Central Banking

NAGINDAS KHANDWALA COLLEGE OF COMMERCE, ARTS AND MANAGEMENT STUDIES

CENTRAL BANKING

PRESENTED TO : PROF. SAPNA MEHTA

T.Y.BANKING & INSURANCE 2007-2008

GROUP MEMBERS NAME

ROLL NO

MEGHNA KAPADIA

516

SWETA MANSETA

518

KARMESH MEHTA

521

UMANG MEHTA

523

1

FORUM PANDYA

525

KRISHNA PATEL

527

SACHIN PANCHAL

554

ACKNOWLEDGEMENT At the outset of this project, I would like to thank our Prof. Ms. SAPNA MEHTA for giving us an opportunity to do such an innovative project in the subject. We would also like to thanks all those people who have helped us in completing this project on time. Without their efforts it would have been quite difficult to complete this project.

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TABLE OF CONTENT

Sr.No. 1 2 3 4 5 6 7 8

Topic Introduction From SSI to SME: Defining the New Paradigm Measures to increase the quantum of credit to SMEs at the right price Credit Guarantee Fund Trust Scheme for Small Industries(CGTSI) Small and Medium Enterprises (SMEs) in India Problems facing the SSI sector Impact of WTO Conclusion

Pg.no. 1 4 6 8 11 14 16 18

INTRODUCTION Despite historic growth figures and a new law to help small-scale industries in the last year, small industries continue to suffer from their traditional problems. In June last year, the President gave his assent to the Micro, Small and Medium Enterprise Development (MSMED) Bill, 2006, whose aim is to promote and develop “small and medium enterprises”. The phrase used before this bill was introduced in 2005 was ‘small-scale industries’, but the MSMED Act sought to create two categories — ‘small’ and ‘medium’. After some small-scale industry associations objected, the term ‘micro’ was introduced. These divisions are based on the size of a company. By bringing larger companies into the bracket, it has been feared that most of bank lendings would go to what has been described as ‘medium’ enterprises. An indication of this is that private and foreign banks regard a company with a turnover between Rs 10 crore-700 crore to be a ‘small and medium enterprise’ (SME). The MSMED Act regards a ‘tiny’ enterprise to be one whose plant and machinery is worth Rs 25 lakh or less, a ‘small’ industry as one whose investment in plant and machinery is between Rs 25 lakh-5 crore, and a medium enterprise as one whose investment is between Rs 5 crore-10 crore. A small-scale industry unit was earlier one whose investment was within Rs 1 crore. Industry units used to deliberately try to remain ‘small’ on paper even if their investments were more than Rs 1 crore (sometimes by dividing companies) so that they could avail of various exemptions and benefits accorded to the small-scale industry (SSI) sector. This also led to a situation where small industries remained small. There were 1,400 items on the SSI list, which meant that those not classified as SSIs could not manufacture these items. These items ranged from auto parts to brass, fisheries to agricultural items. Since 1997, each Budget has removed dozens of items 3

from this list — by now the list is down to 373, mostly agri-items, and the 2007-08 Budget is expected to remove some more. “The de-reservation policy has been responsible for many of us closing our shops,” says Amit Agarwal, president of the Indian Industries Association’s (IIA) Ghaziabad chapter, adding that the withdrawal of State protection and support has been worsened by the coming of Chinese goods into the market. This has forced Indian SSIs to face competition from both Indian and foreign large companies, without having access to reliable credit facilities or basic infrastructure facilities like electricity. “The most important problem we face is lack of electric supply. That is the single most important factor in increasing our production costs,” says Sri Prakash, additional secretary of the Lucknow chapter of the IIA. There is also the problem of stringent labour laws, but this has become easier as the MSMED Act allows state governments to relax labour laws for enterprises with 50 or less employees. Other infrastructure problems that continue to plague SSIs include transport, market information, water, telecom, technology upgradation and quality certification. Small industries are often run alone by an entrepreneur or a family and a lot of their quality entrepreneurial time is compromised in obtaining government clearances, especially environmental ones, and abiding by the complicated tax procedures. The tax procedures may become simpler as the Centre has indicated doing away with exemptions in the 2007-08 Budget, but that only adds to the woes of the small industry. Sunil Vaish, chairman of the Kanpur chapter of the IIA, says that not only have SSIs been long demanding simplification of the taxation and exemption procedures, but also the raising of the excise exemption limit from Rs 1 crore-Rs 3 crore. “The last time this was raised was in 2001 and in five years our costs have doubled,” says Prakash. The SSI sector’s main woe remains credit. The growth rate of the SSI sector has been declining since 1989-90 and its recession seems to have been over by 2001, but during this period the number of sick SSI units also piled up. The new growth is coming from the larger SSIs who have survived this recession, and they are the darlings of the banks now. According to the third all-India census of small-scale industries, the total worth of about 98 percent of SSIs was less than Rs 10 lakh, including the cost of plant and machinery. This means that new policies, particular the emphasis on credit rating, are going to help the 2 percent cream. Several new schemes by banks have emphasized on credit ratings for SSI units so that a criterion can be evolved for lending at different rates as well as reducing the burden of non-performing assets on banks, a large chunk of which comes from sick SSIs. “Credit rating and other financing measures look at balance sheets and small industries have very low marginal profits, so we lose out on this count,” says IIA’s Vaish. The MSMED Act talks of the composition of the Micro and Small Enterprises Facilitation Council but a number of such institutions established over the years have

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failed to check recession and sickness in the SSI sector. These institutions include the ministry of small scale industries, the SSI Board, the Small Industries Development Organization, the Small Industries Service Institute, the Product-cum-Process Centres, Regional Training Centres, National Small Industries Corporation etc. Though it adds another such institution and promises help, the MSMED Act does nothing new to alleviate the problems of the small and tiny industries. From SSI to SME: Defining the New Paradigm Government policy as well as credit policy has so far concentrated on manufacturing units in the small-scale sector. The lowering of trade barriers across the globe has increased the minimum viable scale of enterprises. The size of the unit and technology employed for firms to be globally competitive is now of a higher order. The definition of small-scale sector needs to be revisited and the policy should consider inclusion of services and trade sectors within its ambit. In keeping with global practice. There is also a need to broaden the current concept of the sector and include the medium enterprises in a composite sector of Small and Medium Enterprises (SMEs). A comprehensive legislation, which would enable the paradigm shift from small-scale industry to small and medium enterprises under consideration of Parliament. The Reserve Bank of India, had meanwhile set up an Internal Group which has recommended: "Current SSI/tiny industries definition may continue. Units with investment in plant and machinery in excess of SSI limit and up to Rs.10 crore may be treated as Medium Enterprises (ME). The definition may be reviewed after enactment of the Small and Medium Enterprises Development Bill. Only SSI financing will be included in Priority Sector." It is proposed to accept the recommendation with regard to the credit facilities being offered by the banking sector and accordingly request the Reserve Bank of India to advise the banks to frame a policy for enhancing the flow of credit to both small and medium enterprises, within the overall framework of credit policy of banks to small and medium enterprises. The challenges being faced by the small and medium scale sector may be briefly set out as followsa. Small and Medium Enterprises (SME), particularly the tiny segment of the small enterprises have inadequate access to finance due to lack of financial information and non-formal business practices. SMEs also lack access to private equity and venture capital and have a very limited access to secondary market instruments. b. SMEs face fragmented markets in respect of their inputs as well as products and are vulnerable to market fluctuations. c. SMEs lack easy access to inter-state and international markets. d. The access of SMEs to technology and product innovations is also limited. There is lack of awareness of global best practices.

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e. SMEs face considerable delays in the settlement of dues/payment of bills by the large scale buyers. With the deregulation of the financial sector, the ability of the banks to service the credit requirements of the SME sector depends on the underlying transaction costs, efficient recovery processes and available security. There is an immediate need for the banking sector to focus on credit and finance requirements of SMEs. Measures to increase the quantum of credit to SMEs at the right price  Public Sector Banks will be advised to follow a transparent rating system with cost of credit being linked to the credit rating of the enterprise.  SIDBI in association with Credit Information Bureau India) Ltd. (CIBIL) will expedite setting up a credit rating agency.  SIDBI in association with Indian Banks’ Association (IBA) would collect and pool common data on risk in each identified cluster and develop an IT-enabled application, appraisal and monitoring system for small (including tiny) enterprises. This would help reduce transaction cost as well as improve credit flow to small (including tiny) enterprises in the clusters.  The National Small Industries Corporation has recently introduced a Credit Rating Scheme for encouraging SSI units to get themselves credit rated by reputed credit rating agencies. Public Sector Banks will be advised to consider these ratings appropriately and as per availability, and structure their rates suitably.  SIDBI has developed a Credit Appraisal & Rating Tool (CART) as well as a Risk Assessment Model (RAM) and a comprehensive rating model for risk assessment of credit proposals for SMEs. Public sector banks will be advised to take advantage of these models as appropriate and reduce their transaction costs. Outreach of Formal Credit: Opening of New Accounts The commercial banks (including regional rural banks) with over 67,000 branches, will make concerted efforts to provide credit cover on an average to at least 5 new tiny, small and medium enterprises at each of their semi urban/urban branches per year Nursing the Sick Units Back to Health: Debt Restructuring Reserve Bank will issue detailed guidelines relating to debt restructuring mechanism so as to ensure restructuring of debt of all eligible small and medium enterprises at terms which are not less favorable than the Corporate Debt Restructuring (CDR) mechanism in the banking sector. The restructuring would follow upon a request to that effect from the borrowing unit. All accounts, except those classified as ‘loss assets’ will be eligible for restructuring, provided the industrial units are viable or potentially viable.

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Based on the Reserve Bank’s guidelines, banks may formulate, with the approval of their Boards of Directors, more liberal policies relating to restructuring of accounts. Until the banks formulate their own policies, Reserve Bank’s guidelines will be operative. A one-time settlement scheme to apply to small-scale NPA accounts in the books of the banks as on March 31, 2004 will be introduced. The scheme will be in force upto March 31, 2006. Facilitative Measures Reserve Bank had issued a detailed master circular on March 2005 on the time to be taken for disposing of loan applications of SSI units, the limit up to which banks are obliged to grant collateral-free and composite loans, norms for computation of working capital credit limits to SSI units, opening of atleast one specialized SSI branch in each district, etc. Taking these guidelines as indicative minimum, banks will formulate a comprehensive and more liberal policy relating to advances to SME sector. Until the banks formulate such a policy, the extant instructions of Reserve Bank will be applicable to advances granted or to be granted by banks to SME units. Credit Guarantee Fund Trust Scheme for Small Industries(CGTSI) At present, Member Lending Institutions (MLIs), like banks, are provided guarantee cover of 75% of the amount of default by CGTSI,I respect of term loan and/or working capital facilities up to Rs.25 lakh extended by the MLIs to new and existing SSI units/IT/software units/small scale service business enterprises (SSSBEs), without collateral security and/or third party guarantee. One-time guarantee fee of 2.5% and annual service fee of 0.75% of the credit facility sanctioned are currently charged by CGTSI from the MLIs. In order to reduce the cost of guarantee to the weaker segments of the borrowers, particularly tiny units, the CGTSI will be advised to reduce the one-time guarantee fee from 2.5% to 1.5% for all (i) loans up to Rs.2 lakh, (ii) eligible women entrepreneurs, and (iii) eligible borrowers located in the North Eastern regions (Sikkim) and Jammu & Kashmir. Further, public sector banks will be encouraged to absorb the annual service fee in excess of 0.25% in respect of guarantee for all (i) loans up to Rs.2 lakh, (ii)eligible women entrepreneurs, and (iii) eligible borrowers located in the North Eastern regions(Sikkim) and Jammu & Kashmir. Cluster based approach Cluster based approach for financing SME sector offers possibilities of reduction of transaction costs and mitigation of risk. About 388 clusters have already been identified. Cluster based approach now be treated as a thrust area. Banks will increasingly adopt the cluster-based approach for SME financing. To broaden the financing options for infrastructure development in clusters through public private partnership, SIDBI will formulate a scheme in consultation with the stakeholders.

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SIDBI has already initiated the process of establishing Small Enterprises Financial Centres in select clusters. Risk profile of each cluster would be studied by a professional credit rating agency and such risk profile reports would be made available to commercial banks. Each lead bank of a district will consider adoption of at least one cluster Setting up of Watchdogs: Monitoring and Review The following supervisory arrangements will be ensured: a. The existing institutional arrangements for review of credit to SSI sector like the Standing Advisory Committee in Reserve Bank of India and cells at the banks’ head office level as well as at important regional centres will be made more rigorous and regular. They will also review the flow of credit to small (SSI) and medium enterprises. b. At the Regional offices, the Reserve Bank will constitute empowered committees with the Regional Director of the Reserve Bank as the Chairman to review the progress in SME financing and rehabilitation of sick small (SSI) and medium units and to coordinate with other banks/financial institutions and the state governments in removing bottlenecks, if any, to ensure smooth flow of credit to the sector. The said Regional level committees may decide on the need to have similar committees at cluster/district levels. c. The banks will ensure specialized SME branches in identified clusters/centres with preponderance of small enterprises to enable the entrepreneurs to have easy access to the bank credit and to equip bank personnel to develop requisite expertise. The existing specialised SSI branches may be also be redesignated as SME branches. d. Boards of banks will be advised to review the progress in achieving the self-set targets as also rehabilitation and restructuring of SME accounts on a quarterly basis to ensure that the required emphasis is given to this sector. e. For wider dissemination and easy accessibility, the policy guidelines formulated by Boards of banks as well as instructions/guidelines issued by Reserve Bank will be displayed on the respective websites of Public Sector Banks as well as website of SIDBI. The banks would also be advised to prominently display all the facilities/schemes offered by them to the small entrepreneurs at each of their branches. SMALL AND MEDIUM ENTERPRISES (SMEs) IN INDIA SMEs IN INDIA

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With the advent of planned economy from 1951 and the subsequent industrial policy followed by Government of India, both planners and Government earmarked a special role for small-scale industries and medium scale industries in the Indian economy. Due protection was accorded to both sectors, and particularly for small scale industries from 1951 to 1991, till the nation adopted a policy of liberalization and globalization. Certain products were reserved for small-scale units for a long time, though this list of products is decreasing due to change in industrial policies and climate. SMEs always represented the model of socio-economic policies of Government of India which emphasized judicious use of foreign exchange for import of capital goods and inputs; labour intensive mode of production; employment generation; non concentration of diffusion of economic power in the hands of few (as in the case of big houses); discouraging monopolistic practices of production and marketing; and finally effective contribution to foreign exchange earning of the nation with low importintensive operations. It was also coupled with the policy of de-concentration of industrial activities in few geographical centers. It can be observed that by and large, SMEs in India met the expectations of the Government in this respect. SMEs developed in a manner, which made it possible for them to achieve the following objectives: · High contribution to domestic production · Significant export earnings · Low investment requirements · Operational flexibility · Location wise mobility · Low intensive imports · Capacities to develop appropriate indigenous technology · Import substitution · Contribution towards defense production · Technology – oriented industries · Competitiveness in domestic and export markets At the same time one has to understand the limitations of SMEs, which are: · Low Capital base · Concentration of functions in one / two persons · Inadequate exposure to international environment · Inability to face impact of WTO regime · Inadequate contribution towards R & D · Lack of professionalism In spite of these limitations, the SMEs have made significant contribution towards technological development and exports. SMEs have been established in almost all-major sectors in the Indian industry such as: · Food Processing

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· Agricultural Inputs · Chemicals & Pharmaceuticals · Engineering; Electricals; Electronics · Electro-medical equipment · Textiles and Garments · Leather and leather goods · Meat products · Bio-engineering · Sports goods · Plastics products · Computer Software, etc. As a result of globalization and liberalization, coupled with WTO regime, Indian SMEs have been passing through a transitional period. With slowing down of economy in India and abroad, particularly USA and European Union and enhanced competition from China and a few low cost centers of production from abroad many units have been facing a tough time. Those SMEs who have strong technological base, international business outlook, competitive spirit and willingness to restructure themselves shall withstand the present challenges and come out with shining colors to make their own contribution to the Indian economy. Problems facing the SSI sector The SSI sector confronts several problems despite its strategic importance in any industrialization strategy and its immense potential for employment generation. The problem which continues to be a big hurdle for the development of the sector is lack of access to timely and adequate credit. The Abid Hussain Committee on SSIs (1997) examined the problems of the SSI sector and recommended a package of policies to restructure the industry in the context of current global economic changes. The Expert Committee was of the view that the existing institutional structure for delivering credit to SSEs needs a thorough overhaul. It endorsed the recommendations of the Nayak Committee and urged the RBI to implement the same. The Committee recommended restructuring of financial support through SFCs and SIDCs, tapping of other sources of funding for SSEs, extending credit rating services to small units, and addressing the credit needs of tiny units to ensure that they are not bypassed by the commercial banking system. The overall credit availability for SSIs during 1991-1996 amounts to only 13% of the value of production (AIMA figures). The Nayak Committee had recommended a desirable norm of 20% of the value of production to be made available by way of working capital through term-lending institutions and commercial banks A norm of 75% was set for fixed capital assets whereas actual availability is only 55%. Lack of finance has been one of the major causes of sickness in the SSI sector, blocking access to technological modernization and other

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growth possibilities. There is an urgent need to enlarge flow of credit to the SSI sector from institutional sources. The creation of a facilitating environment for SSIs will centre on access to credit. The Ninth Five Year Plan (1997-2002) estimates additional working capital funds at Rs. 1420 to 1460 billion for the small sector. Lowering interest-rates, specifying a time-frame to clear loan applications and adherence to norms set down by the Nayak Committee are some of the minimum measures that need to be taken. Legislative measures have a role to play with regard to funding and financing of small scale units. There are measures which can basically ensure that impediments to credit availability are removed. (Gopal Choudary). These measures include: ⇒ Right to reasonable credit from commercial banks as per RBI guidelines framed after consultation with representative Board. ⇒ Protection against non-normative demands for security. ⇒ Appeal and enforcement by Ombudsman/Board. ⇒ Access to public funds by way of debentures, deposits, securities. ⇒ Government guarantee for loans from banks. The measures to support Marketing and Competitiveness are as follows: ⇒ State to exempt from contract security. ⇒ Prompt return of contract securities in case of others. ⇒ Prompt payment measures. ⇒ Protection against undue bundling of contracts by the state. ⇒ Protection against restrictive and monopolistic trade practices. ⇒ Ombudsman/arbitral services for enforcement.

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Impact of WTO The emerging challenges to the small-scale sector are to come from the impact of the Agreements under WTO to which India is a signatory along with 134 member countries. The setting up of the WTO in 1995 has altered the framework of international trade towards non-distortive, market-oriented policies. This is in keeping with the policy shift that occurred worldwide since the early 1980s in favour of free market forces and a tilt away from State regulation/intervention in economic activity. This is expected to lead to an expansion in the volume of international trade and changes in the pattern of commodity flows. The main outcomes of WTO-stipulated requirements will be brought about through reduction in export subsidies, greater market access, removal of non-tariff barriers and reduction in tariffs. There will also be tighter patent laws through regulation of intellectual property rights under the TRIPS Agreement which lays down what is to be patented (both products and processes), for what duration (20 years instead of the present 7 years under India's 1970 Patent Law), and on what terms. The responses by trading countries and the reframing of domestic economic policies which will result from the impact of WTO and the repercussions on the global economy of all these changes are highly uncertain as they involve several unforeseeable factors. However, there are certain indications of the shape of future trade patterns. Increased market access to imports (of around 3% of domestic production to be raised to 5%) will mean opening up the domestic market to large flows of imports. The removal of quantitative restrictions (QRs) on imports has been speeded up to 2001. At present 714 items are in the restricted category but imports of these items will soon be freed from all restrictions as announced in the recent EXIM policy. Increased market access under WTO requirements will also mean that our industries can compete for export markets in both developed and developing countries. But the expected surge in our exports can come about only if the SSI sector is restructured to meet the demands of global competitiveness which is the key to the future of small industries in the present context. Conclusion To conclude, we would like to say that the semi sector is of utmost important for any country as for an overall development of the economy requires that not only the large scale sector but also the small scale industries and medium enterprises Especially for a developing country like India where in 70% of the population relies on agricultural products and other products produce by semi scale industries and hence RBI has to make special provision for the development of semi scale industries.

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