Institutions loosing their relevance

Agri, MSME DFIs are failing to meet their objectives

The focus needs to shift from public sector banks to NABARD and SIDBI, whose functions greatly differ from their intended role

When one sees high inflation, the RBI comes to mind. When capital markets misbehave, SEBI is on the radar. When an insurance problem surfaces, the IRDA comes into the picture. These are institutions with proven credibility.

But when credit does not flow to agriculture or when farmers commit suicide, why does NABARD (National Bank for Agriculture and Rural Development) not come to mind? Why do farmers go to the government for a resolution? Similarly, when MSMEs do not get credit on time or do not get the services promised, why is SIDBI not under scanner? Why should the RBI still have a department to resolve issues relating to agriculture and MSMEs and prescribe priority sector boundaries, despite these other institutions?

Agricultural credit

NABARD, a statutory corporation, was set up in 1982, to take up the work of the Agricultural Refinance and Development Corporation (or, Agriculture Refinance Corporation, till 1970), as well as some functions of the Agriculture Credit Department.

The NABARD Act was passed in 1981. Its preamble states that it is: “An Act to establish a development bank...for providing and regulating credit and other facilities for the promotion and development of agriculture (micro-enterprises, small enterprises and medium enterprises, cottage and village industries, handlooms), handicrafts and other rural crafts and other allied economic activities in rural areas with a view to promoting integrated rural development and securing prosperity of rural areas, and for matters connected therewith or incidental thereto.”

NABARD is a development finance institution (DFI) established under the statute to serve the purpose of providing and regulating credit and other facilities for the promotion and development of agriculture. It started regulating cooperative credit, but that space was ceded to commercial banks. It also started with regulating RRBs, but most of them merged into larger entities and RRB branches are now mostly seen in urban and metro centres.

When the statute provided for regulation of credit to agriculture, why did the RBI continue to hold the reins? Is it because of lack of confidence in NABARD, or a reluctance to cede control?

The Rural Infrastructure Development Fund is administered by NABARD. Why should NABARD fund States for infrastructure projects, and in the bargain became a banker for the State — not for agriculture and allied activities, rural and cottage industries? It undertakes more treasury business (pure financial operations) than refinancing of cooperative banks and RRBs at very soft rates, and through them, lends to the farmers of all hues. There has been a compromise of objectives, with full concurrence of both the RBI and the government. NABARD’s income comes more from investments than refinancing or development projects.

Commercial lending

Let us see the other DFI — set up under a separate statute in 1989 — the Small Industries Development Bank of India, or SIDBI. There are several Centrally-supported ‘funds’ for the development of small enterprises. But there is no review in the public domain as to how these funds are performing.

The Centre established SIDBI Venture Capital and the ventures funded were of the real estate sector and MFIs. It has no credible record of financing and promoting micro and small manufacturing enterprises or clusters. SIDBI started direct lending sparsely, with a minimum of ₹50 lakh. It did not consider, during the first decade financing, SME marketing activity as a term lending portfolio. Manufacturing enterprises did not get venture capital at a lower cost than the normal venture capital funds.

Commercial objectives continue to govern its functioning. Its regional offices are so autonomous that they do not even consider responding to RBI guidelines. Most of SIDBI’s lending is through collateral securities. It basks under sovereign protection to diversified activities.

Schemes such as MUDRA, CGTMSE, 59Minute Loan are all under its umbrella, albeit indirectly. No one has questioned SIDBI’s way of functioning in relation to the objectives spelt out in the statute: “An Act to establish the Small Industries Development Bank of India as the principal financial institution for the promotion, financing and development of industry in the small-scale sector and to co-ordinate the functions of the institutions engaged in the promotion, financing or developing industry in the small-scale sector and for matters connected therewith or incidental thereto.”

Thus, both the DFIs targeting specific sectors are non-performers in their supposedly dedicated domains. At a time when the Finance Minister is keen on bringing about institutional reforms, she should shift her antenna from mergers to these two DFIs.

The writer is an economist and risk management specialist. Views are personal

https://www.thehindubusinessline.com/opinion/agri-msme-dfis-are-failing-to-meet-their-objectives/article29625262.ece

Equity route the best for scaling up in MSMEs

Trust equity to transform MSMEs

Along with its good oversight, equity brings greater financial discipline right from the start

By Author

TelanganaToday

B Yerram Raju  |   Published: 7th Oct 2019  12:05 am Updated: 6th Oct 2019  10:17 pm

It is well known that the micro, small and medium enterprises (MSMEs) live in debt markets in India unlike in many other parts of the world where they access equity and debt in reasonably good proportion. In India, 93% of MSME credit is flowing to just 13 States. This skewed distribution requires correction.

Of late, genuinely worried about the continual decline in credit to MSMEs, the government of India introduced MUDRA to comfort these enterprises with Shishu, Kishore and Tarun products. But not even 10% of the total 17 million estimated enterprises was in the manufacturing sector. Then the government introduced 59Minute loan window. Both these efforts have not improved grassroots lending to the sector.

Driven to the wall, the Finance Minister pushed the panic button asking banks to do aggressive canvassing of loans for MSMEs and retail in 400 district-level shamiana meetings. The FM must be aware of both adverse selection of beneficiaries and moral hazard consequences. She expects the banks to tackle them effectively.

Convenient Option

But are there no other means of meeting the financial requirements of MSMEs? Why is equity not being explored as a convenient option? Is it because of the unorganised nature of the sector or because of the undependable clients in the sector? Or both?

Debt has been the most convenient option driven by perverse incentives right from 1950 when the Industrial Policy was announced. Debt, apart from being less costly, takes less than 30 days to deliver while equity takes at least nine months, if not more, where the promoters are assessed through a rigid due diligence process and corporate governance and board rules are put in place before filing the IPO. This process can be shortened if the enterprise has credible historical data for the pre-launch and good governance structure.

Movement from micro to small and small to medium is more governed by greater stake of the promoters through equity infusion. Therefore, such a transition is also extremely slow.

Enabling Ecosystem

District Industrial Centres, introduced in 1980-81 when George Fernandes was the Union Minister for Industries, have been engaged by the State governments to dispense the incentives, raw material like coal, iron, and help in realisation of unrealised debtors through the MSE Facilitation Councils since 2006. The Facilitation Councils, however, did not succeed to resolve the problem of delayed payments to MSMEs.

Manufacturers are the worst hit. Hence, the FM came out with a strict mandate to the PSUs and Central government departments to pay up all their bills by October 15, 2019, and confirm. Hope this would provide a lot of liquidity to the beleaguered MSMEs.

For the transformation from debt to equity access, the ecosystem, capacities and capabilities of firms and the perceptions of entrepreneurs play an important role. Several entrepreneurs are knowledge-insulated and mostly unwilling to unlearn in their growth journey.

Successful Model

Equity firms can participate with the MSMEs over a seven-year period with a gestation period of 1-2 years. Revenue sharing is the model on which it operates and is assessed after sectoral analysis and exits at an appropriate time. The participating equity firm also keeps enhancing skills and scouts for market opportunities of the partner firm. The model is a success in the US.

This equity comes at a cost of 5% more than the market price of debt. But it brings along with it good oversight and greater financial discipline right from day one. Structuring finances and structuring enterprise during the growth is a seamless process.

Scaling them up requires a different level of investments to wean away the entrepreneurs from the protective environment to self-dependence. The biggest problem they invariably come across is the choice of directors for governance. While the Institute of Directors has got on its platform thousands of trained directors, accessing them at affordable levels and verification and validation of their credentials pose problems.

Incentivise Transition

With the economy targeted for $5 trillion by 2022, MSMEs as growth engines and seedbeds of innovation have a significant role to play. Such a role requires that they seamlessly migrate to a higher level of operations during the growth stage.

Fiscal incentives can help such a transition. Having eased the rules for FDI participation and amended the corporate tax structure, it is time to look at what best can be done to make MSMEs go for greater aggregation and contribute significantly to the growing economy.

We have the potential to overtake China if we trust our MSME sector more than now and provide more long-lasting solutions than kneejerk reactions.

Risk Management in Indian Banks and FIs need Improvement

The scale of frauds across the Banks in India, from cooperative banks to commercial banks crossing half a trillion rupees, ballooning NPAs, slow and untimely resolve of bankruptcy cases have exacerbated the credit and operational risks. Finance specialists add to them the impending climate risks.

The PMC Urban Bank is just the tip of the iceberg viewing from regulatory perspective. Lack of oversight is clearly visible. Appointment of Directors failed to honor the ‘fit and proper criteria’. IL&FS and DHL in NBFC space shook up the shadow banking as well. This situation raises more questions than answers and require a firm resolve to warding off financial risks sooner than later, much before they translate into macro-economic risks.

Post-recession (2008), when the regulators hurried to drive risk management and governance of risks relied on Basel Committee. The industry’s new-found focus on risk management was ‘driven largely by a survival mentality and regulatory requirements’, as pointed out by Clifford Rossi and not by internalizing the risk assessment processes and governance improvements.

Rating institutions gave exemplary ratings and yet there was collapse of corporate credit. Risk management committees were set up and Chief Risk Officers were appointed and yet the risk mitigation did not take place. Both the government – the owner of the largest banking space and the Banks do not speak of risk management as a factor that led to the recent surge in frauds. Every product and process in these institutions is put for risk assessment.

New schemes and new programs do not get assessed for all the risks. Institutional failure to unlearn from the past and complacence on the part of Banks and FIs would appear to be the main reason for the current imbroglio. Time is not unripe for a 360⁰ thinking on the subject to put in place a mechanism for risk management and governance.  Noticeably, it is the absence of risk culture that is to blame for the absence of risk governance, process, analytics and expertise.

Banks sit on a mountain of data and claim AI and MML are receiving their immediate attention. The questions that come to my mind are: why then the Banks and FIs are unable to put in place a risk-based pricing system for all their loan products? How is it they fund start ups in manufacturing and services at the same level of interest rates? Again, why an owner-driven or proprietary or partnership micro and small enterprise and a medium enterprise driven by a Board with competent directors are also charged the same price? Why the Banks that claim latest technologies in place failed to transmit the rate cuts of the regulator to the clients requiring a mandatory compliance to pare the rates of interest with the Repo rate?

First and foremost for correction, is the tacit acceptance of failure of governance unabashedly and move to a thorough clean up. The four regulatory institutions – RBI, SEBI, IRDA, PFRDA should sit together and review the rating processes of all the Rating institutions they approved. Rating should not lead to a regulatory arbitrage. A simple uncompiled directive like the corporate institutions should reflect the dues beyond Rs.2lakh per vendor MSMEs did not reduce the rating of many a corporate. Had this been done, many MSMEs would not have become NPAs. There would not have been any need for the FM to give specific mandates to clear the dues to MSMEs before October 15, 2019.

Institutions that are adept at rating corporates have a myopic view of MSMEs and such thinking is largely driven by false risk perception driven by the lenders! Watch out the data – micro and small enterprises constitute around 8% of the credit to them as NPAs and every NPA is not unrecoverable. Rating is also influenced by the collateral rather than the enterprise, entrepreneur and environment over which the Banks have data but with no required behavioral analytics.

I agree with Clifford Ross, the leading risk professional when he says: “Risk professionals need to use disruptive technologies and perhaps find other tools to more effectively assess non-financial risks (e.g., cyber and operational), which have grown substantially over the past five years.

For both financial and non-financial risks, the continued development of risk expertise is vital. A great risk professional possesses the following qualities: (1) a balanced and logical temperament; (2) experience, over-the-cycle; (3) critical thinking; (4) analytical leanings; and (5) an action-driven mindset. What's more, on-the-job training is essential, because we are all at least accidental risk managers.”

*The author of ‘Risk Management – The New Accelerator’, economist and risk management specialist. Can be reached through www.yerramraju1.com