Showing posts with label Credit. Show all posts
Showing posts with label Credit. Show all posts

Wednesday, March 29, 2023

Risk Profiling of Manufacturing Micro and Small Enterprises

 

India’s Micro, Small and Medium Enterprises (MSME) viewed as the lifeblood of the Indian economy, contribute 30 percent to GDP and of them micro enterprises alone are estimated to employ 23 percent of India’s total workforce, according to the data of the Union Ministry of MSME. Access to credit has been the most contentious issue discussed on public platforms and IMF estimated that only 23 percent of the total number of enterprises in this segment got formal access to credit.

 


Post-pandemic, government of India has been laying lot of emphasis on the growth of micro, small and medium enterprises and extending incentives and products for easing the conduct of their business. The Union Finance Minister, in her usual meetings with the bankers, draws her untiring attention to the need for increase in credit to these enterprises. Banks, on their part, do not lose the opportunity to exhibit their fancy to lend to such enterprises.

 

Trust deficit was the major contributory factor from the lenders’ perspective. It is therefore considered expedient to look at the risk profile of such enterprises and see the possible mitigating factors.

 

Latest Profile of the Sector

Interestingly, TransUnion CIBIL-SIDBI MSME Pulse Report for July-September presents a very hopeful perspective presenting a growth of 24 percent year-on-year (Y-o-Y). Credit to ‘micro’, viewed as unmoving window of Banks for five continuous years since 2017 and even on the negative window, reported a 13 percent growth in credit outstanding y-o-y as of September 2022 versus 10.6 percent y-o-y for all the MSMEs y-o-y. Growth in disbursements for micro, small, and medium enterprises had been at 54 percent, 23 percent, and 9 percent respectively during the period.

 

According to RBI’s Financial Access Survey, 72.83 percent of MSME Credit is concentrated in ten states: Maharashtra, Gujarat, Tamil Nadu & Pondicherry, Uttar Pradesh, Delhi, Karnataka, Rajasthan, West Bengal, Telangana, and Haryana. Maharashtra takes the major slice of 26.19 percent. This obviously means that government assistance to the sector also reached these states in a significant measure, at least proportionately viewed.

 

Very small (with aggregate credit exposure not exceeding ₹ 10 lakh), micro1 (with aggregate credit exposure between ₹ 10-50 lakh) and micro2 (with aggregate credit exposure between ₹ 50 lakh-1 crore) experienced growth of 20 per cent, 15 per cent and 11 per cent y-o-y respectively showing sudden spurt in micro lending, which is not just a post-pandemic bounce back, it added.

 

Delinquency rates dropped y-o-y across all the three lender categories (public sector banks/PSBs, private sector banks(PVBs) and NBFCs); the highest drop was in PVBs segment (from 2.8 per cent in FY22-Q2 to 1.5 per cent in FY23-Q2).[i] Street Vendors’ financing programme, MUDRA loans (Rs.3.4cr sanctioned during FY21-22), 59-Minute loan programme for the MSMEs contributed to the steady uptick that was presented apart from the Union Finance Minister dinning into the ears of bankers that credit to MSMEs has been sluggish. There was a pressure on the banks to perform.

 

This positive vibration whittles down suddenly when we hear the Union Minister of State for MSME submits to the Parliament, duly reported in the Financial Express dated 23.02.23: “The number of Udyam-registered MSMEs closed in the current financial year has nearly doubled from the last financial year’s count, showed official data. From 6,222 MSMEs shut during FY22, the count has jumped to 12,307 as of March 9 in FY23 while only 175 units were closed between July 1 (when the Udyam portal was launched) and March 31 in FY21, taking the total number of MSMEs closed to an all-time high of 18,704. Maharashtra had the highest number of casualties with 4,871 Udyam-registered MSMEs shut since July 2020 followed by Tamil Nadu (2,326), Uttar Pradesh (1,568), Gujarat (1,558), Rajasthan (1,297), Bihar (1,075), and more.”

 

Gross Non-performing Assets ratio  (the ratio of total gross NPAs to the total advances made during a particular period by the lender) in MSME loans in FY22 stood at 7.6 per cent, 7.3 per cent in FY21 and 8.9 per cent in FY20. 

 

Resilience and sustainability of industrial growth is inextricably linked to the healthy growth of the manufacturing micro and small enterprises (MMSEs), that happen to front-end the supply chains of the industry at large. The data and analysis of the Transunion report does not provide information on how much is the share of growth of manufacturing MSEs. September 2022 PMI data shows that industrial growth has not kept pace with the overall growth of the economy. The growth obviously occurred in the services sector, due to the digitization of the highest scale, entry of FINTECHs, formalization of the MSMEs, widely dispersed 200-odd incentive schemes from the Union Ministry of MSME, and the unique success of unified payment interface system (UPI). Despite the U.K. Sinha Committee Report calling for cash-flow based lending of working capital to the MSMEs, RBI creating public credit registry, and pushing the banks to move to data-based lending instead of security-based lending, MMSEs did not catch the eye of the banks. Hence, risk profiling of the MMSEs would be necessary to understand the reasons for the trust deficit in the manufacturing sector.

 

Definitional Risk:

Manufacturing and Services have been combined in the way the MSMEs are defined. The changes to the definition adopting the twin criteria of investment and turnover to redefine them have given an escape window for the banks to keep at bay the MMSEs with investment below Rs.1crore (Rs. Ten million). The turnover threshold for such enterprises is five times the investment level – Rs.5cr per annum. While this definition coupled with the insistence of any new enterprise shall register on Udyog-Aadhar portal of Government of India, has enabled only the organized to have access  credit and incentives, it is yet to bring many unorganized MMSEs into the organized fold. Lenders still have their own definition – micro enterprises are those that have outstanding credit of less than Rs.1cr. The law of proportionality demands that the micro enterprises be brought under a separate statute so that the benefits meant for them reach without infringement.

 

By nature, micro manufacturing enterprises are owner-led proprietary or family partnerships. They do not distinguish their firm expenditure from family expenditure. Their books of accounts are also not well organised. Their maintenance of record of stocks of raw materials and finished products is less systematic than their counterparts in the small and medium enterprises even. They are mostly sub-contractors as their scale of production does not permit them to participate in private or public tenders directly. But their working capital cycle accommodates this unorganised way of running their enterprises. They lack counselling and guidance from their lenders as the later have little time for these large numbers in their books of accounts that tend to slip to non-performance at the turn of the hat. Thus, these enterprises have origination risk. Information asymmetry and adverse selection, the two factors that adversely affect the credit risk need mitigation.

 

Covenant Risks: These MMSEs in their eagerness to borrow money sign on the dotted line before their lender. They do not understand the implications of the covenants they are agreeing for. Earlier they were not knowing even the rates of interest. At least now, thanks to the widely publicised monetary policy interventions periodically, they know the interest rates. But they are ignorant of the insurance clauses and their implications. They do not, in many a case, know that their machinery and stocks are jointly insured with the lender and the premium is directly deducted annually from their working capital account. The extent of insurability is least known to them. Such insurance is invariably made with the insurance arm of the Bank that lends the enterprise. But the covenants of the policy are little known to them as the Banks do not share any copy of the insurance policy. This is a grey area.

 

Compliance Risk: MMSEs fail to comply with the regulations relating to products, processes, and finance more out of ignorance than out of own volition. Neither the regulatory institutions nor the financial institutions spare time to explain the implications of non-compliance of the rules and regulations. Environmental regulations and financial regulations are the most breached. Labour Code that has four components are least explained to the MMSEs. It is not uncommon to find that these enterprises fail to maintain even a muster roll and even where maintained does not agree with the reality. The number of persons actually engaged and the number in the roll rarely tally. There is a cost involved in compliance and such cost is felt onerous by the micro manufacturers. When the cost of compliance is more than the cost of avoidance, they prefer the latter. Transparency in the cost of compliance is also found wanting. These are areas of immediate correction to take these enterprises to the globally competitive levels.

 

Human Resource Risks: MMSEs employ on average 8-10 workers including the owners. They invariably depend on migratory labour instead of labour because of the low wages they demand and reliability. Many studies have indicated that they spend little resources on skilling, re-skilling, and up-skilling as the cost of such human resources development is beyond their capacity to absorb. In fact, these MMSEs act as providers of skilled persons to the Small and Medium Enterprises as the labour learn their art of working on the machine duly trained by the proprietors. Some States have insisted on engaging locally available skills and their experience with such persons on the production front has become counter productive and costly. They cannot afford to train their labour in reputed institutions. They require peripatetic trainers who are rarely available.

 

Product Risk: According to a number of studies, 60-70 percent of the MMSEs may conform to the quality of the product requirements but fail in packing and forwarding requirements. This puts the buyers at risk and therefore, the related payments.

 

Pricing Risks: Several manufacturing MSEs adopt neighbourhood pricing of their products as they would not like to lose out in competition with the peers. They lack abilities to cost their products. They also do not much understand the leakages that occur in their supply chains. The product is not priced cost plus. Since debt is their major source of capital they always look to loan swaps and interest subsidy as a major source to beat the pricing competition.

 

Technology Risks: While several enterprises are aware that new technologies have the potential to increase their efficiency, their ability to finance those new technologies is very limited. Quite many are scared to approach their lenders as they would have been in arrears already either of the interest or principal payment. They must have already availed one or two name-sake restructuring of their loans. Their ability to calculate return on investment in technology is also extremely limited. Banks hardly find time to spend time with the entrepreneur and guide him.

 

Payment Risk

Global Alliance for Mass Entrepreneurship (GAME) estimated that the problem of delayed payments to MSMEs is in the magnitude of Rs. 10.7 lakh crore, with 80 percent of this being attributable to delays to micro and small enterprises (MSEs). The problem of delayed payments is exacerbated by the lack of credit, specifically working capital facilities, that are available to these businesses. Reports such as the IFC’s 2018 Financing India’s MSMEs estimate that the total addressable debt requirement of micro and small enterprises was Rs. 24 lakh crores in 2018, with an estimated 70 percent attributable to the elevated working capital needs of these businesses.

 

Sovereign Risk: Industrial policies, Budgetary announcements, Export-Import policies, Trade Policies and not-so-enriching interface between various government departments that deal with the MSMEs and the Union Ministry of Finance, inter-state coordination issues are the various factors that impinge on sovereign risk. Enterprises have to adjust themselves and accommodate for the changes in the way they function rather than seeking instantaneous remedies to their business dealings.

 

Policy formulation for the MSMEs is at risk because of lack of reliable data. There has been no census of the units since 2004, the year of last Census. The data on the Union Ministry of MSME portal is that of 2012. While the data on Udyam registration is captured in isolation, its integration with the existing data did not take place. There is no data of mortality in the figure of 6crore-odd enterprises mentioned on the website.

 

While several state governments and union governments announce a host of incentives, the reach is suspect due to a variety of constraints: 1. Expediency decides the allocated budget for release to the sector and the first hit is the MMSEs, the most vulnerable. 2. There is invariably lack of information relating to the cost of securing these incentives – in terms of number of visits the entrepreneur has to make to the concerned department; the cumbersome approach to the person who actually decides on the sanction and release of the incentives. 3. Weak negotiating ability of the Industrial Associations over the incentive releases, etc.

 

Digitalization of enterprises, Account Aggregators (yet to mature in its access and use), Open Credit Enablement Network (OCEN), Co-lending with NBFCs, Factoring, Trade Related Exchange System (TReDs), have lately entered the Risk Mitigation instrumentality. Yet, the ability of the MMSEs to take advantage of these mitigants is way behind both in terms of awareness and the skills.

 

Therefore, there is a need for developing a separate framework for the MMSEs and a broad-based ecosystem involving policy makers, institutions that act as policy instruments, RBI, Indian Banks Association, NBFCs, Ministry of Agriculture and Cooperation, Ministry of Electronics and Information Technology, Ministry of Environment, Ministry of Energy of the Union Government and the ten state governments that have the major share in MMSEs. This framework should be discussed with the stakeholders in the leading ten states before firming up. Separate line of budget should be provided to meet the announced incentives and institutions like the NIMSME, NIRD, Central Universities and those that are licensed to run technology hubs should monitor the working of the framework.

*The author is an economist, risk management and SME Turnaround Specialist.

 

Thursday, April 21, 2022

 Cumbersome Guarantees and Insurances for MSEs Need Redress

This Blog was published in the Times of India ( see the link below)

Micro, Small, and Medium Enterprises (MSMEs) are extolled as the engines of employment, growth, and key to the supply chain management of medium and large corporate enterprises, leading exporters, manufacture over 6000 products. They have been redefined during the first Covid-19 disruptions to the economy in terms of investment and turnover, replacing the earlier definition restricted to investment in plants and machinery. This sector is next to agriculture which employs the largest number of persons. 98% of enterprises are micro, mostly owned by proprietors or partners. Even partnerships are to a large extent family partners.

Access to credit for the sector is the Achilles Heel. To provide easy and better access the GoI and SIDBI have set up Credit Guarantee Trust for Micro and Small Enterprises in 2000 (CGTMSE). Even during the pandemic, GoI introduced Emergency Credit Linked Guarantee Scheme under Atma Nirbhar Bharat Abhiyan with CGTMSE holding the baby.

But did the sector gain much from the insurances and guarantees in their existing shape? This needs a probe.

Insurance:

When the small-scale industries of Yester decades used to take out insurance cover for the plant and machinery against fire, riot, and risks, through the liability jointly owned by both the credit institution and the borrowing enterprise. After universal banking was ushered in, several banks took to Bank Assurance. A transparent joint insurance policy gave place to a policy that just lists the names of the borrowing MSME firms with the amount insured. The firms are ignorant of their liability under such policy and its renewal terms annually.

There is no evidence of any insurance claim of such bank insurance of enterprise machinery as a primary asset response. On the other hand, as several MSMEs noted that banks have over-booked insurance premium amount upfront with every loan sanction – whether term loan or working capital. Never did such insurance pay off for the MSE in trouble.

Both the MSMEs and the Banks have debated their mutual deficiencies in several media discussions, and they are plagued by mutual distrust.

While the redefinition helped many scale up their enterprises and move to exports quickly, there were lakhs that shut their doors during the pandemic. The impact of redefining has been such that a negative 1.8% MSE outstanding loan in FY20 has moved to 4.8% year-on-year by the third quarter as the existing.

Guarantees:

The 'strength' of a guarantee that allows credit to the enterprises without collateral or third party, is context-dependent: it depends on its nature, the legal environments that are relevant, current practices, and the context when the lender exercises his right. Yet, for twenty years, institutional credit to the sector leaves a gaping hole of Rs.279 trillion according to the International Financial Corporation (2015) study.

RBI mandated Banks to extend credit to micro-enterprises under CGTMSE up to Rs.10lakhs per enterprise. While the CGTMSE can extend guarantees to MSEs up to Rs.2crore, the covers range from 75 to 85 percent of the loans. During the last three years (2018-21), even retail loans and the service sector are being covered with guarantees while the extent of such guarantees is limited to 50% of retail loans. One hundred Member-Lending institutions (MLIs) that include 23 NBFCs are availing of the facility and yet several of them express serious reservations over such ailment.

Annual Report of CGTMSE for Fy2021 reveals that 47 percent of guarantees pertained to loan amounts of less than Rs.10lakhs (mandated by the RBI to extend without any collateral); 18% are in the range of loan amount of Rs.10lakhs-25lakhs; 14% are in the range of Rs.25lakhs-50lakhs; 12% are in the range of Rs.50lakhs-100lakhs, and 9% are in the range of Rs.100lakhs-200lakhs. Rs.45,851crore have been provided guarantee cover during the year 2020-21.

MLI concerns:

The guarantee portfolio increased after the retail, hybrid-collateral, and NBFCs joined, as these three constituted 49% of the guarantees extended during FY 21. It is the 1.18crore of the 6.3crore MSMEs that need a guarantee more than the rest. MLIs opine that the guarantee premium of 1-1.25 percent involved a lot of paperwork, follow-up for receiving the claim amount that too, after declaring the asset as NPA.

Banks have to prove that they have taken all the measures that include issuing legal notices, follow-up on recovery, provisioning for the loans, and proceeding against the borrowers under SARFAESI Act where the assets are partially guaranteed. These factors lead to a lack of trust by the CGTMSE both the MSEs and Banks.

The Way Forward

MSEs in manufacturing that forms an important component of sustainable supply chain management of Industry 4.0 need different forms of credit acceleration and insurance mechanism.

While the Banks should evaluate the credit risks of such enterprises on transparent parameters and extend credit to MSEs along with counseling, mentoring, and follow-up, the enterprises should digitize their operations and derive benefits from a large number of schemes recently floated by the Ministry of MSME, GoI.

Since fourteen states take 88 percent of MSE outstanding credit, and these MSEs reported less NPAs than their elder brothers in the corporate sector, each enterprise can be insured for various risks that include, fire, riot risks, natural calamities, the pandemic-like situations, plant and machinery, storage, other supply-chain disruptions, and cash flows on a graded scale. Once the enterprise pays the premium based on the risk it chooses to cover, and such risks are well-measured, insurance will ensure that the enterprise will be a going concern, and banks can extend the needed help duly assessing their risk cover as well. It is time for a change the guarantee is looked at and replaced it with Insurance, for which purpose, the GoI may appoint a High-powered Committee.

The policy should be transparent and discussed with the stakeholders in at least ten of the fourteen MSME-dominant states before introduction.


https://timesofindia.indiatimes.com/blogs/fincorp/cumbersome-guarantees-and-insurances-for-mses-need-redress/

 

 

Saturday, January 28, 2017

MSME Credit Supply Shrinks

Commercial Banks proved sweet nothings in their offerings to the MSEs while a myriad of their loan products focused on medium enterprises or the mid-corporate sector. 


Manufacturing MSEs going by RBI November 2016 data reveals that they share 42.9% outstanding credit with a negative growth of 9.2%. Manufacturing sector was the largest employer providing employment to 30.3 million (23.1%) persons, 78.9% of whom are in proprietary enterprises – mostly MSEs (Sixth Economic Census). Notwithstanding Jan Dhan, financial inclusion viewed in this prism is yet to gain colours.

Demonetisation only added further woes upsetting the credit supply to the MSEs as acknowledged by all the Industry Associations and grudgingly by the banks. It is time to see what is in store for the micro and small enterprise sector in the coming year’s budget.  
Innovation holds the key for inclusive entrepreneurship. If ‘Make in India’ were to succeed it should happen in rural India as well. In several States rural entrepreneurship is very backward mainly because of the following reasons:

Land, the key input has become scarce and is highly overvalued for any rural enterprise to access. Affordability distances the enterprise set-up. The entrepreneur cannot access the needed infrastructure with full compliance to regulations because he is ignorant of the latter. He realizes the cost of compliance is going to exceed the cost of avoidance.

Start-up MSMEs find it almost impossible to invest in land because of its prohibitive cost. Building rural industrial townships by the States with the required infrastructure like, safe drinking water, industrial water, electricity, packaging, testing and branding or co-branding facilities, multi-storied residential complexes for the workers on lease basis with industry participation, primary and upper primary schools, crèches, play grounds and cultural spaces would be the best alternative to boost this sector. Fiscal incentives like income tax exemption for a five year period for investments in such infrastructure would be in order.