Sme Financing (2007 Format)

SMALL AND MEDIUM ENTERPRISES FINANCING 1

Definition of Micro, Small and Medium Enterprises A micro enterprise is an enterprise where investment in plant and machinery does not exceed Rs. 25 lakh A small enterprise is an enterprise where the investment in plant and machinery is more than Rs. 25 lakh but does not exceed Rs. 5 crore A medium enterprise is an enterprise where the investment in plant and machinery is more than Rs.5 crore but does not exceed Rs.10 crore 2

Indian view of SMEs • Traditionally defined as: • • • •

Small Scale Industries (SSIs) Small Scale Enterprises (traders and services) Small Road Transport Organisation Professionals

• Focus primarily on manufacturing and less on servicing • Concentration on traditional industry textile, engineering, jute, auto ancillary 3

Characteristics of the SMEs •

The growth recorded by SSI in India is 2% more than any other sector

•

The sector accounts for 9% of the country’s GDP

•

The sector employs more than 20 million people (Employment contribution by SMEs in Andhra Pradesh is 7.5%)

•

It has been estimated that a lakh rupees of investment in fixed assets in the small scale sector generates employment for four persons

•

Among the large PSBs, state bank of India’s SMEs exposure grew by 24% in 2008

•

All banks are targeting SMEs credit growth of 25%

•

It has been estimated that a lakh rupees of investment in fixed assets in the small scale sector produces 4.62 lakhs worth of goods or services with an approximate value addition of ten percentage points 4

Characteristics of the SMEs • Public sector banks’ overall credit to SME sector grew by 26% in 2006-2007, which amounted to Rs.1,85,000 cores • Reserve Bank of India has advised all commercial banks to achieve 20% annual growth in SME lending till 2010 • Non-traditional products constitute a massive 95% of the SSI exports • SIDO, SIDBI, NABARD, NSIC, export promotion authorities are actively involved in the development of SMEs in India • 45%-50% of the Indian Exports is being contributed by SSI Sector • Direct exports from the SSI Sector account for nearly 35% of

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Effect of liberalization on sme credit policies • Earmarking of credit for tiny sector within overall lending to small industries • Opening of specialized SSI bank branches • Establishment of National Equity Fund for venture capital support • Technology Development & Modernization Fund through SIDBI • Enhancement of turnover limit for assessing aggregate working capital requirement • Enhancement of limit of composite loan to Rs. 10 lakhs. (Rs 1 million)

Th e Co mpreh ensi ve Poli cy Pac kage an noun ced on 30th August 20 00

• Launch of Credit Guarantee Scheme to cover loans up to Rs. 50 lakhs(Rs 5.0 million) • Launch of Credit Linked Capital Subsidy Scheme to provide for subsidy against loans taken for technology upgradation • Further enhancement of ceiling composite loan limit to Rs. 25 lakhs (Rs 2.5 million) • Enhancement of project cost limit under National Equity Fund to Rs. 50 lakhs (Rs 5 million)

Overview of Indian SME Market • In the last decade SMEs have grown faster than the overall economy • SMEs contribute • 95% of all industry establishments • 40% of domestic exports and industry output • 35% of manufacturing sector

• Industry related contribution has been declining • Dominance of service and trade in line with higher growth registered by service sectors 8

Page 27 table

Traditional Banking • SME in India characterised by: • • • • •

Low capitalisation and limited assets Geographical diversity and high mortality Poor access to capital markets Cash intensity in transactions Lack of credit information

• Poor financial disclosure on account of tax issues • Directed lending based on Central Bank guidelines 10

The Need an d Me thod Theory of funding necessities

Requirements of smes • Loyal and lasting banking relationships • Doorstep banking • Reliable Service Quality • Comfort/ Relationship with bank staff • Proximity to delivery channels • Low delivery cost • Combination of personal and business banking 12

The traditional approach • High asset impairment • 9.5% of the SMEs have been categorised sick • Largely in the manufacturing sector

• Post implementation of the WTO/ GATT norms • Textile, and major SME dominated industry have suffered setbacks • Exports not able to keep up

• Survival has become difficult without high protection

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Sa li en t F eatures of S MEs Turno ve r

Ass ets

• Difficult to benchmark across sectors/ industry • Not a true indicator of capital invested • Difficult to assign broad based risk band • Inconsistency in valuation • Service/ manufacturing risk profiles difficult to benchmark • Within industry specific to capital intensive nature of industry

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Sa li en t F eatures of S MEs No . of em plo yees

• Difficult to compare internationally • Difficult given India’s labour intensive operations • Representative of capital backing business

Net W or th

• Sustainability of business governed by capital deployed

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Areas fina nc ial in stit uti ons w ould evalu at e b ef ore de cidin g whether to grant credi t

Management

Acceptable financial conditions Collateral Value Sound and feasible business and plans Positive outlook of industry Clean litigation records

In dicativ e P ara me ters o f S ME s Debt-equity Ratio- 3:1 Promoter's Contribution- As may be required to arrive at the Debt Equity ratio of 3:1 Margin for Term Loan All backward areas in the State 25% Other areas and Municipal limits of all cities of the state 30%

In dicativ e P ara me ters o f S ME s

Rate of Interest

(table on page 65)

In dicativ e P ara me ters o f S ME s Repayment Working Capital Component Not exceeding 10 years (including moratorium upto 13 years)

Term Loan Component Not exceeding 8 1/2 years (including moratorium of 18 months)

Security: Fixed assets and hypothecations or collateral

PR OBLEMS IN L END ING T O S MES • Prospects: This refers to both the Industry and Firm analysis in terms of growth prospects, financial stability, threat perceptions and the like • Purpose: The need and form of Loan • Payment: The possibility of repayment • Person: The will and ability of a person to repay • Protection: The type of security provided to the lender, its value and ease of liquidation

GOVERN MENT INITIA TIV ES National Equity Fund Scheme (NEF) Direct Credit Schemes Technology Up gradation Fund Scheme for Textile Industries (TUFS) Direct Discounting Scheme - Equipment (DDS-E) Composite Loan Scheme (CLS) Single Window Scheme (SWS) CREDIT GUARANTEE FUND SCHEME FOR SMEs

NSIC SCHEMES: Bill Financing Working Capital Finance Export Development Finance The Equipment Leasing ScheME

Th e C re dit F aci li ties fr om NABAR D Providing refinance to lending institutions in rural areas Bringing about or promoting institutional development and evaluating, monitoring and inspecting the client banks Acts as a coordinator in the operations of rural credit institutions Extends assistance to the government, the Reserve Bank of India and other organizations in matters relating to rural development Offers training and research facilities for banks, cooperatives and organizations working in the field of rural development Helps the state governments in reaching their targets of providing assistance to eligible institutions in agriculture and rural development Acts as regulator for cooperative banks and

MY THS AB OUT SMAL L AND MEDIUM

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SMEs p redomi nan tl y w an t cred it

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Asse ts c ontr ibut e m aj or por ti on o f Ban k SME re lat ed p rof its

l

Despite the focus on lending, deposits generate most SME profits

l

Only speciality lenders can consistently profit from credit alone

l

Banks must focus on deposit generation

l

Small business lending should enhance or support the deposit relationship

l

Cash Management Services a key product requirement 25

Br ick an d Mor tar sup por t m an dat or y for d evelop ing SME busi ness l

Swedbank, Sweden l 40% of SME clients use tele banking l 35% of SME clients net banking

l

Wells Fargo - largest US based lender to SME l Non branch based delivery l Centralised hubs for credit operations, servicing l Delivery outsourced

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The c ause s of sickne ss o f SME indu stri es • Diversion of funds • Dissension among partners • ·Shortage of power • ·Technological obsolescence • ·Overdependence on purchases by Government • ·Lack of awareness of credit facilities available • ·Lack of knowledge about various credit schemes

The c ause s of sickne ss o f SME indu stri es High risk on account of poor financial and marketing management Vulnerability to high market risk and high rate of mortality Non availability of information regarding their performance on regular basis to assess and rate their strength and weaknesses High transaction costs involved in financing SMEs leading to ultimately non remunerative to borrower ass well as lender Poor margin in transactions due to involvement of middlemen

EXISTING GAPS Delivery of finance not linked with delivery of business development Financing institutions do not assume the role of partners to SMEs both in assuming risks and assisting in management and marketing Non- existence of reliable information systems to study the risk pattern and to provide market intelligence to SMEs Non availability of suitable debt and equity instruments to help SMEs to raise fund from the capital market

Advantages of sme financing l

Low risk given the support of the Corporate

l

Historically low NPAs

l

RaROC returns are high despite the declining interest yield curve

l

High risk return ratio

l

Creates cross selling opportunity within the Corporate and the SMEs

l

Exit barriers are high once the product is rolled out

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RE CENT INNO VATIONS • Venture capital funds have been floated to share risk, cost of funding and to provide support on market and management knowhow • Credit guarantee and rating institutions have been floated to support banks to assume risk unhesitatingly in financing SMEs • More appropriate credit instruments have been developed to help SME to have facile credit with less cost and collaterals • Better information systems and training modules have been developed to make SME viable and acceptable

INNO VATiv e stra tigie s to f in an ce sme s • Creating partnership relationship of micro financing institutions with SMEs for risk sharing • Developing equity market and venture capital for SMEs • Evolving credit cards to maintain required liquidity in operation of SMEs • Building kiosks at village centers to disseminates market intelligence and data on technological up gradation and climate • Providing facilities for securitization of debts for improving liquidity of financing • Developing derivative market for price risk

Recent developments Some initiatives have been taken by commercial banks in India to make SME financing less risky. In this special mention is providing rating facility. Besides this, venture capital has been floated to assume higher risk Lending on the merit of the project rather than on the basis of collateral is gradually evolving particularly with the help of venture capital Change in lending strategies: 6. Transaction lending technology 7. Relationship lending technology 8. Mixed technology, i.e. taking risk cover and sharing the risk through marketable products.

CGTMSE One of the major causes for low availability of bank finance to this sector is the high risk perception of the banks in lending to MSEs and consequent insistence on collaterals which are not easily available with these enterprises. The problem is more serious for micro enterprises requiring small loans and the first generation entrepreneurs. The Credit Guarantee Fund Scheme for Micro and Small Enterprises (CGMSE) was launched by the Government of India to make available collateral-free credit to the micro and small enterprise sector. Both the existing and the new enterprises are eligible to be covered under the scheme. The Ministry of Micro, Small and Medium Enterprises and Small Industries Development Bank of India (SIDBI), established a Trust named Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) to implement the Credit Guarantee Fund Scheme for Micro and Small Enterprises. The scheme was formally launched on August 30, 2000 and is operational with effect from 1st January 2000. The corpus of CGTMSE is being contributed by the Government and SIDBI in the ratio of 4:1 respectively and has contributed Rs.1346.54 crore to the corpus of the Trust up to September 30, 2007. Based on the future requirement, the corpus is likely to be raised to Rs.2500 crore.

INNOVATIONS

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CASE S TUD Y

BA NK O F I NDI A: SME P RODUCT SUI TE

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SME

• Customised liability product / solution • Integrated to other product suites • Fee based revenue model • Web based delivery • Customer interface through Call centre • Minimum Branch use

Institutional

• Correspondent banking products • Co-operative Banks • Suite of Settlement banking products

Corporate Linked

• Dealer Finance • Vendor Finance • Equipment Finance

• ATM sharing / remittance products

• Leveraging Corporate relationships

• Liability / Investment Management

• Cross Sell Liability products

• Advisory products • Web based delivery

Standalone

• All units with networth of Rs.0.50 crore upto Rs.50.00 crore • Asset size Rs.5500.00 crore • Diverse & undifferentiated • Shift them on liability platform • Card / web based delivery

E-Finance

• Technology platform for other business • SME Portal • SME business card solution / processing • Settlement Banking operations • Factory processing for trade finance / correspondent banking products

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Liability products Th e k ey driv er f or SME Business Prim ar y product of fering t o be Current A cc ount w ith wrap ar ou nd se r vice s Cust omised of fering base d on relati onsh ips

Ce ntralisa tion of pr ocesses

Client acqu isit io n and ser vi cing

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Wi nd ow to cr os s sel l

Service & Delivery box point lHigh value cash transactions

lLogging

requests

Call centre

Branch

Processes all trade related requests for a city

lInformation

lDrop

Trade finance factory

lHandles

exceptions sells lMonitors accounts lCross

Account/ Relationship manager

Customer

lFor

all transactions except high value cash

ATM

Processes all pure credit related requests

Credit factory

lInformation

lProvide

support backbone for all transaction requests requests lServices RPC/CPC doorstep “Processing centres*” deliveries

lLogging

Internet

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Corporate linked business Clie nt A cquisit io n and Mar ketin g Relat io nsh ip M anage rs t o ide ntify po tential Appr aisal Pre-app roved an d para me terised Deliv er y Ch annel neut ra l an d par tly o ut so ur ced t o channel Monit oring Cre dit F act or y - CO PS Ser vicing Call C entre s, BPO ,

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Dr ive r of S M E as se ts

Other Services •

Power-Pay

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Payroll management • payroll • retirement • employee benefit and PF management

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4th party logistics

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PFS loan and credit products

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Insurance - life and non life

•

Office products

•

Bill payment module 42

Other Services •

Credit cards

•

Forex services

•

Tax computation

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Cash flow analysis

•

Legal advisory

•

Mutual fund advisory

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Personal services - hotel, airlines

•

Software and other equipment

•

Human resources - head hunting services 43

NEED o f the hou r Most of the research studies on financing of SMEs have highlighted the need to link availability of finance to SMEs to the delivery of business development to improve its viability. It is therefore necessary to evolve a model that shall provide for a partnership in between SMEs and banks. The partnership concept takes care of sharing of risk in business proportionate to their respective financial involvement. Moreover, if we extend the partnership concept further, it would also help borrower to get more acceptable rate of interest. In fact, such partnership concept may lead to sharing of earnings instead of charging interest on loan as is prevalent in Islamic sharing of earnings instead of charging interest on loan as is prevalent in Islamic banking which of late is growing in importance due to present rise in oil prices. Moreover, it is necessary to build reliable information on SMEs to help assess market opportunities and risk management There is also an urgent need to develop equity market for SMEs. This may be done by spreading success stories of SMEs in India. It has been the 71 findings of many research studies that SMEs mostly depend upon external capital and this should not be only loans from banks but should be partly equity raised from the market besides the nominal equity held by the promoter. In this the supportive role of mutual funds and venture capitals could be of great help in developing capital market for SMEs. Further, securitization is another area to be developed to take care of nonperforming assets (NPAs) that are blocking regular flow of funds to credit institutions catering to SMEs. It is obvious that in India gradually banks should adopt relationship lending technology and treat transaction lending technology as a complimentary and not a substitute strategy. Along with this risk cover and

LIS T OF KEY F INANC IAL INST ITUTIONS · INDUSTRIAL FINANCE CORPORATION OF INDIA (IFCI) · INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA (ICICI) · INDUSTRIAL DEVELOPMENT BANK OF INDIA (IDBI) · EXPORT-IMPORT BANK OF INDIA (EXIM BANK) · INDUSTRIAL RECONSTRUCTION BANK OF INDIA (IRBI) · SHIPPING CREDIT AND INVESTMENT CORPORATION OF INDIA (SCICI) · INFRASTRUCTURE LEASING AND FINANCIAL SERVICES LTD. (IL&FS) · TECHNOLOGY DEVELOPMENT AND INFORMATION CORPORATION OF INDIA LTD. (TDICI) · RISK CAPITAL AND TECHNOLOGY FINANCE CORPORATION LTD. (RCTFC) · TOURISM FINANCE CORPORATION OF INDIA (TFCI) · NATIONAL BANK FOR AGRICULTURAL AND RURAL DEVELOPMENT (NABARD) · NATIONAL SMALL INDUSTRIES CORPRATION (NSIC) · STATE FINANCIAL CORPORATIONS (SFCs) · STATE INDUSTRIAL DEVELOPMENT CORPORATIONS · STATE INDUSTRIAL INVESTMENT CORPORATIONS (SIICs) · STATE SMALL INDUSTRIES DEVELOPMENT CORPORATIONS (SSIDCs) · SMALL INDUSTRIES DEVELOPMENT BANK OF INDIA (SIDBI) · NATIONAL CO-OPERATIVE DEVELOPMENT CORPORATION (NCDC)

THE TATA C APIT AL P ER SPEC TI VE

Challenges Ahead Lo wer cost of ac

quisit io n of c lients

To c hurn and re tain cre dit w or thy clie nts Main tain high qua lit y po rtfolio Ensur e clie nt and pr od uc t level profit ability Lo wer transact io n c osts

Opt im ise int ere st and f ee based income

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No t qu ite ea sy !!!

Suggestions for Tata capital Retain exist in g clie nts and widen “sh throu gh cr oss sell

are of w alle t”

Pre appr oved se lect io n of c redit expo sures Dynamic po r tf olio t rac king Seg mentati on ba se d o n c ust omer k no wledge Pr oduct of ferin g ba se d o n c ust omer demand Bran ch ne utra l deliv er y A ggressiv e BPO Le verage t ec hno lo gy t o enh ance spr ead s

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Le ad th e S M E Pa ck