MSMEs and the Union Budget

MSMEs and the Union Budget 2019-20

The time is ripe for expectations on a few counts: The first time Woman FM would be compassionate; since she combines in her portfolio the Corporate Affairs as well, the B2B can expect some reliefs for the micro and small manufacturing enterprises; fiscal reliefs will have a slant towards production and employment to push growth and would deal harshly the wilful defaulters both on tax and loan fronts.

Banks bit by huge corporate loan defaults started looking at MSMEs afresh as windows of opportunity although their attitude towards funding manufacturing enterprises still hangs on the unforeseen risks. This is so mainly because of the need for monitoring and supervision of these fledgling enterprises who will continually need mentoring, counselling and handholding and these involve manpower and related costs.

Post liberalization Banks have cut down costs on this count but at the same time charge for them in their books of accounts to ward off accountability. Banks can be legitimized to outsource such tasks at a small price from a few accredited institutions provided the banks do not charge their clients on this count. This is a non-budgetary intervention that the FM can make.

The cascading effect of large corporate defaulters on their vendors in the small sector and the banks’ unwillingness to buy this argument before applying their sledge hammer of SARFAESI Act action needs a novel treatment to the defaults arising therefrom.The allowable leeway for corporates that June 7, 2019 circular of RBI could be extended to MSMEs in the following areas: firstly, the lenders should have a Board approved policy for Resolution Plan; second, they should conform to transparent timelines for implementing Resolution Plan; third, they shall require independent credit evaluation (ICE) of the residual debt by credit rating agencies (CRAs) specifically authorised by the Reserve Bank for this purpose. Fourth, the cost of such independent credit evaluation should be borne by the lender and not the borrower.

Because of the large numbers requiring such effort, Union Ministry of MSMEs can accredit institutions like the Industrial Health Clinics wherever promoted by the State Governments and at least one more Accounting Firm that should pass the independent test of legitimacy with passion for the MSME sector.

Several units where power itself a major input like induction furnaces is, rubber, rolling mills, etc., the reforms in the power sector jacked up the price of this input by as much as 100% making them uncompetitive. Hence in the interest of the employment intensive manufacturing micro and small enterprises, the cost of power can be subsidized linked to GST as it will enable sharing the cost of subsidy equal with that of the state government.

Start-up manufacturing MSEs 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.

Hand looms and handicrafts cost the consumer high and leave little margins for the producers. Therefore, there is need for providing safe havens at both the ends to maintain production demand-driven. Present incentive system needs revisit to rationalize them.

Existing urban industrial estates should be up-scaled and modified to provide all the logistic facilities closer to the MSEs under PPP mode. It is important for India that has competing demands on land space to develop lease markets in a big way sooner than later to keep double digit growth moving sustainably.

Industrial work space should be made available on leasehold basis for 15-20 years with permission to mortgage leasehold rights in favour of lending institutions. The caveat should be that the lending institutions should be ordained to take recourse to this security only if it is sold to a frim of similar manufacturing facility and not for real estate or housing purposes.

To provide comfort to the micro and small enterprises in mainstreaming themselves into the economy, both ease of doing business and exit should be of greater comfort than now. Enterprises should be incentivized for vertical growth and all perverse incentives that led to spawning of enterprises horizontally should end. Lately, MoCA is seen to be over-regulating, making small and medium enterprises shun equity markets. There is need for extending regulatory reprieve for SMEs to access bourses.

IBC-like code for micro and small enterprises is imperative for providing easy exit route. Invariably apart from the debt overhang, sovereign dues pose severe problem for those that would like to exit the enterprise sector. Accommodative stance in this regard would be dis-allowing Banks to attach and to sell the only dwelling house of the entrepreneur under SARFAESI Act provisions.

If the enterprise has availed state incentives either while establishing or running the enterprise (like the interest rate pegged to 3 percent per annum in some states), such enterprises shall be eligible for exit route only after ensuring that they have not been diverted to building non-manufacturing assets: wherever capital subsidy has been availed by the unit, the State shall have the first right of recourse to such asset if the enterprise seeks winding up within five years of establishment.

In order that unorganised MSEs become organised and employment is truly reflected in the musters, even zero-based GST-applied manufacturing MSEs should be ordained to submit the GST returns quarterly. Firms that offer cloud-based but customised ERP solutions to the MSEs should be incentivised so that the MSEs embrace this accounting solution at least cost.

MSEs with turnover of up to Rs.10cr that engage accounting consultancy services should be provided fiscal incentive by way of income tax reduction. Tax compliance in the process will be incentivized.

Guarantees of CGTMSE did not provide the much-needed comfort as banks did not buy the scheme for enterprises drawing credit for more than Rs.10lakhs. MSEs look to the budget in terms of the banks sharing the guarantee premium on 50:50 basis with the MSEs or reduced premium for those buying the higher guarantee cover. Wherever the banks take collateral to hedge the uncovered guarantee risk, units should secure credit at lower rate of interest than otherwise.

The FM would do well to include in the budget tax incentives for strategic partners’ investments in the organisations meant for revival of the potentially viable units. This can be by way of exempting them from income tax for the first three years up to a limit of R.500lakh per unit. This will speed up restructuring of viable enterprises faster and in larger numbers.

MSEs particularly suffer from the absence of responsible and credible consulting services. Hence dedicated consulting firms with stakeholder participated – either promoted/partnered by the state governments or NBFCs through a separate Corpus Fund dedicated to the cause of MSEs should be qualified for GST exemption for five years, provided they work on low-yielding assets.

Government departments of both union and state governments should mandatorily become members of the Registered Trade Exchanges to deliver the advantages of e-commerce to the MSMEs and facilitate online payments of bills drawn on the former. It is pertinent to mention that so far trading has not moved significantly in this direction and most delayed payments are by the government departments and PSUs. MSE Facilitation Councils have inherent conflict of interests and the best would be to do away with them and the costs saved can move to incentivise e-commerce.

https://knnindia.co.in/news/newsdetails/msme//msmes-and-the-union-budget-2019-20

Enable MSEs breath fresh air

B. Yerram Raju

Banks want to revive. Large industry wants to revive. Firms like Jet Airways, Zee, Essar Steel and the big are given breather by the Banks and they are all NPAs for more than a year. Reserve Bank of India also encourages Banks to come out of the red. But when it comes to the micro and small enterprises (MSE) who have been vendors to the large firms and part of the supply chain, Banks almost shut the doors.

Interesting backdrop emerges from the latest Financial Stability Report. Discussing the sectoral deployment of Gross Bank Credit, exposure to industry sector expanded by 2.3% in Q2 FY19 as compared a meagre 0.7% in Q4 FY18. Large industry gained the most with almost 3% increase in exposure in the most recent quarter, as compared to 0.8% recorded in March 2018.

The manufacturing MSME segment on the other hand languished further as it experienced a negative growth of (-) 1.4% in September as compared to nearly 1% credit expansion recorded in March. Banks continued to be risk averse as much of credit increase occurred in working capital segment and not term loan segment.

Banks are no less to blame than the MSEs for their ills. Many MSE projects have been financed without consideration of the total costs of the project in most cases that came to our notice, that includes machinery installation costs, rates and taxes including GST, loading and unloading charges, transit insurance costs and other connected expenses.  Trial run for commercial production that should be part of pre-operative costs is also not included in the total project cost.  In addition, interest during the construction period is also debited to the working capital account opened simultaneously with the Term Loan account while such working capital account should be opened only from the date of commercial operations. Consequently, even by the time the unit starts commercial production, the unit becomes sick.

Moratorium should start from the date of release of last installment whereas most banks are starting from the date of first installment.  Sometimes, project implementation delays like delay in release of successive term loan instalments, receipt of imported machinery and its erection etc., would result in time overruns and cost overruns besides repayment starting well before commercial production.  This practice leads to inadequate financing of the enterprise and this is another contributory factor for sickness of the enterprise.

RBI’s Master Directions dated March 17, 2016 on Revival and Restructuring suggest that each Bank appoint Zonal Committee to consider revival. Corrective Action was to be initiated for Special Mention Accounts – SMA within certain time frame: SMA-0 to be provided corrective action. SMA-1 to go for restructuring and SMA-2 for recovery. Zonal Committees were not formed; even where formed, there is no record as to how many have been revived following the Directives.  Though RBI Empowered Committee meets every quarter no reliable data on the revival of manufacturing MSEs was available. RBI’s instructions on manufacturing micro and small enterprise revival seem glossy.

Yielding to the pressure of MSME Ministry, RBI on January 1, 2019, i.e., after a lapse of two years and over since the Master Directions, new directions for restructuring were issued. This circular clearly says that the standard assets SMA-0,1,2 need to be restructured and the exercise should be completed by March 2020 for loans up to Rs.25cr. There is an overdrive among banks now to restructure the SMA accounts. This is certainly a very efficient NPA-preventive tool if effectively implemented.

Neither the RBI nor the Banks consider ‘a known devil is better than an unknown angel’. Some unknown angels are fast turning into unknown devils as well.

The major issues in revival are: NPAs for revival require fresh margins from the beleaguered enterprise; provisioning continues at the same level even after revival; Banks do not have time to have dialogue with the entrepreneur when the unit develops symptoms of sickness; long drawn illness turns into a potential cancer turning the unit unviable. Weeding out willful defaulters is possible even in the first quarter of default during which time banks invariably tolerate.

It is intriguing that the units closed for six months due to failure to pay up electricity dues remain active in banks’ books of accounts. Good number of them has the potential to revive unless they willfully defaulted. During the first 3months of such non-payment of electricity dues proper diagnostics would help the revival.

1.         All NPA-MSMEs in manufacturing sector up to Rs.1cr due for consideration for revival even though the banker may take a different view, should be referred to an external accredited institution (EAI):

a.         Such accreditation could be given for an independent organization like the Industrial Health Clinic wherever set up or to a Committee set up by the State Government involving bank representatives that should include MSME-DI. The Committee should also hear the entrepreneur.

2.         Above Rs.1cr but up to Rs.25cr, such consideration for revival shall be referred to a Committee of the Bank at the appropriate level that should include ‘MSME Expert’, MSME-DI representative, and a State Government representative in order that interests of sovereign dues is taken due notice of and equitable attention is devoted for their recovery as part of revival package.  The committee before taking any decision should hear the view point of the entrepreneur, Revival Policy of the state government and record the same in the minutes for considering or otherwise duly giving valid reasons thereof.

4.         All such revival package shall consider the following financial facilitation:

a.         Freezing the status of the classification of asset on the date of reference to the external institution or the Committee of the Bank for one year or till the date of rejection.

b.         Reversal of penal interest and other penal charges;

c.         Charging simple interest at MCLR from the date of reference for one year;

d.         Fees/Charges levied by the EAI including IHCs should be borne by the GoI through a special fund set up for the purpose;

e.         Bank should share ‘pari pasu’ charge on the borrower’s assets for any external funding towards borrower’s margin including such funding by the IHCs;

f.          Additional funding where required, should be charged at MCLR by the involved agencies.

Such guidelines should be applicable to all the Banks, NBFCs, SIDBI and SFCs. ‘Behind every small enterprise, there is a story worth knowing.’

Aspirational Budget 2019

Union Budget 2019 – Exceeded Expectations

Amidst the honco of high growth and reducing retail inflation this pre-Election Budget largely fulfilled the expectations of farmers, middle class, real estate. Disposable income in the hands of salary earners and the middle class would jump due to the increase in IT exemption limit to Rs.5.lakhs, up to Rs.50000 standard deduction and non-taxable income from bank and post office deposits up to Rs.40000 and this would surely spur the domestic savings stagnated at around 30% till now and also stimulates the demand.

Farmers certainly have something to cheer. All farmers having less than 5acres would get monthly income of Rs.6000 under direct benefit scheme. There were 12.76cr operational holdings under the command of farmers owning below 5 acres according to Agriculture Census. At the allocation of Rs.75000cr against this item of budget at Rs.6000 it can reach only 12.5cr if there was no further subdivision and fragmentation. But such a measure alone is a big bonanza for farmers. Integrated look at agriculture sector – animal husbandry and fisheries also got a big boost. One can’t expect more from interim budget. Tenant farmers are just ignored although 80% of suicides occurred in this group that has a share of 14% of land under cultivation according to the NSSO data.

Micro and small enterprises having loans up to Rs.1cr would get interest subvention of 2% for the first time. We should hope that this benefit would reach the intended and the banks would not take advantage of this concession.

NDA did well in the cleanliness drive; but performed poorly in providing safe drinking water. While the NDA spent 77% of allocation on this score, still its reach to the poor is far too distant. If the reach improves, expenditure on health may decline. Coupled with this, environmental clean up providing for fresh air should have been provided at least 2% of the Budget in line with the Climate commitments to the UN.

In this backdrop well calculated Fiscal Deficit would cross even the 3.4% of GDP. CAD at 2.3% is on sensitive border. If the oil prices go northwards, then this will upset the apple cart of growth and lead to higher inflation than the one taken forgranted at little above 2%. It will cross 5.5% during the next six months. Even RBI inflation expectation at 4% will have a zolt. 

Mention was made about Banks and NPAs. While the reforms like the IBC code accelerated the recovery process from the corporate loans much more clean up is required in the stables of banks, looking at the staggering frauds of Rs.41,500cr and the recent sacking of ICICI Bank CEO. Lot more is needed in improving governance over which the FM had no word.

Education is in a big mess and Employment is in doldrums. It is strategy rather than spending that requires attention in both the cases and real time monitoring is the need of the hour. This did not get any attention. Draft Employment Report of NSS unfolded a big rise in unemployment. When 55% of the population is below the age of 25 years, strategies for employment and enterprise promotion, and education are clear areas of neglect in the budget.

Budget understandably is at best an estimate. Although NDA has displayed better spending of the allocations, outcomes need regular monitoring and this should be done within the public glare.

Union Budget 2019

Union Budget 2019 – Reasonable Expectations

Amidst the honco of high growth and reducing retail inflation this pre-Election Budget has some just expectations. Tax-GDP ratio of 17.5% can be pitched up to 20% given the fact that the rich have been growing. Domestic savings at around 30% has to improve and investments have to be less volatile for which the foundation has been well laid by considerable acclaim in EODB.

Demand stimulation and medium term employment have to improve significantly. Farmers certainly have high hopes notwithstanding the limitations of union government in this regard as Agriculture is a concurrent subject. It is wise to give up the announcement of crop loan targets as it is not related to the Budget per se. States like Telangana and MP have done well in Income support schemes and Center would do well to support such initiatives in some appropriate proportion.

Assurance of Basic Income may have to wait for the 15^th Finance Commission’s recommendations. One announcement can be setting up a fund for Price compensation for farmers whenever the MSP and market prices have wide divergence at the point of farmer reach.

All the tenant farmers and small and marginal farmers above 65years could be provided pension of Rs.5000 per annum as their ability to work and earn their annual incomes is eroded completely by then. This can be done through a pooled fund out of the 2% of income earned on commodity exchanges and 1% of agricultural insurance premium.

NDA did well in the cleanliness drive; but performed poorly in providing safe drinking water. While the NDA spent 77% of allocation on this score, still its reach to the poor is far too distant. If the reach improves, expenditure on health may decline. Coupled with this, environmental clean up providing for fresh air should be provided at least 2% of the Budget.

Education is in a big mess and Employment is in doldrums. It is strategy rather than spending that requires attention in both the cases and real time monitoring is the need of the hour.

Banking: Restructure NABARD by hiving off RIDF portfolio; RRB and Cooperatives and Rural Development through Watershed, SHGs, FPOs and finance to tenant farmers and agriculture marketing as 3 separate subsidiaries. Similarly, SIDBI needs restructuring to provide assured lending to micro and small manufacturing enterprises and revival of incipient sick and sick MSMEs by way of external support mechanisms. Union Government would do well to announce any compelling credit products only through a committee of select bankers.

Budget understandably is a best estimate. But outcomes are important and they need effective monitoring.

12-point Agenda for the RBI Committee on MSMEs

Pain points for the MSME sector

MSMEs Credit woes in stock

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

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

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

Credit crunch

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

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

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

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

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

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

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

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

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

* Thresholds in priority sector portfolio.

* Credit risk assessment of the MSMEs

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

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

* Cluster Development — Additional lending incentives.

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

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

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

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

* Recommendations to the Centre on policy initiatives.

* Digitisation of MSME lending and managing its transition.

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

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

privacy and data security.

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

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

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

Published on December 27, 2018, The Hindu Business Line

Making MSMEs buzz again

Making MSMEs buzz again

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

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

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

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

Defining MSMEs

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

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

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

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

Many Challenges

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

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

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

Simple Steps

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

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

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

Data Integration

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

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

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

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

Values are the Elixir of Life

Values are the elixir of life

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

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

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

Why Merger of PSBs not a good idea?

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

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

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

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

 

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

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

Against this backdrop, the latest merger is enigmatic.

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

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

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

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

Profitability ratios

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

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

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

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

Looking ahead

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

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