By Parnika Jhunjhunwala
A report by financial services firm Resurgent India claims that mergers of small banks may hurt the Micro, Small and Medium Enterprises (MSME) sector as the resultant large lenders will be less keen on smaller sized loans. Given the fact that services of big banks are less personable and associated with a higher fee, big banks are less motivated to lend loans to MSME due to smaller business accounts. The claim is true to some extent.
However, the mergers of small banks might not prove to be entirely harmful. Bank mergers mean more capital, better geographic footprint and improved technology to work with, thus, enhancing efficiency.
The current scenario of MSMEs in India
According to the Prime Minister’s Task Force on MSME in 2010, the MSME sector, called the backbone of the Indian economy contribute 8% to India’s GDP and around 40% of exports. The main obstacle to this sector is a lack of adequate capital and credit along with the inability to access new technology. Other issues include fluctuations in earnings, lack of credit ratings and credit records and the absence of collateral.
To channelise credit flow to the MSME sector, the RBI has mandated bank targets for lending to the MSMEs as part of the Priority Sector Lending Norms. The government has also established the Small Industries Development Bank of India (SIDBI) to finance the MSME sector. To tackle the problem of lack of collateral, it has set up the Credit Guarantee Fund Trust Scheme for Micro and Small Industries (CGTMSE) which offers credit guarantee of 75% of the loan amount to the lending institutions.
Moreover, the SIDBI in collaboration with various public and private sector banks has launched the SME (Small and Medium Enterprise) Rating Agency which assesses the overall condition of the SME before issuing loans.
However, a study by Indian School of Business(ISB) reveals that only 25% of the funding for MSMEs comes from banks and FIs. This calls upon the need for strengthening the existing system and establishing alternative methods of raising finance.
Implications of merger
The merger of small banks can lead to diversification. Given that small banks lack adequate capital, merging with other banks will allow them to pool resources and dedicate an entire section which handles management of MSME loans alone. The techniques of specialisation and diversification are bound to enhance efficiency.
A stellar example of diversification is Gruh Finance, that provides loans for affordable housing. It is a subsidiary of blue-chip housing finance company, HDFC. Gruh has its own 23 pointer loan assessment system which requires working with the individuals and figuring out their income patterns and ability to pay. This model of assessing the credit worthiness of prospective borrowers can be studied and adapted in the MSME sector as well.
Merging of banks thus might actually be helpful. If that is not the case then a dozen other alternatives can be figured out too.
Alternative methods of raising finance
Last September, the RBI approved 10 Small Finance Banks to be set up to expand access of financial services in rural and semi-urban areas. These institutions will lend 75% of their deposits to the borrowers who qualify as Priority sectors (which includes the MSME sector) as defined by the RBI. A study by the IFC and McKinsey and Co. suggest that out of the approximately 445 million emerging MSMEs, 78% of them are informal enterprises. Reaching informal businesses will have to be built on micro finance approaches.
The CEO of Cambodia based micro finance institution Amret described how the company moved up from micro loans to SME loans over time. SMEs comprise a small portion of the loans lent by Micro Finance Institutions (MFIs) but they have shown a promising performance. They have helped balance imports and exports, reduce unemployment levels and increase support to micro-activities. The central bank of Cambodia is in favour of such institutions that will increase their lending to SMEs to tap the large SME client base.
Pooling in resources
MFIs can expand their market to include the MSME sector as well. It can also come up with its own credit assessment tool similar to Gruh finance to scrutinise their credit ratings before lending loans.
Another source of finance for MSMEs is equity financing. Venture capitalists provide the right expertise to the MSMEs since they too have a stake in the business. Thus, the enterprise gets a steady capital base along with the expertise and contacts of the capitalists.
The RBI is also pondering upon a “Co-Origination” model wherein both the bank and the MFI or NBFC (Non-Banking Financial Company) will join at both the underwriting and loan level and share the loan amount at an agreed percentage. This proposal will ensure that the MFIs which have a detailed understanding of the ground level and banks will work together to facilitate easy credit. This proposition is a win-win for Banks, MFIs and MSMEs.
Taking all the possibilities into consideration, the merger of small banks might actually force the economy to look into cheaper and more efficient alternatives which boost the growth of the MSME sector.
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