SME Lending: Capsule for Start Up India

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A year ago Hon’ble Prime Minister Mr. Narendra Modi launched the ‘Start Up India’ campaign from the Red Fort, on August 15, 2015. The campaign blended well with the 5T-3D-3S (Five ‘T’s- Tradition, Talent, Tourism, Trade and Technology; three Ds- Democracy, Demography and Demand and three Ss- Skill, Speed and Scale) approach of Mr. Modi towards building “Brand India”. The purpose of the campaign went beyond creating first time entrepreneurs and aimed at maximising employment generation, promoting industrial and economic growth, and bolster the sagging manufacturing exports. All these would feed into the flagship program “Make in India”.

India has some successful start-up stories to tell, ranging from Flipkart, CarTrade, Bookmyshow, all of which have innovation as their core competency. Majority of these marquee names were nurtured by committed investors. Angel investors and venture capitalists ensured timely availability of capital, a critical prerequisite for every start up. It is fair to assume that every SME will not be able to attract private investors.

Fortunately, public sector financial institutions have taken initiatives to provide capital support in the form of long term equity to SMEs. SBI Small and Micro Interest Free Loan as Equity (SMILE) launched in 2010 provides non-interest bearing seed capital up to INR 10 lakh (~USD 20,000 in 2010), over and above the project finance facility. SIDBI has launched five funds to promote MSMEs across states and sectors. It is also raising corpus for Stand Up India Fund, focussing on providing capital to marginalised communities and women entrepreneurs. At the core of these initiatives, is ‘investment led growth’; ‘Lending for growth’ remains to be explored. There was a gap of 56 per cent in total credit demand for 2013-14, leaving us with a huge under supplied lending market.

As per Annual Report of Ministry of Micro, Small and Medium Enterprises (MSME) 2015-16, rate of growth of credit to MSMEs declined from 30.0 per cent (2012-13) to 13.4 per cent (2014-15).

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Intuitively, SMEs approach financial institutions (FIs) for sustenance. The DNA of a lender is diametrically opposite of an investor. Lenders focus on ability of the SME to timely service debt obligations and value of collateral encumbered. In case of greenfield enterprises, with limited collateral, FIs would need to be more than lenders and become business facilitators also.

As propellants of capital to the last mile, start-up SME lenders need to provide support to Selfsustainable SMEs using Innovative methods at the right Time (SIT).

Self-sustainable: A commercially sound futuristic business plan should imply prospective business opportunity for the lender too.

Innovative: FIs will have to strike a fine balance between the role of a lender and an investor, creatively building technology driven architecture, tailored for start-up SMEs.

Timely: Without compromising on asset quality, the lender should ensure no opportunity is foregone solely due to lack of availability capital. Paucity of capital diverts entrepreneur’s bandwidth from operations to fund management.

Considering SMEs’ financing needs a change in prevailing mind set, an innovative approach is needed.

  1. Greater use of technology for reducing cost of lending: Using utility payment records to assess creditworthiness, uniform payment interfaces and Post Bank of India for credit disbursement
  2. Supplier linked lending: Extending credit to corporates with the objective to on-lend it to SMEs engaged in its value chain
  3. Cluster based lending: Credit to clusters based on sector, product, geography. Loan taken by one or more group members is backed by the cluster, jointly
  4. Risk Sharing Fund: Both, FI and State share risk, in case of an adverse account performance through a fiscal fund, similar to MSME credit risk compensation fund in China
  5. Linking tax incentives to job creation, adherence to compliance, and value addition
  6. Draw mechanisms to identify reckless entrepreneurs. For example, link promoter’s salary to profitability, monitor the rate of interest on loans from friends and family. No tolerance for ‘wilful failure’.

Tailored SME lending approach may invite resistance from multiple stakeholders in FIs due to two reasons. First, lenders in SMEs will need to empower credit officers with skills specific to start-up enterprise evaluation. Second, FIs would need to invest in processes and technology. Lending will graduate from credit appraisal to business plan evaluation.

Start Up India is a strategic initiative, with a long term goal of raising a generation of new entrepreneurs who will have a critical role in expanding much needed employment. It lays thrust on incubating business ideas and creating the spirit of enterprise in a knowledge driven economy.

Small Business Administration in USA and National Financiera (NAFIN) model in Mexico may be studied in the Indian MSME context. Start Up India could transform Indian banks from lenders to business facilitators. At the same time, Indian banks can steer Start Up India from a campaign to an agent of job creation and economic growth.

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Gunja Kapoor is an Associate Fellow with Pahle India Foundation (PIF). She has over 5 years of experience in financial research and analysis. Prior to joining Pahle India Foundation, she has worked with a real estate private equity fund and CRISIL Ratings. She is an MBA from XIM, Bhubaneswar and B.E from VTU, Karnataka. Her broad areas of interest include financial inclusion, technology, and policies related to the SME sector.