a precursor to attaining equity and social justice is yet to gain acceptance in the wake of water wars.

Government of Telangana holds a beacon light in water policy with the world acclaimed Mission Bhagirath assuring to provide drinking water to every household in the State every day and Mission Kakatiya, tank-linking project that cleaned up 30000 of 46000 tanks in the state. Adaptation to climate change, demand management and water use efficiency in the wake of ever declining ground water resources also deserve greater attention.

Fiscal Responsibility:

Fiscal deficit is bound to exist to some degree or the other as the State has a constitutional responsibility to ensure welfare, safety and security of all the citizens. The earning capabilities are not neutral to size of the villages on one side and the natural resource base of the villages on the other. Such fiscal deficit occurs right from decentralized level to the State and Central level.

The resources should preferably be from the sub-regional fiscal allocations – i.e., the panchayats and mandals, for the assessment of the need can best happen at the village level and not at the District and State levels. Therefore, there is need for insisting on a transparent mechanism of sub-regional allocations and releases of the resources.

The ability of the villages to levy taxes and cess just does not exist and even if it existed, it has to be integrated with the regional pool of resource. For example, property taxes, drinking water cess, drainage cess, etc can be collected at the village level and their deployment for effective maintenance can be ensured through a decentralized monitoring mechanism that should include professional surveillance and social audit.

Natural disasters are unpredictable and so are the resources required for restoring normalcy in the affected areas. Many a time the expenditure cannot wait assessment of damage. These will initially cut into the budgetary allocations for various sectors but have to be replaced with appropriate fiscal initiatives. A few states have recurring floods while a few others have frequently occurring drought. Each disaster cannot be treated with the same brush.

 “There is enough evidence of growth leading to reduction in poverty: Prof S.S. Bhalla has proved (Inclusion: January-March 2012) that during the 21-year period (1984-2005) growth was around 55% and poverty decline was about 2 percent per annum (in log terms). In the five year period since 2004-05, as the growth increased the pace of poverty decline also more than doubled to 4.7% per annum.”

Reaching the poor through Jan Dhan and Mobile access led to greater financial inclusion and the social benefits of schemes like Mid Day meals programmes with the twin aim of higher enrolment and lessening poverty at the Union level; Kalyan Lakshmi schemes easing the burden of marriage costs, schemes meant for financial and social security for the farmers through ‘Rythu Bandhu’ and Rythu Bhima of Telangana Government serving as role models; making MNREGS more inclusive, 2-bed room houses for the poor from Telangana Government; and central and state schemes for providing houses to the poor etc., are all in the direction of economic empowerment of the poor and social security.

Investment Climate

If investment climate has to distance from state led incentives, there is a case for more tax reforms. While the GoI may be happy at the steady inflows of direct taxes, there is a case of reduction in the income tax and corporate tax. Both are possible if the Government can eye on increasing the share transaction tax where the tax administration expense is almost zero. Both the buyer and seller of the shares buys or sells with an eye on gains. The present STT at 0.15% can move to 1%. Since the tax deducted instantly moves to revenue kit of GoI as all demat accounts FRBM comes with ease.

Finally, In the backdrop of unprecedented pile up of NPAs, financial sector reforms leading to improvement in governance of the PSBs cry for immediate attention. This should preferably start with the winding up of the Department of Banking with the GoI. All these reform measures have the potential to take the growth to higher trajectory with stability at the expected ten percent per annum.

Published in Telangana Today's Opinion Column on 15th August 2018.

Reclassifying MSMEs

Turnover definition causes more confusion

Definition of MSMEs - Contentious

The outdated definitions of MSMEs are set to change. Union Ministry of MSME introduced an Amendment to the MSME Development Act 2006 to redefine the sector basing on annual turnover as the single criterion.

While change in the definition from the sole criterion of investment in plant and machinery that has facilitated Inspection Raj is long overdue, again moving to single criterion of turnover is fraught with greater risks than before for the MSMEs.

Globally,they are the backbone of the economy with some definitions showing their contribution accounting for 95% of the world’s GDP.

The term "SME" encompasses a broad spectrum of definitions. The definition varies from country to country. Generally these guidelines are based upon either headcount or sales or assets or a combination of any two or all of them. Some are backed by law while others are by practice and policy.

Indian MSMEs that significantly contribute to economic growth are already suffering several disabilities and while resolving one, leading to many more would be disastrous. The objective of change in definition of the sector should be providing jobs, wealth and innovation.

When the economy is set to be the third largest in the world with increase in WB rankings of Ease of Doing Business, it is important to ensure that each segment of the economy, more so the sector that has the largest potential for employment creation and enterprise promotion, moves in tune with the developed economies. Definitions vary across the multilateral institutions like the World Bank, UNIDO, OECD etc.

World Bank defined SMEs based on Employment and Assets. Out of 18 countries in Asia, Caribbean, East Africa, West Africa, South Africa, Latin America, North America, Eastern Europe six countries defined in terms of Assets, Employment and Turnover. 9 countries defined in terms of two of the three criteria – either assets and employment or employment and turnover. Only four countries including India defined in terms of a single criterion – assets or employment. Philippines, Thailand Bolivia, Mozambique and Rwanda defined in terms of employment as single criterion, employment.

or example the Inter-American Development Bank defines SMEs as having a maximum of 100 employees and less than $3 million in revenue. In Europe, they are defined as having manpower fewer than 250 employees and United States define them with employees less than 500. As general guidelines, the World Bank defines SMEs as those enterprises with a maximum of 300 employees, $15 million in annual revenue, and $15 million in assets. In Kenya, there are different definitions of SMEs which are yet to be consolidated. For example, a national baseline survey of MSEs carried out in 1999 defines a small enterprise as one which employs 6-10 people while a medium one is expected to have 11-100 employees.

Employment as a criterion to define the sector has widely been prevailing. Number of employees by itself is no indicator for efficiency of the enterprise. It is also no guarantee for growth. In fact, there would be a positive effect of economic growth on jobs. This criterion applied singly has again the consequence of services sector like the IT getting undue advantage as even 10 employees can contribute to a turnover of Rs.500cr annually.

Turnover as a single criterion has the deleterious consequences of over-flexibility. It also has the immediate consequence of picking up NPA status with the turnover threshold of Rs.75cr annually for the small and Rs.500cr for the medium. Presently the gross NPAs of the MSME sector stand at around 7-8 percent.  

Depending on trade cycles, the turnover may increase or decrease the redefined thresholds. Whenever such change occurs, it would be well-nigh impossible to reclassify and extend or withdraw the entitlements of incentives, wherever available for this sector. It will be preposterous to presume that GST would resolve the moving turnover thresholds for qualifying the enterprise in a particular category. Obtaining credit would become more difficult.

Any two criteria defining the sector would be more rational and lead to better growth of the sector. Doing away with investment in plant and machinery is welcome but replace them with employment and turnover. It will also be possible to attract more global investments into the sector. This would help MSMEs engaging labour on more competitive terms than now and also measuring their contribution to the turnover.

Modified version of the article has been published in the Hindu Business Line Today. 

Time for third wave of banking reforms

1969 followed by 1980 were considered as years of radical reform when 20 banks were nationalized. 80 percent of the banking sector was brought under the control of GoI with the declared objective of ‘controlling the commanding heights of the economy’.

Access to banking for the poor was the main aim and rural development was the focus. This era saw loan melas, the first Agricultural Loan write-off in 1990 and the birth of new institutions at the apex level – one for agriculture and rural development, viz., NABARD and the other for small industries, SIDBI. Both these institutions cannot claim that they are close to achieving their intended objectives. They act more as banks for the governments doing more treasury business than banking for the target groups.

Come mid-1990s, Narasimham Committee recommendations were accepted and the big bang reforms as economists and bankers termed it, allowing for privatization of banks in the name of ushering in competition. Banks competed alright but not for serving the unserved population but for profits. Technology was introduced. Costs of technology being huge had to be recovered from the customers. Charges for services started rising. Internet facilities were introduced. Convenience banking and convenience charges became the order of the day.

Technology became the master and banks became servants. Huge numbers of complaints started and Banking Ombudsman had to be appointed by the regulator. Banks were supposed to be financial intermediaries – intermediation between those who save and those who require money for acquiring productive assets and even consumption requirements. This intermediation was taken to the extreme, introducing universal banking providing for sale of third party products .

Yet, the reach to the unbanked and under-banked had to be thought of through financial literacy and board approved financial inclusion agenda despite the emergence of new institutions: MFIs, Banking Correspondents, Small Finance Banks and India Postal Bank etc. 2014 saw the ‘Jandhan’ as new avatar of ‘no-frill’ savings bank accounts. Credit to the needy sectors and persons had signs of improvement, al bait for short period.

Overall economic health depends on the vitality of the financial sector. This vitality was lost during the last ten years with irresponsible lending to corporates, several at the behest of government and vested interests resulting in unsustainable non-performing loans currently standing at Rs.10trn. Mechanical application of accountability to credit decisions has left bank managers shy of taking normal business risks. This has led to committee decisions on credit to large conglomerates making no one accountable for their failure.  Efforts to ‘tame the shrew’ through legal support  systems led to SARFAESI ACT 2002 and IBC code 2016.

The worst scenario prevails now: where the CBI is digging the graves of past sins of several bank top brasses fixing accountability for the current unrecoverable debts. If these Bank top executives followed unethical practices and extended patronage, more unethical is the investigating agencies announcing the names of the ‘offenders’ even before the charge sheets are filed and guilt is fully  established.

There is again a call for third generation reforms. The central issue of banking today is reducing government ownership in banks. With 82 percent of total banking in public space, government is active owner. It appoints the Chairpersons, Managing Directors, independent directors It reviews performance and directs the banks in appointments, transfers and closure or expansion of branches. These banks lost their autonomy and the freedom to run as banks either with a social purpose or commercial outlook.

Chidambaram who presided over the Finance Ministry after leaving the portfolio, delivering the Rajiv Gandhi Memorial Lecture on 21^st August 1998 said: “the bureaucracy and the political system have developed a vested interest in maintaining the status quo – over 60% of the work of the Banking Division in the Ministry of Finance relates to Parliament work, a largely unproductive use of time.” It is a different matter that he did nothing after he again became the FM post 2009. Narasimham Committee suggested the winding up of Department of Banking for such reasons and is time to accede to this recommendation as the first agenda on reforms.

Cash credit system of lending should give place to working capital demand loan when the monthly or quarterly demands on the repayment become possible for review and timely action. Single dwelling house of any small enterprise should be prevented from SARFAESI proceedings in regard to micro enterprises, particularly when the Bank did not cover the loan under the CGTMSE.  

The second should be: let the ownership take responsibility for all the lapses and regulator admitting to laxity. This would mean refurbishing the capital of banks to the extent of shortfall in NCLT decisions by the government purely as a one-time measure.

Bank inspections and audits have become a matter of ridicule in the wake of serious frauds and malfeasance that came to light during this decade. ICAI should work on realistic accounting policies and accounting standards and disclosure norms. Audit begins where accountability ends, as the saying goes. RBI should restart the bank inspections of 1980s when a few large advances and branches were also being inspected. It should perform its regulatory function without fear of consequences.  Prompt action should follow on lapses noticed. 

Governance improvement in banks should be the third agenda on reforms. RBI should stop sending its persons to the Boards of Banks. Board should review its performance once in six months against the Director’s own commitment each year as to his contribution to the functioning of the Bank.

It’s time to restore the trust deficit in banks by GoI and RBI through vigorous media campaigns and supporting measures assuring service to every type of customer on time and at transparent cost. Safety, security, easy access at affordable cost of both deposit and credit services shall reign supreme on the reform agenda. RBI may appoint a high level committee of a few of the past governors and reputed economists sans MoF bureaucrat, with a mandate to provide the reform agenda within the next three months.

Published in Telangana Today, 19.7.18

Proportionate Regulation helps MSMEs

Huge NPAs in corporate sector of the order exceeding Rs.10trillion and the increasing credit outflow for MSMEs from the NBFCs, on the verge of taking away the meat our of the portfolio have woken up the commercial banks to lend to this sector more responsibly. Banks like SBI, Canara Bank, Indian Bank, Syndicate Bank, and PNB are in the lead while the others are still in wait and watch approach. This context demands an inquest of the present status. Definition of the sector matters when we want to measure the MSME credit growth.

SIDBI defines MSMEs having credit outstanding of less than Rs.1cr as micro; 1cr-25cr as small and Rs.25cr-100cr as medium and beyond Rs.100cr as large for measuring credit growth while the MSME Development Act 2006 defines manufacturing MSMEs by way of investment in plant and machinery as of now: Less than Rs.25lakhs as micro; Rs.25lakhs-500lakhs as small; and Rs.500-1000lakhs as medium. An amendment is awaiting Parliament’s nod for changing the measure to turnover to make the sector ‘globally’ competitive and investment friendly. The new definition keeps micro enterprises at Rs.5cr annual turnover. SIDBI’s analysis follows neither the impending change nor the existing pattern for analyzing the MSME credit growth.

MSME Pulse April-June 2018, an arm of SIDBI measures growth in the sector by credit exposure mentioned above: MSME with a portfolio of Rs.12.6trn is pitched at 22.2% for micro and 12.8% for small Y-o-Y at the end of March 2018. Medium and large industry has recorded 7.2% and 5.9% correspondingly. The market share of new private banks and NBFCs has been growing at 30% and 10.9% respectively. NBFCs are now permitted the CGTMSE cover as well and this measure would see further growth in lending by these enterprises.

RBI Bulletin June 18 puts the micro and small, medium (as defined under MSMED Act) and large enterprises’ credit growth Y-0-Y at 1%, 0.3% and 3.6% respectively while in the financial year so far (up to end April), -1.8%,-2.7% and -0.9% correspondingly. Manufacturing enterprises under micro and small segments registered just 0.3% Y-o-Y reflecting the poor risk perception of the banks of these enterprises. Viewing from the risk perspective, even according to MSME Plus, NPAs of micro enterprises have been stable and range bound at 8.8% while for SME segment it is 11.2%. NPAs of MSMEs have a cascading effect of the NPAs in the corporate sector to which they act as vendors.

The Corporate entities issue cheques for the bills payable to the MSMEs before the last date of the quarter only to ask them not to present during the first week of the following month lest their order book shrinks. This measure will help conformance to the rule that above Rs.2lakhs dues to the MSMEs should be reflected in their quarterly balance sheets. No MSME can complain openly as they are in captive markets.

Most of the PSUs and Government departments do not honor the bills on time and the MSEs approaching the MSE Facilitation Council gets hardly a reprieve. The lender is a government owned bank; the defaulter is a government department or PSU; the arbitrator is a Government Executive. With such deep rooted conflict of interest, the MSEs hardly got justice. Even the disputed claims are not followed up with deposit of 75% of the amount settled by the Council. Even if deposited such amount would be in the Court but would not go for credit of the judgment debtor MSE that is reeling under NPA. Banks left with no option are proceeding under SARFAESI Act provisions even against the only dwelling house of the entrepreneur. They hardly have capacity and financial muscle to fight legally. Many capable of producing to capacity close their shutters prematurely.

Trade related electronic discounting system (TReDS) has on board only 34 PSUs. Several Government departments are yet to register on the exchange. This is a platform created for facilitating payment of 75% of the bill amount traded through this exchange for MSMEs that also register on the exchange and sell their goods to the registered members. Only a few banks registered on the exchange. Several state run firms did not register on this exchange. To swear by this instrument as a big boon to MSMEs will be  unrealistic.

Banks have not been putting their Board approved policy on their websites either for MSME lending or OTS or Revival and Restructuring. Banks are also reported to be charging huge penalties at no less than 18% p.a., on irregularities in the accounts and collecting inspection charges for inspections they rarely did. So is the case with SME Exporters. Banks have been mandated in June 2016 itself to set up zonal committees to ensure conformance to put in place corrective action plan, revival and restructuring and as a last resort recovery. But these instructions are sparingly implemented. The recent amendment to NPA recognition at 180days is hard to implement as the systems do not allow.

In the current environment of trust deficit, proportionate regulation by the RBI should help. RBI should move away from its stance of distancing from micro management since banks are failing the MSMEs. They levy inspection charges for visits to the units that were not made; debit interest and penal interest on the overdue amount fully knowing that the account became overdue not because of willful default but due to the cascading effect of the corporate NPAs. RBI should therefore prescribe boundaries of penalties for the irregular accounts; charges on forex dealings; modifying the IRAC norms and better monitoring of the revival and restructuring processes. Instances are staring at us where the proprietor or proprietrix falling terminally sick and unable to run the industry seeks exit but has no exit route. Government of India would do well to amend the SARFAESI Act 2002 provisions exempting the only dwelling house offered as collateral and not recognizing collateral going concurrent with the CGTMSE thresholds on par with the agricultural lands.

*The Author is Adviser, Government of Telangana, Telangana Industrial Health Clinic Ltd., The views are personal.

http://knnindia.co.in/blog/blogdetails/msme-credit-on-the-banks-radar-again-proportionate-regulation-helps

 Published on 12.07.2018

India Enters 50th Year of Bank Nationalization

Just a year to go for the golden jubilee of bank nationalization on July 19 leaves nothing to banks for jubilation. Current generation of bankers working more on systems than on knowledge hardly visualize the journey of Indian Banking that is on rough roads today.

First decade of nationalization of banks was a decade of committees and committees; second decade was one of consolidation of the gains of nationalization; third decade was one of computerization, introduction of income recognition and asset classification norms, newer balance sheets and banking reforms; fourth decade saw introduction of Basel norms of risk management in full measure; fifth, a decaying decade for banking sector, ending from a year now witnessed the setting up of a Monetary Policy Committee, deterioration in assets through reckless lending resulting in huge non-performing loans, particularly, to infrastructure and big corporates at the behest of the government, demonetization, frauds and malfeasance, bad governance. Government’s proposals to set up Bad Bank drew flak. When LIC is there, why have a bad bank?

During the first decade, to bring about a change in the mindset and meet up with the goals of bank nationalization, GoI and RBI set up nearly 50 study groups and working committees. During the first five years, six groups went into the study of general functioning of banks, six more studied the priority sector lending and nine teams devoted their attention to giving a direction to industry and trade.

In the next five years, 10 working groups concentrated on general functions while 12 studied lending to agriculture and allied activities and seven groups studied aspects related to industry and trade. Persons who worked on those Committees, to name a few, are of high integrity and discipline: R.G. Saraya, D.R. Gadgil, R.K. Talwar, V.T. Dehejia, P.L. Tandon, R.K. Hazari, S.S. Shiralkar, B. Sivaraman, M. Narasimham. NABARD had been set up as a statutory body. Schemes like IRDP, SEEUY, DRI and modifications to certain institutional mechanisms like the Lead Bank Scheme and Service Area Planning, setting up of Regional Rural Banks, had their birth during this period. Bank chairpersons were visiting villages and several farm enterprises.

Second decade saw a spurt in social lending, project finance for agriculture with many a small and marginal farmer benefiting and lending to small scale industries. Directed lending came for attack with several borrowers turning as defaulters. Rajiv Gandhi in a public meeting mentioned that only 16paise of a rupee lent was going to the beneficiaries of government sponsored schemes.

Third decade has changed the texture of banking in India. Narasimham Committee set up by Government in the wake of liberalization, privatization and globalization recommended for providing space to private banks to usher in a spirit of competitiveness among PSBs among many others. IRAC norms were introduced. Balance sheets built on accrued income basis were given a go-by.

Profitability and viability of banking came to the policy front. Banks started looking at rural lending portfolio and rural branches as unviable. also witnessed the resurgence of private banking with ICICI reverse merger, HDFC Bank, UTI Bank etc. The traditional private banks with Federal Bank Ltd in the lead also started making inroads in to unserved areas. Retail banking and housing finance made inroads into the lending portfolio. Micro finance institutions also entered the finance space with aggressive approaches.

Fourth decade saw the surge of arm-chair lending and template-based lending. Systems have replaced men in intelligent appraisal of loans. Asset reconstruction companies were born following the enactment of SARFAESI Act 2002. India demonstrated its resilience to the 2008 World recession in the financial sector. Net banking made banks close in the time gaps in serving the customers, al bait, urban and computer literate customers. ATMs proved a good service delivery instrument.

Fifth decade saw the progressive downfall of banking system. CDR, S$A, and RBI’s Asset Quality Review, behest lending to the corporate entities, poor surveillance, unconcerned Boards, and poor governance ended up in over >Rs.10trn NPAs. It also saw the likes of Vijaya Mallya, Nirav Modi, Chokshi etc., who challenged banks’ lending patterns. They also challenged the regulatory institutions.

Adding to this, Demonetization has exposed the infrastructural inadequacies in banking to tackle a disruption of that dimension in the economy. Banks in their anxiety to retain profit started fleecing the customers with high service charges – some transparent and more non-transparent.

Distance between customers and banks has been increasing reducing the trust between them. Supply based banking ushered in. Banks do more non-banking business with hefty commissions that dwarf their salaries.

At a time when institutional memory is waning, this article should unfold to the policy makers a few  lessons: 1. Deal with problems comprehensively and address them through collective and well-informed wisdom; 2. Trust in innovation and assess the innovation of its capacity to offer solutions material to the sector; 3.  Improve governance: let there be a pool of independent directors from whom choice can be made by the regulator; 4. No Bank shall be left without a Managing Director even for a week; 5. Make sure that banks do banking and not selling insurance policies, mutual funds and other third party products that could also include laddus and medallions at pilgrim centers.  

The Hindu Business Line, 19.07.2018