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/

 

 

Access to Finance: MSMEs

 

Access to Finance – the Achilles Heel for the MSMEs

Economic restructuring followed by financial deregulation has brought in its wake the need for a change in the very mindset of credit analysts. Infusion of liquidity into banks has strengthened confidence in depositors more than the borrowers.

Share of MSMEs in GDP was of the order of 29 percent with a credit flow constituting 15% of the total credit disbursal of Banks and NBFCs. This amounts to approximately Rs.17trn. Government of India in its overreach to $5trn economy by 2022, has proposed that the share of MSMEs in GDP should reach 50%.

We have seen the most enticing schemes under Atma Nirbhar Bharat Abhiyan Scheme 1 reached only 55% in terms of disbursements, which targeted incremental credit of 20% working capital to the pandemic-struck standard assets in the MSME sector. In regard to the second scheme that targeted the sub-standard and NPAs for revival and provision of equity banks are shy to move fast – in a once bitten, twice shy mood.

It is unfortunate that we should be discussing this issue for decades despite a number of initiatives taken by the RBI and GoI. Priority sector guidelines have been modified allowing banks to co-lend with all NBFCs with no restrictions in order to push lending to this sector. The measure should enhance the risk appetite among banks by co-sharing the risks with the NBFCs. During the years 2015-20, borrowers’ accounting practices moved to the regulatory conformance zone. This should actually rebuild the lost trust among lenders and borrowers.

In Telangana, as many as 8,435 MSME units have commenced their operations since formation of the state, with an investment of about Rs.11,487crore. Since January 2015, MSMEs have provided additional employment opportunities to approximately 1.59 lakh persons.

While micro industries account for approximately 58.07% of total units, their share of investment and employment generation is comparatively less—11.92% and 30.12%, respectively. Small units account for 63.44% of total MSME investment and 55.41% of total MSME employment—the highest for both categories.

Telangana is the only State to have set up a separate institution to revive and restructure the manufacturing micro and small enterprises, viz., Telangana Industrial Health Clinic Ltd with a seed capital of Rs.100mn.

A couple of case studies would be in order where the TIHCL have been successful in not just reviving the enterprise but also substantially scale up their operations, save the lock-down period.

In times of uncertainty as now, investors hesitate to start new enterprises except in greenfield areas like the IT and Pharma. We should not allow the existing viable enterprises to shut their doors for want of some critical funding or margin money or buttressing his equity.

M/s. Deccan Pulverisers Private Limited promoted by two women entrepreneurs, engaged in manufacturing mineral powder from quartz/feldspar mineral stones, availed a term loan from SFC to the extent of Rs.6.2mn without any arrangement for working capital. State Government has sanctioned Rs.2.1mn as investment subsidy and other incentives.

The machinery was ordered as soon as the Financial Institution (FI) sanctioned the loan, but the installation of machinery was delayed from vendors end. The business did not receive expected export orders and the promoter searched for buyers in the local markets. In initial stages could not find an appropriate buyer who can pay in 60 days due to this the receivables were delayed and the payments to the FI were also delayed, FI started charging penal interest for the delayed payments.

In the meantime, the constructed factory shed was damaged due to heavy rains and cyclone, the entrepreneur repaired the shed from his own funds. The project was not feasible with one machine as the margins were too low in the local markets the promoter has installed a second machine with his own funds and increased the unit’s production capacity.

Due to irregularities in the repayment, FI has issued demand notice on 6^th September 2019 asking the unit to pay overdue interest and instalments amounting to ₹ 20 lacs by 1^st October 2019, failing which they will take further steps like legal action etc., The promoter and the company were in the great stress as it shattered their goals and dreams.

After a detailed diagnostic study and discussion with the SFC, we arrived at a revival package for the unit. We noticed that the high interest rate of 17% p.a., and delay in arrival were the principal reasons for the unit to turn incipient sick.

 

TIHCL has extended critical amount funding that enabled him to regularise his term loan account with the SFC. We also arranged for the priority release of incentive blocked for a year. The sword on their necks has been removed and they started production in January this year. But the pandemic struck, and they could restart production only in July this year. At present they attained 80% of their capacity utilization and a turnover of Rs,8.2mn. One of the PSBs agreed in principle to sanction working capital as well.

 Another enterprise, Suresh Textiles, a sole proprietary unit similarly shattered was assisted by the TIHCL. This entrepreneur with 20 years of weaving experience has set up 40 semi-automatic power looms initially. Later he converted them to fully automatic looms to produce shirting cloth in the year 2017. He started commercial production in 2019, the year of slow growth of the economy. The unit stopped its operations during the period of upgradation for nearly six months. During this stress period he approached the TIHCL for a solution.

Problems Identified by TIHCL-

·       Ab Initio sickness detected due to inadequate financing

·       Introduction of GST post-sanctioning of loan caused additional burden on proprietor as equity parked for working capital was utilized for GST payments on machinery.

·       Subsequently this caused cash crunch for production and unit became sick within one year from establishment.

 Revival Package-

TIHCL has conducted diagnostic study and found that the unit has suffered shortage of working capital due to external factors.  It has proposed to the primary lender for enhancing the limits for operating the unit. 

As proposed, primary lender has sanctioned additional loan of ₹14 lakhs and TIHCL has sanctioned margin loan of ₹3.73 lakhs along with the primary lender for the revival of the unit.  TIHCL now handholding and reviewing the unit periodically for efficient business operations and to control the stress in the unit.  

Overall, post revival and rehabilitation by TIHCL, the unit is performing well and improved chances of growing the business.  From nil capacity, the unit has reached 50% capacity utilization during the last three months and is confident of reaching 100% capacity in the next four months.  His experience taught him that raw material bought from outside the State would save the input costs by 15%. He is prompt in repaying the instalments and is now poised for growing big.

 Both the units have digitised their operations and installed ERP solution that enabled the TIHCL to monitor off-site the units’ performance regularly and guide the entrepreneurs.

 In more than 80% of the units that knocked our doors for support, we noticed that their working capital eroded with the banks debiting the instalments on the retail loans sanctioned to them – either for buying a car or home or both. Where the housing loan is taken this automatically collateralized the otherwise CGTMSE guaranteed loan. Their failure to repay due to the eroded working capital, turned them NPA and proceedings against their securities followed as a natural course. MSMEs were the first option of banks to lure them to retail loans, that became their thrust area. It is advisable for the MSMEs to take retail loans from banks other than those that granted them the working capital and also have proper financial planning for their personal assets and enterprise assets for growth.

 Transunion CIBIL has also announced a MSME Health Index based on two parameters – growth and development. Growth is based on the enterprises ability to access credit while development is assessed on the basis of NPA status in banks.

 Rating institutions are yet to come out with rating specifically targeting the manufacturing MSMEs. There are several issues in rating mechanisms and also the extension of guarantee by the CGTMSE. These need resolution for easy access to credit.

 Digitization of all enterprises does not brook delay. Telangana Government entered into an arrangement to provide free accounting software to 20000 enterprises to accelerate digitization. This will certainly bring transparency, accountability, and better compliance of the lending institutions’ terms and conditions of sanction thus rebuilding the lost trust among the banks and MSMEs.

 TIHCL is a co-lending institution and the banks that are interested to speed up their processes of revival and restructuring and take assistance for monitoring and supervision of their MSME assets are welcome to seek our support. Nothing comes free. But the costs that the enterprises and banks incur in their collaborative efforts with us are far minimal and we assure that their NPA portfolio would turn performing with their association with us.

 TIHCL has tailor made loan products for various types of stress faced by the MSEs and for women start-ups and for cluster-based units. Margin loan assistance, Critical amount finance, Margin money for start-ups, working capital requirements for the other types of enterprises. Every enterprise is digitised for its operations under our direction and support. It is for the units and banks to take advantage of our presence. Rates of interest range between 9 and 10 percent.

 TIHCL is keen on ensuring sustainability of enterprises through timely counselling, mentoring and advisory services on a continuing basis and this is our USP.

(This is the text of my address at the MSME Summit held by the CII-Hyderabad on the 7th November, 2020)

 

Roots to Fruits - The Journey of Development Banker

 

ROOTS TO FRUITS

This Book is all about Yerram Raju? Not just that. Apart from his life story, this book is the quint essence of development banking and financial inclusion that the country has been pursuing as its unfinished economic agenda.

 

He is perhaps one of the few to start his writing spree at the age of 20 and continuing for 60 years in a row. Not a single year was without a few articles from him, that too in reputed financial dailies and journals. This is perhaps his last book in life, that will end up with the publication of Part 2 by December 5, 2020.

 

Large families of the ilk to which the author belonged are consigned to history, following the family planning since the 1950s. Eldest of the twelve children, the author describes vividly how his parents have instilled great values, ethics and austerity. This formed the roots of his career path to pluck of the fruits in his later part of life.

 

Author’s mother proudly said that her contribution to GDP of India was significant with two of her children – one a reputed gastroenterologist in Texas and the other a reputed Certified Professional Accountant in the US. The second son is a Professor in Yoga at Chennai. With all the sisters married to their choicest spouses, they had a fulfilled life. The parents of the Author Dr. Raju who lived beyond 94yrs and 81yrs respectively had an enriching life nurturing great ambitions in their children.

 

The Book depicts his intense affection towards parents, his own family, and great reverence to his teachers. His verse on Mother and his prose on Father are moving stories. It is a tell-tale story of the growth of a large family and its contribution to the growth of the economy.  All the children of this large family, however, preferred nuclear families.

          

Since Yerram Raju, the author, grew up in austerity and simplicity, he saw his three daughters grew up in the same environment. Though they all wanted to stay in India when married, all of them moved to different countries.

 

The Book offers lessons to several upcoming youth on the choices one can make when confronted with multiple options having equal opportunities for career growth. The interviews faced by him can guide the youth. His career in Textile Mills threw up lots of challenges that he ably faced. His parental dependence made him leave the opportunity to take up one of the more challenging competitive careers – civil services and financial services.

 

His choice of banking backed by emotion had its fruits. He could see the rarest of rare things to happen – retirement of his father serving the same branch where he was posted as Agent, at his hands. Doing PhD instead of pursuing professional course that would have seen a rise in the banking career faster than he had, speaks of his continued choice of academics. This enabled him later to teach the civil servants at Lal Bahadur Shastri Academy of Administration, Mussoorie and Administrative Staff College of India. He was also an external examiner for doctoral degree of three universities. It is difficult to find a banker adorning     s u c h     position.

 

Lending to agriculture and allied activities, particularly to the financially excluded like the marginal small farmers, potters, small enterprises was an obsession with him. Simplification of systems and procedures always attracted his attention.

 

The author in this brief of 130-odd pages, describes the journey of development banking as it took place post nationalization of Banks in India. For those looking for solutions to the problems of credit to the poor and needy, this book offers ready-made solutions. The presentation is simple and lucid.

 

          According to him, “Development Banking involves deposit mobilization through innovative schemes considering the needs of a variety of customers and servicing them, both online and offline, and financing development projects that add scheme specific infrastructure for lending and financial inclusion. Social banking is part of development banking. Both require efficient credit risk management. Extension services is part of social banking. Handholding, mentoring, counselling are essential requirements for social banking. It is treated as part of narrow banking, these days.”

         

          He won many an accolade both in the Bank and outside. One such is the recognition as International Man of the Year 1991 by the International Biographical Society, Cambridge for his contribution to rural development.

 

This book offers lessons on recovery of agricultural loans. According to the author, recovery is both an art and science. His success as banker, offers many a lesson for the current day bankers deeply mired in NPAs.

 

The Book is laced with quite a few case studies and provides lots of lessons on development banking. Part 1 of the Autobiography of the author up to the age of sixty years, ends with his transition to academics and consultancy. His relocation prompted by his stint with LBS National Academy proved a good decision at the right time of his career.

 

Readers can look to Part 2 for a greater excitement as it covers policy analysis of the country’s transition to liberalization, privatization, and globalization. The key milestones in this part 1 indicate that the areas would cover financial risk management and institutional innovation.

Available at Amazon store: www.amazon.in/amazon.com

 

Little Cheer for Bank Nationalization

INDIA NEEDS TO DO SOMETHING MORE…

CRISIS OR NO CRISIS

                                                                                   

The Day of Bank Nationalization in India passed off on Sunday. Smiles were kept years behind. None talk of village adoption scheme; no Chairman would go to a village these days to see how their rural branches are helping the farmers or the MSME is financed. No pride in ownership. No regret for bad governance.

But for a full page pull-out by the All India Bank Employees’ Association on the 20^th July, 2020, who remembers the Nationalization Day? Neither the employees, nor the disappointed customers that include even the Banks’ own pensioners, nor those seeking credit from them recall the Day. People are only alert on wearing masks and spiriting their palms before handling the currency received from outsiders. Everyone cries wolf on the ever-bulging non-performing assets. The only solid reform that we boast of is the Insolvency and Bankruptcy Code. Job creation is hurt badly in the organized sector with near-65% of MSMEs shutting their windows in pandemic. Their markets are yet to revive.

Banks in UK, Iceland, and even the US resorted to the most criticized and least preferred route of nationalization of banks, when they confronted a crisis. The then OBAMA initiative that received positive response of stock markets since the announcement of Toxic Loan basket takeover under a joint Government-Private Fund, was however inadequate to retrofit the lost confidence in the financial system. 

The revival of ‘protectionist’ actions would seem to be asserting more in finance than in trade.  While the regulators of G-20 would be meeting at the shortly, global regulatory regime has serious limitations and they should be realigned with domestic regulations that have compulsive cultural characteristics. 

Events so far have proved beyond doubt that a global regulatory regime would not be able to provide appropriate solutions to the type of recession that had set in due to pandemic. No prediction as to when it would end. Annual Balance Sheets for 2020 are waiting for finalization in several institutions. Basel III may have introduced a modicum of discipline and uniformity in risk discipline among Banks globally. Several regulators sought more flexibility. It is important for India to realize its distinction in the emerging economic scenario and how necessary it is to turn the head on the screws.

At the commencement of Covid attack, India did well and even till now, we do not find people scrambling for food because farmer and rural India stood by the nation.  The biggest blunder of the system is more announcements than actions and imperfect monitoring and undependable statistics. All the rating agencies, IMF and World Bank kept the ratings low and estimated growth of 42% in 2021. Opening the economy with lot of courage has not been taken too kindly by Corona that has been surging every day crossing the 10lakh persons. India took the 4th rank in the world in Corona affected nations.

Second, we have the key sectors like Steel, Zinc, other Metals and Coal as also the transportation system largely in the public sector. We entered the Commodity markets and derivative markets in our anxiety to mix with the globe. WTO is almost nearing collapse with most countries choosing to adopt policies that secure their own nations and people, not caring so much for the global discipline. 

Third, there was no demand recession of the magnitude that the other countries in the globe faced.  Still the rural areas where still 65 percent of our population lives, drive the demand growth.  Having said that some facts that can be hardly ignored: there is a steep decline in job growth; steep declines have also set in the private sector trumped up by the global recession; the urban and metro retail chains took a severe beating; the real estate and housing boom that irrationally stepped up land values across the country took the first heat-stroke and with them, the dependent MSME sector that is seen as the engine of growth.

Fourth, Banks that lent heavily for the retail sector and real estate sector started facing the continuous decline in their performing assets.  They lost confidence in the resurgence of the demand and the productive capacities of the manufacturing sector.  Most public sector banks even, refused to go with the RBI to pump credit. 

Atma Nirbhar Bharat Abhiyan, the stimuli announced to combat Covid-19, injecting more than Rs.20lakh liquidity, still face risk aversion from the Banks. This high liquidity released only moved to the investments in treasury instruments and to quote Subba Rao, former Governor, gave confidence to depositors in the Banking system that their monies are safe with the Banks, notwithstanding PMC Bank resolution still waiting at the doors of the RBI. It has two windows: one, investments and the other credit. The latest report on Investments not withstanding the $10mn investment announced by Google, all the investment projects are reported to be lagging behind and the cost over-run of the projects already swallowed the entire incentive package.

MSMEs are yet to come out of the two shocks of demonetization and GST. After the redefinition, and after a host of digital platforms placed within their reach, the access to credit by all counts is a poor show. Out of the National Credit Guarantee Trust linked credit incentive to the standard assets, Banks disbursed only 50% or less. This was supposed to be automatic release of 20% additional working capital. The second window to the stressed assets through Sub-ordinated debt is yet to open as the operating instructions were received only a few weeks back.

SIZE – AN IRRATIONAL CONCERN

Merger of PSBs taken up while the economy was slowing down is yet to show up the results. The market value of the SBI post-merger is way behind its peer, HDFC in the private sector. Sanctioning Rs.1200cr to a known defaulter in its books and erstwhile chronic NPA resolving through IBC, does not hold SBI in any high esteem either among global peers or its own clients. Government of India, by merging PSBs to 10 from 28 did not gain either in image or confidence of the people. Several clients say that corruption has become endemic in PSBs and not even acknowledging a complaint, or a letter of customer is so habitual that the latter are in the lurch.

While the Government’s efforts to digitize the delivery system have borne fruits reasonably going by the way the MNREG wages and other direct benefits reached the intended groups during the last two years, financial inclusion is way behind. The reach of banks to the poor has declined.

Regulator’s job is to make sure that the vertical and horizontal growth of institutions should not be allowed to go with a feeling that because of their size they are insulated from collapse and that the Government and regulator had to do something to keep them afloat even in the worst event like bankruptcy.  This is where the RBI should reformulate its views and ensure that the organizational structures irrespective of their affiliations do not overboard the governance and do not oversize.

The silos-based regulatory system currently in vogue, with the RBI regulating Banks and NBFCs, Stock Markets by the SEBI, Pensions by the Pension Fund Regulatory Development Authority, Insurance by the Insurance Regulatory Development Authority, and Commodity Futures by the Futures Market Commission should be effectively brought under Financial Services Regulatory Authority. Department of Financial Services, Union Ministry of Finance may have persons of eminence but when it comes to examining micro issues for macro management, it left lot to deliver. Collective wisdom needs to emerge to improve financial regulation and governance that affects 130bn people does not brook delay.  

India, for example does not have credit risk insurance of the order prevailing in either Italy, or Germany or South Africa.  The Credit Guarantee Trust for Micro and Small Enterprises is but a poor cousin of the trade and credit risk. Credit Risk could not be introduced in India as the IRDA was apprehensive of the consequences of credit default.  It is perhaps of the opinion that the moral turpitude would reach new dimensions if credit risk is introduced. 

Percy Mistry Committee called for a unified regulatory architecture for resolving issues dealing with segmentation of financial markets into banking, capital markets, insurance, pensions, derivatives etc. Sweden, Singapore, UAE, UK, Republic of Korea to cite a few have already moved into the unified regulatory system.

OPERATIONAL ISSSUES:

Warren Buffet, the most reputed investor, is quoted at number of places: “Derivatives were financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” Over-the-counter derivatives that are off-balance sheet instruments come to surface suddenly when their collaterals fall and when their values become riskier to hold, killing in one stroke rest of the healthy assets of the Banks. The delivery and recipient systems have not reached a level of maturity to play with them, even a decade after their active entry.  Indian financial system cannot afford the consequences of systemic risks arising from their instrumentality.

Let me go to the most familiar area – Credit Risk that is mostly understood as risk of default.  Here the risks arising from asymmetric information have not been dealt with. The Credit Information Bureau India Ltd.,(CIBIL) is the only institution that currently unfolds client’s historic information at  price.  Entry of multiple players with the enactment of Credit Information Services Act of 2005 is put on hold.  Trade and Credit information services should enter the competitive domain for the information system to get into a semblance of order.

Credit rating agencies in India that are approved by the RBI are none other than the Fitch, Standard and Poor, Moodys etc., whose ratings busted on the threshold of sub-prime crisis and beyond.  There is no proof that they are doing their job differently.  Until the rating agencies’ services are paid for by the financing institutions that make use of the ratings and hold them accountable for the ratings, there is no guarantee that the ratings per se would add to the quality of the credit portfolio the banks carry in respect of the rated assets. 

While the Government and the RBI, Insurance and Capital Market regulatory authorities have proved one-upmanship over the other regulatory authorities in reasonably insulating the Indian Financial System from the impacts of the current global crisis, a large gap remains in what is needed to be done. The time to put things in the right shape is now and right away.

It is high time to appoint a High-level Committee that should also include outside experts to clean up the banking system with an open mind.

------------------------------------------------------------------------------------------------------------*The Author is an Economist with three decades of banking experience and a Risk Management Specialist He can be reached at yerramr@gmail.com The views are author’s own.

https://www.moneylife.in/article/ramping-up-the-banks-india-needs-to-do-something-more-crisis-or-no-crisis/60966.html

Ten point Policy for MSMEs

Sweet nothings for MSMEs

Risk aversion can’t be turned into risk appetite with excess liquidity in the hands of hesitant lenders

MSMEs, the lifeline of the economy and the main job-provider, has no oxygen left. The Micro, Small and Medium Enterprises (MSMEs) have been the worst affected by the pandemic but only sweet nothings have been coming as announcements for the sector. The RBI offered a deceptive comfort: standard assets as on March 1, 2020, would get a relief of three-month moratorium with no interest relief; review of the working capital requirements and pumping in liquidity of the order of 3.37% of GDP combined with the GoI relief for the weaker sections by way of cash remittances into the Jan Dhan accounts.

There was further relief by way of refinance from Sidbi: Rs 50,000 crore; Nabard: Rs 25,000 crore among others. The net result of previous liquidity injection as per the RBI April 2020 Bulletin is 0.7% year-on-year credit growth for the industry. Sectorwise: manufacturing micro and small enterprises was -0.4%; food processing: -3.1%; textiles: -6.6%; leather and leather products: -2.3%, all engineering: -0.4, state-sponsored SC/ST credit: -70.4%; export credit: -13.2%. Will all these negatives turn positive with the new liquidity? Risk aversion cannot be turned into risk appetite with excess liquidity in the hands of a hesitant lender.

In a pandemic, history tells us that massive credit and large fiscal expansion should go in sync to pump-prime the economy to a new normal.

Realistic View

When the manufacturing MSMEs open their shutters, they will find all the machinery waiting to be greased; sheds to be broomed; factory premises to be sanitised, and all tools readied. Several bills pending for payment require renegotiation. Labour will mainly demand their lost wages rather than renewing their work.

All supply chains are choked and each link in the chain needs to be looked at by the size of investment needed for re-functioning to the level of at least 60% capacity, Without this, interest commitments may not be honoured. The entrepreneur will, therefore, have to set his priorities right and decide which corners need to be cut and which widened.

The immediate trigger for enterprises in Telangana is deferment of fixed electricity charges for April and May without penalty and they will get 1% rebate on payment.

Several enterprises would first search for cash from banks and NBFCs. This would depend on the collateral securities they had and their previous track record. Banks are not poised as of now to lend on a cash flow basis. They may still try to work out estimates based on the pre-Covid-19 performance levels. This is the first tragedy. There may be a few understanding branch managers, who will take the risk and lend.

Next thing, the entrepreneur needs to negotiate with the existing labour. It will be a very hard negotiation and he will need to find money to pay the wages for the shutdown period first. Some understanding labour may oblige with deferred wages but they would be just a few. Most fair-weather friends would come up with suggestions like pledging gold; mortgaging excess property, etc but no cash. Private moneylenders too would be hard to come by.

The demands of all national associations like the CII, FCCI, PHDCCI have been kept waiting at the doors of the Finance Ministry. The UK Sinha Committee Report that recommended Rs 10,000 crore fund of funds and Rs 5,000 crore Distressed Asset Fund have not been set up. After set up, if they are kept in the conservative hands of Sidbi, it will be of no use. The Fund should address payment of wages of all the manufacturing MSMEs based on the muster roll and ESI evidence.

Assessing Demand

It is unlikely that products would be in demand at the same level. People have become austere. Every person, who faced a compensation cut, would continue to move the demand curve to essentials than FMCG. Sectors like pharmaceuticals, medical equipment, processed foods, packaging that were functioning on the fringe could move to higher capacities. All others will have to make rounds to the banks for their merciful looks!

Every enterprise will have to envision a new future – different scenarios have to be built and they should convince investors and lenders. They cannot look to the global markets immediately as the pandemic has levelled them all.

As far as India is concerned, a great opportunity is knocking. China has lost its sheen and credibility. Global markets hitherto linked to China would be looking at ways to pull off from them. Entrepreneurs should carefully set their trigger points. It is here that the policy vacuum can hurt hard.

Ten-Point Policy

1. Redefine MSMEs by way of turnover
2. Allocate specific portfolio for manufacturing sector to make ‘Made in India’ a reality
3. Enterprise should digitise operations and have a consent-based ERP architecture
4. Bundle up all existing credit (term loan plus working capital, inclusive of interest) for enterprises with a turnover of Rs 10 crore – extend a moratorium till December 31, 2020, after converting it into a Fixed Interest Term Loan carrying interest at 6% pa, for repayment thereafter in 48 annual instalments
5. Evaluate working capital requirements on cash flow basis
6. Discount all the bills drawn on government departments, PSUs and even large undertakings that carry credit rating of AAA and above at 75% and credit into the client account, provided the invoice clearly says that the purchase is within the approved annual budget.
7. Credit Guarantee Fund Trust for Micro and Small Enterprises should do portfolio guarantee up to Rs 5 crore and then second charge on the collateral security with the lender for the balance up to Rs 10 crore
8. Declare NPA threshold at 180 days overdue and redefine the Special Mention Accounts — 0,1,2 at 60, 90, 180 days
9. Review all existing limits, legal proceedings, auctions etc, and ensure that no viable enterprise will exit
10. For the rest of the enterprises, make exit comfortable: fair treatment of sovereign dues; priority to the creditors on first-in-first out; and transfer of assets to those who would like to acquire them. These accounts should be subject to a third party review by a State government accredited agency.

Thereafter, the industry should draw up their trigger points and rational action plan in consultation with the lender/investor. All Industry Associations should nominate one or two active Executive Committee Members to form a think-tank or negotiating team for regular interface with both State and Union governments.

(The writer has authored ‘The Story of Indian MSMEs’)

https://telanganatoday.com/sweet-nothings-for-msmes

Coping with post-COVID-19 Disruption

Coping with post Covid-19 Disruption

Post pandemic prediction can’t be a soothsayer’s job. Preparing the economy from a tremendous shock and staying inside home for nearly a month in some States and could be longer as we see the accelerated rate of spread of Covid-19 hit persons, is the biggest challenge. India is not a city state like Singapore or Finance hub like Hong Kong. The optimists expect the lockdown to be lifted by the 14^th April while the less optimistic put it to the end of April. We need to think of the strategies and actions phased over short, medium and long term with matching resources right now. This should be both sectoral and geographical specifics.

While we are the leading global pharmaceutical suppliers, the low and inefficient health sector management with historically low outlays suddenly got the awakening call with the CVD spread and the need for public health systems to step up their capabilities. Yet, the call of the nation has been very ably responded to the greatest consternation of the rest of the world.

The country, with diversity nowhere else existing, is the biggest challenge and opportunity to the governments. Diversity has capacity to cross hold risks across segments and has innate resilience when calamity befalls. It also provides scope for innovation as people think more actively under pressure than leisure. When none can be in laid back comfort that existed before, people keep working out differently different things. For example, there have been more webinars during the last one month than during the last six months. There have also been more video conferences and skype calls as people started working from home. This may gradually turn out as new order of functioning.

One of my nieces from Bengaluru tells me that as Director of a Union Government organization working from home became a true challenge as deliverables rest with her than with other members of her team. Even the forgotten kitchen started demanding her time with children demanding newer tastes and new dishes. This is making her work for 14 hours instead of 7 hours in office. There is a whole paradigm shift in the work environment., not for one but many like her – with no gender discrimination.

What would be the future like? Very many organizations could find new economies of scale in a combination of work from home and work at office. More factories will have to think of reworking their supply chains that thoroughly disrupted due to the CVD, New leadership paradigms emerge. The 10 percent manufacturing small enterprises manufacturing gloves, sanitizers, masks, medical emergency kits to combat CVD will find near extinction of such market. They should expect this to happen and therefore prepare from now on the way to re-engineer their process to newer products and new markets. They will notice that institutions and persons that were after them during their need will turn their faces and likely to hold up their bills in their search for finding cash margins for fresh initiatives.

Our country will have to reinvent itself in workspaces and relationships like never before. In this process, at the micro level, enterprises will re-engineer their production and processes and search for new markets. Many will find the exit to be a problem.

Amidst a supply driven crisis, the unrest and plummeted resources of all kinds, as also eroded markets, MSMEs will require sustainable process consultants to rescue them at affordable costs. Here, the governments in looking at the sovereign dues and the banks looking at the stuck balance sheets of MSMEs should learn the art of turn around management or seek recourse to experts in turn around management.

Every nation will be on the uncertainty horizon. Risk mapping will be difficult. Everyone has been a looser. Non-performing loans will surge unless the thresholds change. Indian regulators need not wait for the world to guide them. They can guide the world. BCBS has already provided for applying the thresholds for SME sector as per the needs of the country. The time for action is now. The threshold should move to a 180day horizon till December 2020 subject to a review after six months. This will automatically provide for higher leverage in lending for the MSME sector, the nerve wire of production that has been contributing 35% of GDP, 45% of exports and employing 112mn persons.

The poor and daily wage earners, the hawkers, the wayside eateries, many disabled, contract workers – both skilled and unskilled, need government subsidies, even salary buffers, supplies and cash to meet their daily needs for at least three more months until the industries and enterprises re-look for employing them.

Fiscal responsibility under these circumstances of both the State and Union governments already hit by the lowest ever tax returns requires out-of-the-box thinking to meet the situation. Several relief funds of the CMs and PM, private donors and even CSR funding even amidst the near 10 percent hit on most corporate balance sheets would be inadequate for revival of the economy. It may take at least nine months to one year to cone to a new normal which would be far less than that we had in the slowing economy.

Even if people have cash in their hands, which itself is doubtful, they will not get the goods and services as the lockdown succeeding the slowdown of the economy, there will be supply driven inflation. Scarcity stares in all areas.

Courage is the watch word. In times of distress people display amazing unity while immediately after normalcy is restored the same set of people will most likely diverge. While the demand to lift the lockdown in toto will surface with more vigor than now, it would be prudent to release in parcels to rework on the efficiency of the health sector infrastructure, doctors, nurses, para medical staff on one side and on to ensure that the wheels of production get back to normalcy gradually, on the other. Second, the discipline enforced should be redirected to finance, transport and manufacturing sectors.

The focus of trade will suddenly think of new protectionism, new direction of investments, newer regional allies in trade and new relationships. The denuded investor firms and the huge number of corporates off-loading the bonds in the markets for liquidity are bound to put pressure on the financial sector. This recession is very unlike the 2008 or even 1930 and it will be a prolonged and widely spread across 200 nations in the globe.

Banks are systems driven and not enterprise driven, Unless the instructions are fed to the system, the concessions do not take effect. In several Banks, even the usual half-yearly reviews of several accounts on a regular basis did not take place. The disaster today is extraordinary and requires extraordinary speed of action post new normal.

At a time when the demand for credit is at the lowest level due to several manufacturing and trading enterprises shut their shops due to lockdown and are seeing future as more uncertain than now, liquidity doors have been kept open by the RBI as though that was the problem area that required urgent attention. Even during the last six months RBI has been extremely accommodative to Banks both in capital buffer and liquidity commitments. But the credit did not move to a higher zone in non-food segments.

“These capital and liquidity buffers are designed to support the economy in adverse situations,” as the Fed said in a statement. Fed’s other hope is exactly what the India incorporated is looking for: less rigidity from the banks in extending the required debt, post pandemic. COVID-19 has caused serious disruption to global supply chains and has a huge impact on financial markets and trade ecosystem. It is important to retain the customers and governments post pandemic and rebuild their lost supply chains to operate sustainably.

India’s biggest advantage is its demographics and therefore, the future needs to be addressed with alacrity so that entrepreneurship will not be governed by the hoary past but a bright future.

The Author is an economist and risk management specialist. The views are personal.

Published in Money Life 2^nd April 2020; www.moneylife.in

Impact of Covid -19; Review of Measures taken

RBI in its Monetary Policy statement on the 27^th March 2020 front-ended the effort of banks through pumping liquidity, 3-month moratorium on term loan instalments, working capital while interest will continue to accrue during the moratorium period with a further clarification that instalments will include the payments falling due from March 1, 2020 to May 31, 2020: (i) principal and/or interest components; (ii) bullet repayments; (iii) Equated Monthly instalments; (iv) credit card dues; review of working capital limits of all enterprises. 3% CRR recommended by Narasimhan Committee, Tarapore and Ashok Lahri at different points of time has been announced.

Interest will continue to be charged on the EMIs and they would to that extent enlarge the instalments that follow the moratorium. To expect the industry to recover immediately after the lockdown period is over will be an overestimation. McKinsey says:” Restarting production facilities can be more challenging than shutting them down. It requires a thoughtful approach to revive the supply chain, match volume to actual demand, and, most importantly, protect the workforce.” They require minimum six months to get back into the full supply chain. Banks’ sagacity to reassess working capital lies here. Banks should not cut down the limits because the size of the Balance sheets of all firms will be downside of the previous years including their own.

Future lending shall be cash flow based and not Balance sheet ratio based or even just turnover based (Banks are asked to extend minimum of 20% of projected turnover while most have adopted this as the maximum and this includes SIDBI).

RBI February data indicates that as of January 2020 credit growth to agriculture and allied activities decelerated to 6.5% from 7.6% in January 2019; to industry more than halved during the same period; to services sector decelerated to 8.9% from 23.9% whereas for personal loans it grew by 16.9%. This position prevails despite liquidity infusion measures during the last two monetary policy initiatives. Therefore, risk aversion and not liquidity is the problem with banks.

The already risk-averse banks can hardly lend during this period of lockdown seeing temporary shutdown of 90% enterprises. They can only provide online comfort following the policy announcement, al bait for three months! For a running industry to increase capacity is easier than a re-opened industry after lockdown. Further, investment required after re-starting is also going to be much more than now. Therefore, banks must prepare to lend more aggressively immediately after the current period. But can they move away from aversion to appetite in taking legitimate credit risk, without improving their lending infrastructure?

A few special efforts that still beg attention are:

·       Banks to stop all SARFAESI proceedings and developing forbearance for the manufacturing MSEs.

·       Extension of NPA threshold to 180 days, effective January 2020 quickly that will keep accounts standard for any further booster doses to flow to the industry.        

T    

Special Mention Accounts 1 & 2 categories will also need uniform forbearance.

·       Unfunded limits – LCs, Guarantees, ECGs falling due between January and May 2020 should not be revoked for non-compliance but their periods extended by another six months. RBI directive is imperative.

·      

A       All viability tests shall be done by State Government accredited agencies

·       GST should be reduced to 5% till the end of December 2020 for all the enterprises that would submit their quarterly returns as required under law, even if at exempted thresholds. Review of impact should be based on an evaluation study by all the Industry Chambers.

·       All MSMEs that maintain record of manpower employed verifiable with EPF and ESI registrations.

·       All MSMEs may be permitted to engage contract labour with the social security burden absorbed by the State Government on reduced commitments annually by 20% provided they all are digitized for all transactions.

·       Power Tariff should be cut by 50% for all the manufacturing enterprises provided they are all digitized and registered under Udyog Aadhar or TSiPASS.

·       All MSME Funds should be maintained and monitored by the DC-MSME through NSIC instead of SIDBI.

GoI may focus more on cleaning up the financial sector with a sense of urgency to render its services effectively in tackling this uncertainty effectively. At one end, cash relief from the exchequer should flow to all digitized Jan Dhan and Mudra loan accounts and at the other end, credit shall pump prime the economy with responsible and timely deployment post lockdown.

More digitized developed economies are redirecting their efforts to containing the spread and holding people in discipline using WhatsApp, digital alarms at the Carona Control Rooms etc.

South Korea has transferred cash to all the SMEs to pay for their labour for one month. US has announced a $2 trillion package to combat the new war. Several nations across the world – with 196 affected by this monster Carona - are seriously contemplating the relief packages. G-20 announced $5trn relief package. For once everyone stopped thinking of fiscal deficit. Extraordinary problems require extraordinary solutions.

No time for Hobson’s choice. Saving lives is more important than saving the economy, no doubt. But preparing the economy to respond to the post COVID-19 very effectively also brooks no let-up in efforts.

*This is part of the article published on the 30^th March in Telangana Today with some additions.  A Response write up to the CII.