in SMB Finance

India is home to a large number of MSMEs and startup companies. With ~29.8 million MSMEs in India, they make up for 8% of our Nation’s GDP, provide employment to over 80 million people (also creating close to 1 million new jobs annually), contribute to 45% of the manufacturing output and account for 40% of exports from our country. They are the crucial implants in the economy and contribute significantly to the economic and national progress of India. One of the major vantages of SMEs is the fact that they can render large employment opportunities at comparatively lower cost of capital than large institutions are capable of doing. In addition to this they play another key role in India- Industrialization of rural areas. It is no wonder then that the current budget lays emphasis on SMEs and agriculture; the government knows that it is these MSMEs which will drive growth and progress into our rural areas.

SMEs contribute to 8% of GDP, 45% of manufacturing output, 40% of exports, employ over 80million people and create 1 million jobs annually

But, for all the glorious contributions of the SME’s to the economy, they are constantly under the burden of insufficient access to funds. The majority of these SMEs do not have access to a loan or the eligibility to apply for one for that matter. Most of the traditional lenders prefer the old school collateral based lending and assess the borrower based on previous profitability with at least three years of sustained growth. Unrealistic expectations on these companies that are tardy in growth and operating in sectors that don’t support high cash flows, results in most of them being turned down when it comes to loan approvals.

The need for collateral backed lending renders most of the SMEs ineligible for loans Click To Tweet

The Need for Funding Among MSMEs

To get a better picture of the plight of these MSMEs we need to look at the % of these MSMEs who are able to access institutional finance. Based on the MSME census report of 2007, the percentage of enterprises that did not have access to finance stood at 92.8%. While only 5.2% of these industries were funded through institutional sources and 2.1% through non-institutional sources. Look at it this way- for every 100 MSME out there 93 of them have to find funds on their own and it is only 5 that will be funded through banks while the others rely on individual lenders or non-bank sources.

The same report puts the financing demand gap among MSMEs at ₹29 trillion or $526 billion. Yes, the figure is huge and agreed that not all demand is real demand; which is why we need to break it down a bit. ₹29 trillion may be the requirement of all the MSMEs put together but the actual amount that is viable for financing is lesser.

Type of EnterpriseShare of debt demand (%)
Sick enterprises in default13%
New enterprises < 1 year in operation23%
Rejected by formal financial institutions1%
Voluntary exclusion25%
Total62%

Taken from the IFC report on MSME finance in India

For the sake of assessing the actual demand for financing that exists among the SMEs let us exclude the above from the total demand. That leaves us with 38% of ₹29 trillion which is viable for financing consideration. This comes to an amount of ₹9.9 trillion, a fraction of the original amount and going forward we will refer to this amount as the actual demand among with SMEs.

To puts things into perspective, the amount allocated in the proposed budget for investments into the SMEs was ₹3,464.77 crore or ₹34,64,77,00,000. The demand for funding among the SMEs is ₹99,00,00,00,00,000.

sme-demand-budget-allocation

While this comparison is not conclusive of anything it is just to provide a basis to understand the enormity of the need for capital among our SMEs. Please note that the budgetary allocation for SMEs is merely the government’s estimate on the investments proposed for this sector. It does not signify the amount available for lending to these MSMEs.

But what we are seeing here is actual demand for working capital requested by these MSMEs. Because demand seeks available supply, the first and obvious source for supply would be the banks. While we have already seen that banks require collateral for loan disbursals and that majority of the SME loan seekers are turned down, we need to analyze this from the bank’s perspective as well to get a 360o panorama.

How Banks Engage in the SME Portfolio

Banks that lend heavily in their SME portfolio have around 13% to 15% of their lending in this sector. It might also be interesting to note that the Public sector banks seem to have a more robust profile in SME lending when compared to their private sector counterparts. In accordance with the RBI guidelines, banks charge the direct advances to SMEs @0.25%. In this article we shall analyse the top Public Sector and Private Sector bank annual reports. In particular we will look at their SME lending and understand few aspects about it.

Public Sector Banks

Below is a list of the top 10 public sector banks by their weighted assessment in the NSE. We shall then analyse the annual reports of these banks to see how their SME portfolio performs. The focus will be to look at the Restructured SME loans to find out the amount of loans that are still active at the end of the FY 2014-15. Restructuring of loans is an activity that banks take frequently to deal with NPA (non performing assets). When a borrower defaults on either the interest or the principal amount the quality of the loan goes south. When there are repeated defaults on a loan, the loan is said to be a sub-standard one or a non-performing asset. Banks undertake restructures on loans in order to remove these bad assets from their balance sheets and improve the quality of their books. The loans are most often, refinanced and given back to the borrower for the unpaid amount under a ‘restructured’ term or in plain words as a new loan. This is why looking at the o/s restructured amount at the end of the FY can help us in understanding the active lending the bank has in this sector.

Public Sector BankSME Write offTotal SME LendingRestructure- SME
Punjab National Bank40,06361,2621,33,115
State Bank of India-1,3331,81,47471229
Bank of Baroda-98631,5725,627
Union Bank16454,7551,582
Bank of India10454,4061,428
Canara Bank29760,6041,191
Allahabad Bank64813121,139
Oriental Bank of Commerce63-927
Syndicate Bank024,665395
IDBI Bank0-0

₹ in crores rounded to nearest integer value. The data represented here has been obtained from the annual report of these banks.

Another comparison to be made is to analyze the new loans that were given out during the year and compare it with the restructured loans as a % of the total SME lending during the year. One of the major reasons that banks shy away from aggressive SME lending could be because of the % of these loans that need to be restructured to save the balance sheet of the banks. This again is not a complete picture as this ignores the amount that is written off. The restructured loans are loans refinanced only post the write offs.

Private Sector Banks

Private sector banks have a more passive SME lending portfolio in general. Although they may support and actively campaign for SME growth and participate in events organized at promoting SME growth, they do not have a robust credit in this sector. Our analysis will consist of only 6 banks in this sector as the other 4 do not have any cases restructured on account of CDR mechanism or SME debt restructuring in the current or previous year.

Pvt Sector BankRestructure - SMEWrite off end of FY
Karur Vysa Bank478
IndusInd Bank321
Karnataka Bank2116
City Union Bank188
Axis Bank0.50.1
HDFC Bank0.50.1

₹ in crores rounded to nearest integer value. The data represented here has been obtained from the annual report of these banks.

As you can see in the case of both the public sector and private sector banks, the write off from the NPA is a significant amount. But the private sector banks have limited exposure to these MSME loans as a whole and therefore the portion of NPAs written off do not have any significant impact on their books.

The Real Comparison

If you’re still with me then this is where we crack open the egg. Let’s take a macro look at what we’ve seen so far. If we were to combine the total of all the lending that the banks have infused into the SME sector and compare that with the total of the SME financing demand, the result would be surprising.

total-sme-demand

Evidently, the total demand for financing among the MSMEs amount to ₹9.9 trillion of which conventional banking caters to only ₹5.2 trillion. However, this amount is not exclusively dedicated for the SME sector. Part of this lending also applies to the lending in the agriculture sector. The amount would be considerably lower if we took only the lending to the SMEs. This leaves a gap of ₹4.7 trillion that is still an active demand for capital from the MSMEs out there.

Now I find it a rather exasperating task to put such large number into quotidian perspective. So here’s what, we all know that the GDP is a huge thing for a country, cause it represents the sum total value of all the goods and services produced in that country during that year. If that is the case, then we need to look at this ₹4.7 trillion in terms of GDP.

As you can see, the market for funding requirements in the MSME segment is greater than the entire GDP of Cyprus. Or to be more specific, the opportunity in India is greater by ₹3.2 trillion. Try beating that!

Now this is where we complete the entire loop and circle back to where we started. Why is the #FinTech industry growing exponentially? It’s simple – because it’s a ₹4,700,000,000,000 market out there that’s waiting to be mined! How cool is that? But the real deal here is that no major player has sunk their roots deep enough to establish themselves as the big one – yet. Add to that the prospects of growth in this space and it is possible that this ₹4.7 trillion deficit will only grow bigger as more and more enterprises join the SME segment.

There is no definite way of knowing if this will happen or at what rate this could happen. But then again all the facts seem to support the argument that it will. The government itself has started pushing aggressively to encourage entrepreneurship and facilitate the growth of MSMEs. Given the stimulus that this budget provides and the pace at which the MSME sector has grown over the past decade, it’s safe to assume that we are at the inflection point in the history of fintech.

The article at a glance

To sum it up, we saw that the demand for capital among the MSMEs is a staggering ₹29 trillion market. Since the entire portion of the MSMEs seeking finance do not qualify for funding, we broke it down to assess only those prime enterprises who are viable for funding and that put the actual demand for funding in this sector at ₹9.9 trillion.

Next we took a look at few of the public sector and private sector banks to understand how they function in bridging this gap. The data was suggestive that the banks has limited and calculated exposure to this sector and a considerable portion of the loans were restructured and refinanced. We then tried to estimate the entire cost of lending that these banks made towards the MSME sector and did a comparison of that amount with the total demand for funding among the MSME sector. We found a financing shortfall of ₹4.7 trillion.

To capitalize on this opportunity, our markets have witnessed significant growth in the #FinTech industry with new players trying to cater to this demand for funding among the MSMEs. For as long as the banks refrain from closing this gap for capital requirements the open market will witness new enterprises sprouting up with the intention of gaining a foothold in this market.

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