SMEs' Access to Equity Markets

SMEs Access to Capital Markets in India

It took almost a decade since the SME Exchange has been formalised to see 60 floats in a month. Still the total number of listings on the SME bourses is not something that the growing Indian economy can be proud of.

In India, most SMEs operate in debt markets. Cost of raising debt for SMEs is increasingly becoming problematic both from the points of adequacy and timeliness and most often banks remove the umbrella in times of either too hot Sun or heavy downpour. But in a digital world simplifying businesses in the small sector also demands investments where the returns come gradually and not at the pace at which a financial institution extending credit demands. It is therefore necessary for the firms in the sector to look for enhancing equity.

Debt is cumbersome and equity is costly. Later is better choice if the SME has a modicum of discipline as creditors armed with amended SARFAESI Act 2016 and Insolvency and Bankruptcy Code are likely to be draconian. But such access demands of SMEs, better financial discipline, healthy balance sheets, and good governance.  Scale of operation also matters for access to equity markets. Most often, The enterprise should have the habit of monitoring its debtors and creditors on a continuing basis and make finance a slave and not master of its operations.

“Need for Equity financing”

While SMEs face challenges in accessing credit, they may also lack awareness of equity as an alternate source of financing. The nascent financing requirements for a start-up are met by informal financing from friends and family. Such seed money invested in a small business is in the nature of equity but is not formally recognised as such in SMEs without a formal legal structure.

Even for start-ups that are more aware, the creation of a formalised venture often requires the aid of incubators and angel investors that provide financing and other services. Further scale-up then requires higher amount of capital, which is typically provided by venture capital funds. Apart from equity capital, the venture also needs debt for working capital.

Access to equity financing has been examined in detail in the Report of the Committee on Angel Investment and Early Stage Venture Capital (Mitra Committee), June 2012. The key issues are related to differential taxation of investments, and the need for certain enablers to expand the availability of equity capital for early stage companies. Small and Medium Enterprises (SME) The SME platform of the Exchange is intended for small and medium sized companies with high growth potential. The SME platform of the Exchange shall be open for SMEs whose post issue paid up capital shall be less than or equal to Rs.25 crores.

Across countries, the SME sector has thrived primarily on the back of access to financing through various facilities such as government-backed guarantees, credit insurance for export oriented units and schemes for equity financing. These facilities are supplemented by institutional infrastructure for advocacy, technical research, refinancing platforms and easy access to services. Both BSE and NSE of India have launched their versions of SME exchange in 2012.

BCB Finance Ltd (BSE) and EMERGE (NSE) are the two equity platforms. SMEs being small companies are at the beginning of their growth cycle and are also at the extreme end of the risk curve – very high levels of return are accompanied by very high levels of risk.

SMEs on the growth curve invariably look for easy access to capital. FDIs are also allowed for investing in SMEs up to 25% of equity without any prior approvals. In the emerging market scenario, where mergers and acquisitions have been increasingly surfacing, firms both in India and abroad have been looking for such options for expansion. But for this to happen, SMEs should have strong equity base and the SME exchange route is a safe option to access capital markets.

Facilitation for SMEs:

The two distinct advantages of using dedicated SME platforms are: easy listing norms; and IPO listing norms are simple. For an investor, it becomes easier to search from segregated stocks as there will be limited number of firms.

However, trading pick up has been slow. This has to improve only with the Market makers using some proprietary funds only for the purpose of supporting stocks through two way quotes on daily basis and hold a minimum specified amount of capital or stock in the SME. Confidence building in the exchange for small firms is extremely important at the moment. Minimum lot size is Rs. 1lakh.

Investors need to understand SME business risks and corporate governance principles and there is need for capacity building on this count.

A minimum preparation of six months is imperative for firms to access capital through this route and handholding has to be done by the EMERGE-like firms. Till November 25^th 2016, BSE data reveals that while 161 firms with a Market Cap of Rs,16,155cr, raising Rs.1257 cr., 18 (12%) have migrated to the Main Board. No SME has been suspended till date.

Prabhat Kumar Committee on MSMEs while examining this issue categorically recommended that the SMEs on growth path proposing to access equity markets should be provided incentives. A few of them appear to be akin to some international practices in USA, UK, Israel, European nations, Turkey and China.

The Committee recommends that (i) the Government should meet a part of expenditure of SMEs incurred by them in the initial listing of their equity on the SME exchanges. This part reimbursement of listing expenditure could either be limited up to 50% of the total listing expenditure or Rs.I0 Lakhs whichever is lower; (ii) the Government should provide tax exemption for the investments in IPOs of SME companies under section 80C of the Income Tax Act 1961 within the overall prevailing ceiling limit of Rs. 1,50,000/-; (iii) establishing a separate 'SME Equity Investment Fund' by the Ministry of MSME to be managed by a professionally run entity of fund managers.

The government may also introduce a provision for Special Purpose Vehicle (SPV) to allow a group of angel investors to come together as an SPV and then invest in manufacturing start-ups. Even though angel investments are generally in a group, there is no provision to create an SPV for the same, so all individuals have to invest separately, leading to a large number of shareholders, which becomes an impediment for raising further funding from institutional investors.

Telangana Industrial Health Clinic Ltd., in the offing with 10% of corpus fund of Rs.100cr coming from the state government has in prospect a window to encourage manufacturing SME start ups to go to equity markets under a tie-up with the NSE-EMERGE with initial contribution of up to Rs.50lakhs or 10% of the float whichever is lower. The firm has a risk balancing model.

*The author is an economist and risk management specialist, presently serving as Adviser, MSME sector, Government of Telangana. The views are personal.

http://knnindia.co.in/blog/blogdetails/smes-access-to-capital-markets-in-india

How to redefine and rebuild the banks in India

How to redefine and rebuild Banks?

‘Banks are basically meant to allocate capital to businesses and consumers efficiently.’ Post demonetization, customers feel the pain more than gain in banks. Farmers getting inadequate and untimely credit from banks take to huge private debt only to commit suicides later.

Manufacturing micro and small enterprises, the seed beds of employment and entrepreneurship, are being shown the door by the banks notwithstanding the CGTMSE guarantee up to Rs.2crore. Banks never went beyond the mandated Rs.10lakh guarantee cover for the MSEs.

Large number of customers is slapped with irrational minimum balances in their accounts and levy of penalties at will. RBI is averse to regulate such overtures in the name of micro management of banks being not their role.

With over 38% of the population still illiterate, Jan Dhan and Mudra Yojana as instruments of financial inclusion have only become compulsive agenda for the banking sector. Banks- Public sector or private sector, have their eyes set only on profit. Such profits are dwindling with net interest margins declining following the growing NPAs.

Institutional innovations like the Small Payment Banks, India Post and the likes as also the MFIs have also proved inadequate to meet the needs of the present leave alone the future banking needs of the population.

Cashless banking leading to poor inflow of deposits during the last four months and cashless ATMs demonstrate the erosion of faith in banking in India. Bad banking and good economy cannot co-exist and therefore, it is imperative that innovative institutional solutions should be thought of.

Indian economy targeting double digit growth ere long has competing clientele bases in the current milieu of banking. Domain banking has moved to high tech banking. Men at counters have now become slaves of the machine instead of being masters. Public sector banks have long back forgotten their purpose and their owner proving no better.

Emerging context requires that banking is redefined to meet the specificities of farming, employment, entrepreneurship, infrastructure, and international finance as distinct entities. In fact, Narasimham Committee (1991) suggested consolidation and convergence of the PSBs into six to serve the needs of the service sector, holding government securities, and retail lending; Local Area Banks to cater to the farmers and small entrepreneurs; International Bank to cater to the needs of exports and imports. Development Finance institutions, left untouched, would fund the infrastructure sector. FSLRC also echoed the same in its Report. This is the time to look at the spirit of such recommendations and rebuild the banks to regain the fast eroding trust in banking by the larger customer base of this country.

KISAN BANK:

Breaking the nexus between the farmer and politician can happen only when there is mutual trust between the bank and the farmer. Farm sector, consisting of crop farming (organic, precision, green technologies etc.), dairy farming, shrimp farming, poultry farming, sheep farming and agricultural marketing by itself is inherently capable of cross holding risks, save exceptions like the tsunamis, severe drought for long spells, huge typhoons. It is only in the event of such natural calamities that a Disaster Mitigation Fund should come to the rescue.

The existing commercial banks should shed this portfolio in favour of RRBs and merge all the rural branches with the RRBs. RRBs should be redesigned to take to farm lending in a big way – from farm machinery to crop farming and allied sectors on a project basis. Insurance plays a vital role in mitigating credit risk and therefore, the insurance products should be redesigned and modified on the lines of South Korean model.

All the Rural Cooperative Banks could continue their lending to the farm sector parallel to the RRBs as the lending requirements are huge and farmers require multiple but dedicated lending institutions.

RBI has not been comprehensive in regulating the sector. It is better that NABARD is restructured to play an exclusive refinance and regulatory role over the entire farm and rural lending consistent with its purpose of formation. Its other functions like the RIDF can be relegated to a new institution hived off from the NABARD.

UDYOG MITRA Bank

Nurturing entrepreneurship and promoting employment in manufacturing are moving at snail space in the Start Up, Stand Up and Make-in-India initiatives. Prabhat Kumar Committee (2017) called for setting up a National MSME Authority directly under the PMO to correct the milieu.

All the MSEs should be financed by dedicated MSE Bank Branches. All the existing SME branches should be brought under a new regulatory institution. SIDBI has disappointed the sector. It has to first consolidate all its FUNDS into just five: Incubation Fund; Venture Capital; Equity Fund to meet the margin requirements of MSEs when and where required; Marketing Fund to meet the market promotional requirements; Technology Fund; and Revival and Rehabilitation fund.

SIDBI should reshape into refinance and regulatory institution for the MSME sector with focus on manufacturing and manufacturing alone. It should divest its direct lending portfolio to avoid any conflict of interest. Its present lending to real estate and non-manufacturing MSME lending should be transferred to the commercial banks. RBI which is not currently able to cope with the regulatory burden of this sector can transfer it to SIDBI,

Vaanijya Banks (Commercial Bank):

All the existing commercial banks – both in the public and private sector – would do well confining to the project finance, lending to real estate, services sector, housing, exports and imports etc. All the Banks should constitute at the Board level a sub-committee on Development Banking to work on the transition arrangements to the above functionality.

Maulika Vitta Vitharana Samstha (Infrastructure Bank)

Huge NPAs have come from the practice of lending long with short term resource base coupled with lack of experience in assessing the risks in lending for infrastructure projects. ‘All the perfumes of Arabia’ (RBI’s structural debt restructuring solutions) did not sweeten the bloody hands of banks. It is time to revisit the universal banking model and reestablish Infrastructure Bank to fund the infrastructure projects and logistic parks.

These measures would help achieving the growth like never before.

RBI and GoI could constitute a High Level Committee to work on the modalities for transiting to the new structural transformation of the financial sector.

http://www.moneylife.in/article/how-to-redefine-and-rebuild-banks-for-emerging-demands/50376.html

Politics and Economics of Crop Loan Waivers

Cost of Crop Loan Waivers

SBI Chairman Arundhati Bhattacharya’s impromptu remarks on loan waiver promises of the States to the farmers have attracted the politicians’ ire. Equity and discipline are two sides of the coin of farm lending. If the Banks maintain equity, and care for lending discipline more, borrower discipline would not take a toll.

Loan waivers announced by the State Governments should be met by the state exchequer and not the centre, Venkayya Naidu, the Union Minister said. But when the BJP announced it, decrying the earlier moves of AP and Telangana Governments, it gained political traction and the states demanded a cake in the bargain from the centre with several like Maharashtra, Tamilnadu, Karnataka joining the chorus. Have farm loans become unviable and farmers untrustworthy borrowers? Are there no alternatives to rescue the farmers’ woes?

Unfortunately, lending discipline is lax. Roll over of crop loan with interest as a new loan (this we call book adjustment) and a small incremental credit for crops that take more loan component than that is actually grown on the field has become the order of the day. In South India, it is jewel loans that get accounted for as crop loans. Otherwise one cannot find an explanation for only 20.9% of crop loans getting insurance cover against the mandatory debit of premium for all the crop loans disbursed.

Some grameen banks are debiting processing fee and inspection charges for crop loans and that too without the borrowers knowing it. On top, they charge interest on those debits if not able to recover them.

Arm chair lending even for farm sector has become the order of the day due to inadequate or lack of field staff. Earlier, controlling authorities and even top management used to visit the adopted villages as a semblance of identifying with rural credit activity. One is hard put to find such visits. These are not wild allegations, but facts that came out during the crop loan waiver evaluation done in Telangana by the Development and Research services private limited.

Farmers did not fail the nation in spite of failure of the monsoons, failure of governments not releasing the promised incentives in time, insurance failing them year after year and markets ditching them on the price front. But bankers failed the farmer and the nation with absolute impunity. Any crop loan target set for them by the government is shown to be achieved.

Earlier Loan write offs of 1990 for Rs.10000cr and Rs.70000cr of 2008 were a political stroke and were criticised for lax implementation by the CAG Audits placed before the Parliament.

Telangana Government waiver scheme covers only institutional crop loan including jewel loans outstanding as on 31^st March 2014 up to Rs.1,00,000 per farmer family, spouse and dependent children. It defined eligible short term production loan as loans given for raising crops that are to be repaid within 18months and includes working capital loan for traditional and non-traditional plantation and horticulture. Claims are reimbursed by the Government on the basis of a certificate from the bank that the waived amount has been actually credited into the farmer’s account.

Every lending institution is mandatorily responsible for the correctness and integrity of the list of eligible farmers under the scheme and the particulars of loan waiver in respect of each farmer. All the bankers are expected to provide fresh loans as the existing liability up to Rs.1lakh per farmer family has been picked up by the state government under the scheme.

Evaluation exercise revealed that the farmers to the extent of 70% are happy with the reprieve given to them particularly because they were affected by severe drought for two years in a row although they were unhappy that the waiver instalments were released late leading to delay in release of fresh crop loans by the banks. Fresh crop loans were inordinately delayed in 60 to 70 percent cases during 2014.They wished that the state government would have released in one single go the announced benefit.

55.5% was the share of the crop sector in the total agriculture loans. Government of Telangana agreed for writing off crop loans to an extent of Rs. 16,160crores constituting 76.19% and gave detailed instructions to the banks after consulting the SLBC.

The State having more than 80 percent of small and marginal farmers with loans from multiple institutions and also from private lenders and traders faced problems in addressing the competing demands on the claims for waiver.

Banks’ loan books and farmers’ land record passbooks proved equally non-transparent. Borrowers as well as their parents with identical names figuring in different banks posed impregnable identification issues requiring over six months for resolution at the sub-district level before the first instalment was released.

Average loan amount subject to waiver was a little less than Rs.55000 per farmer family against the announced Rs.1lakh.

Major Public Sector Banks had gross NPAs in Short term crop loans of the order of 2.4% in 2016 as against nearly 8% in 2015.

DRS study came to the conclusion that loan waivers are not a permanent solution to the recurring problems of the farmers either due to man-made or natural calamities.

Solution lies in appropriate insurance mechanisms with individual farmers and income insurance as focus and not the crop insurance that takes threshold limits of crop yields based on area affected historically.

South Korea that supports agriculture sector ranking top among the world’s highest subsidy providers, offers excellent example in this direction.

Korean farmers also get the benefit of a comprehensive agricultural insurance scheme managed by the National Agricultural Cooperative Federation (NACF) with reinsurance support on a quota share basis from a group of domestic reinsurers. The government supports the scheme in four different ways i) provides 50 percent premium subsidies for crops and livestock; ii) acts as a reinsurer of last resort for the liability in excess of 180 percent local market loss ratio;(iii) 100 percent of the NACF’s crop insurance operational expenses and 50 percent of livestock insurance operational expenses are subsidized by federal government budget; and (iv) It participates in product research and development. The insurance coverage in Korea is voluntary.

It will be worthwhile investment on the part of government both in terms of time and resources to provide sustainable income insurance to the farmers on a pan India platform on similar lines, so that the recurring demand for the loan write offs can be warded off.

*The author is an economist and risk management  specialist and part of the DRS Study Team.

 http://telanganatoday.news/cost-of-crop-loan-waiver/250317

Pre-merger SBI on the verge of bankruptcy?

Customers of State Bank of India (SBI), especially in south India, are forced to ask whether SBI is headed for bankruptcy as they find 99% of the automatic teller machines (ATMs) shut down and all branches declining withdrawals from the depositors’ savings account beyond a limit. Bank branches are refusing to honour cheques drawn on them, either their own or on third party, in spite of sufficient balance in the account. To top it, the bank’s branches refuse to give written objection for returning the cheque across the counter.  

In February, SBI, in a regulatory filing had stated, “…the entire undertaking of State Bank of Bikaner & Jaipur (SBBJ), State Bank of Mysore (SBM), State Bank of Travancore (SBT), State Bank of Patiala (SBP) and State Bank of Hyderabad (SBH) shall stand transferred to and vested in the State Bank of India from 1 April 2017.”

What does the rule-book say? Is it because of systemic failure or management failure? Does the blame rest with the SBI, or with the Reserve Bank of India (RBI) as well, as it has been a silent spectator for the last 15 days? Just last week, when Bandaru Dattatreya, the Union Minister for Labour, approached the RBI’s office at  Hyderabad, the central bank said that it has pumped in Rs1,170 crore worth of currency into the system, with half of it in the ATMs of banks and the rest to the bank branches.

Section 5 (c) of the Banking Regulation Act, 1949 defines a banking company as any company that transacts ‘banking business’ in India. 

The Act clarifies, in clause (b) of the same section, that the expression ‘banking’ found in the definition should mean accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheques, drafts, order or otherwise. To constitute the business of banking today, the banker must also undertake to pay cheques drawn upon himself (the banker) by his customers in favour of third parties up to the amount standing to their credit in their ‘current accounts’, and to collect cheques for his customers and credit the proceeds to their current accounts. Lending by itself does not constitute banking business, clarifies ML Tannan. 

A recall to all this became necessary, for the banks, even of the ilk of the SBI, seem to have forgotten the basics of banking. Yesterday I paid a carpenter for the work done at my house, by way of a ‘bearer’ cheque drawn on my savings bank account, Rs13,750, which was presented at the counter. The official at the counter and the accountant refused to pay the amount, saying that they can pay cash only up to Rs5,000 as they do not have enough cash. This is not a solitary instance. During the last fortnight, many customers faced this situation. Many members of the Resident Welfare Association, Kalyanapuri, Hyderabad, brought up this issue and demanded its resolution.

The payee asked for written objection, which the bank officials refused to provide. The cheque was otherwise in order in all respects – with proper date, proper signature, with no difference between words and figures and on top of all adequate balance in the account.  Negotiable Instrument Act requires that if a cheque or Bill of Exchange, is returned either on the counter or in clearing, an objection memo duly signed by the authorised official of the bank shall be provided with relevant reason.

In case a bank branch declines to honour the cheque in writing for want of cash in its vaults it would amount to the bank going bankrupt. In the case of SBI it is also the Agent of Reserve Bank of India and operates currency chest at number of branches. Whenever one branch falls short of the cash, the Bank is supposed to make arrangement for filling the vault with the required quantum depending on the needs of the branch. The transaction between the branches on such count can form internal cash management of the bank and only information to the RBI is adequate.

Contrary to this entire practice if the bank chooses to tell its customers that since there are not enough deposits coming into its vault and is therefore restricting payments to its customers withdrawals up to whatever limit it decides surely amounts to sheer mismanagement and frustrates the customers.

Since the bank is shutting off the ATMs and refusing to pay cash either in full or in part, the customers seem to have stopped depositing cash into their accounts and preferred to keep cash for the rainy day and meeting their essential cash requirements. This sets the vicious circle into play.

Whenever creditors’ demands are not met and assets do not support liabilities of a bank, that bank is said to be on the verge of bankruptcy. But by statute, the SBI cannot go into liquidation at its will.

Customers are losing faith in the banks with which they have been transacting for decades!! Bad banking and good economy can never co-exist. Let not SBI declare bankruptcy ahead of its merger.

http://www.moneylife.in/article/pre-merger-is-sbi-heading-towards-bankruptcy/50020.html

Budget 2017 for MSMEs

MSMEs and the Union Budget 2017

This is the time of expectations amidst the gloom of demonetisation. MSMEs hit worst in post demonetisation are looking eagerly to the FM for careful crafting of fiscal policy to boost the morale of MSMEs, particularly those in the manufacturing sector.

Banks have almost shut their doors to the manufacturing micro and small enterprises by biting their teeth strong through the recently amended SAFRAESI Act provisions. Their courage melts in the case of corporate defaulters. Large corporate defaulters cast a shadow of default on their vendors in the small sector and the banks are unwilling to buy this argument though the NPAs in the small industry segment is not significant compared to their elder brothers.

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.

The Demon of Demonetisation

http://www.moneylife.in/article/the-demon-of-demonetisation/49255.html

In recent RBI history, some highlights: smooth transition to Basel regulations and efficient monetary policy under Bimal Jalan and Rangarajan, global aplomb post-recession under YV Reddy, preventing hyperinflation by Subbarao and taming of the NPAs by Raghuram Rajan. These achievements have put the RBI in prime position among central banks of the world. But the utter lack of planning and monumental mismanagement post-demonetisation by the same institution have tarnished its image.  

Banking operations other than currency operations in the country have almost come to a halt, barring exceptions. Credit is on a downturn. All the rating agencies, including Nomura, have down-rated the economic growth. The road to recovery sans GST is going to be difficult.

Asking the Right Questions on Demonetisation

This is what many in the country – both economists and non-economists – are doing. Strange indeed that fiction should overtake facts when an eminent economist and a popular columnist, Bibek Debroy chose to counter Manmohan Singh-likes that are just handful in the country in a column in the Hindu dated 12th December, '16. The fact is that majority of the population were in support of demonetisation. I demanded for it even in 2011 for three reasons that the PM mentioned. There was one more reason at that time – to contain inflation that was razing at 8.5% then.The fiction is that 98.7% of households have bank accounts that too with the proportions mentioned by him.