MSME funding: banks need to design client-specific products

IMPROVING COMPETITIVENESS: An artisan making incense sticks from bamboo with his indigenously manufactured bamboo splinter machine. — FILE PHOTO

IMPROVING COMPETITIVENESS: An artisan making incense sticks from bamboo with his indigenously manufactured bamboo splinter machine. — FILE PHOTO  

Micro, small and medium enterprises (MSMEs), apart from playing a significant role in meeting national objectives of balanced growth, poverty alleviation and equity promotion, serve as nurseries for corporate enterprises of future. Thus, MSME financing is the latest buzzword in the financial sector in India. Though financing to MSMEs is on high priority, it is also highly risky. Banks face difficulties in extending credit to MSMEs mainly due to asymmetric information system and lack of reliable credit history. As a result, banks rely heavily on collateral-based lending rather than cash-flow analysis while dealing with small-scale sector borrowers.

Funding advantages

As loans to MSMEs are priced relatively higher when compared with large corporates, the average account profitability (%) from the MSME segment is higher than banks' large corporate portfolio. Moreover, considering the average small ticket size, MSME financing offers possibility of diversification of asset base, which will minimise the impact of possibility of poor quality of assets while minimising sectoral client concentration.

Considering the comparative advantages and disadvantages of funding to MSMEs, there are some strategies which banks may adopt to increase their credit portfolio.

Banks may explore the possibility to incentivise their large corporate clients for procuring products from MSMEs, financed by them. This would facilitate ready market to MSMEs thereby mitigating risks associated with MSMEs financing. Further, it will help in effective monitoring of their accounts.

Robust risk mitigants

Banks need to emphasise on issues like (i) a customised risk rating model for MSMEs¸ where banks should give more weightage to primary information about the borrower, namely, personal net worth, track record of his personal loan accounts, dealing with his suppliers and clients especially large corporates and availability of cash or near cash collateral security, (ii) identifying the stage of product in product lifecycle, (iii) selection of appropriate technology, (iv) rigorous commercial appraisal for assessment of market and its future potential and (v) design and development of an appropriate MIS for exchange of data / information among banks /FIs which may be used for proper selection as well as monitoring of MSMEs. Further to mitigate the risk of MSME financing, banks need to collect and pool common data on risk associated with each identified cluster and develop an IT-enabled, appraisal and monitoring system for small enterprises within the cluster.

Banks may consider designing some products on (i) financing for environmental protection/pollution control initiatives/ common effluent treatment facility, (ii) funding for technology upgradation including setting up of computerised MIS and (iii) securitisation of loan portfolio would provide banks double benefit in the form of additional liquidity and release of capital.

Based on risk factors, repayment capability and future cash inflow, banks may design some customised products where low interest rate can be charged initially and higher rate subsequently. For wider acceptability of products in the market, banks may offer finance to MSMEs specifically for branding and marketing of products/services at concessional interest rate which may be backed by government subsidy.

Apart from developing client-specific, need-based loan products for MSMEs, there is a need for wider delivery channel to cater to the timely need of finance to this sector. In this regard, banks may follow some strategies like (i) cluster-based funding through opening of branches or satellite outlets mainly in Tamil Nadu, Andhra Pradesh, Karnataka, Maharashtra, Gujarat, West Bengal, Punjab, Haryana and NCR where the concentration of MSMEs are more, (ii) to select some sectors/ sub-sectors having high potential, namely, agro-based industries, bio-fuel and biotechnology, auto ancillary, textiles and apparels and (iii) maintain close liaison with the industrial promotion/ development agencies. This will provide access to the MSME entrepreneurs and thereby may help avoid adverse selection.

To sum up, though various steps have been initiated in the recent past to boost the flow of credit to MSMEs, still there is huge gap in financing to this sector.

There are many conventional explanations for the tepid growth of credit to MSMEs, namely, lack of sufficient collateral, opacity in operations, dominance of proprietorship pattern of ownership and lack of credit history as most of the firms are young.

To increase bank credit to this sector, there is also a need to improve competitiveness of this sector.

A special package may be devised for these MSMEs where some tax holiday say for five years can be extended for incurring capital expenditure in R&D-related activities. The possibility of enhancing the extant limit of credit guarantee for MSMEs having consistent good track record could also be an option which will help banks as it may reduce risk and transaction cost.

It also overcomes limitation of MSMEs to provide acceptable collateral.

Further various chambers of commerce may organise business fair at local as well international level for the benefit of MSMEs, so that MSMEs could acquire information about local / global market which would provide vital inputs to them about demand for their products and would also help develop networks among suppliers and clients. To provide easy access of funds for R&D and branding, corporate bodies may set up venture capital funds for emerging entrepreneurs.

MSMEs may utilise the services of specialised marketing agencies for promoting products/ services through the online mode which will provide wider coverage and faster reach at affordable cost.


Deputy General Manager, IDBI Bank

Though various steps have been initiated in the recent past to boost the flow of credit to MSMEs, still there is a huge gap in financing to this sector.

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