Why are firms not taking credit?

Bornali Bhandari, Samarth Gupta, Ajaya K Sahu, KS Urs

To aid firms and businesses during the Coronavirus (SARS-Cov-2) pandemic and the associated lockdowns, monetary and fiscal policies have focused on infusing capital to ailing firms.  Several measures have been announced which include subsidised rate or special credit facilities, greater repayment flexibility or extended loan tenures.  As the second wave grips the country, and local lockdowns are imposed, the Reserve Bank of India has already announced special measures on the credit front.  However, are firms taking credit? The NCAER quarterly Business Expectation Surveys (N-BES) of firms covering six cities covering four regions reveal low propensity for credit uptake by firms. 

The share of firms taking credit had steadily fallen from pre-March 2020 to Q4: 2020-21. Barely 16% of responding firms took credit during Apr-Dec 2020.  It went down to 4% during January-March 2021.  There was a marginal uptick in planning to take credit (6% firms) in H1: 2021-22. However, the share of large firms (annual turnover greater than Rs 100 crore) taking credit fell at a faster pace in 2020 compared to small firms. Similarly plans to take credit in H1: 2021-22 rose at a slower pace for larger firms compared to small ones (Figure 1).

Low credit uptake indicates that the credit disbursal policy has worked in a limited fashion. This then raises an important question—why are firms not taking credit? In this article, we use the 116^th round of N-BES conducted in March 2021 where we sought responses by firms on reasons for not taking credit. Our responses can be categorized into three factors—demand-based or no preference, cost-based, and contractual. 

Demand-based Factors

Credit uptake may remain low if firms do not require credit. For example, they may have internal sources of credit or demand for factor inputs may remain low due to low demand for final goods. Figure 2 shows the proportion of firms for these responses across various size categories. We see a clear dichotomy between small and large firms. Large firms claim to have adequate capital. Small sized firms, however, remain constrained by the demand for final goods—as they do not receive new orders, and their demand for all inputs, including credit, is likely to remain low. 

Cost-based Factors

Cost of obtaining credit is the interest one has to pay over the loan duration or, in some cases, the collateral one has to offer to obtain capital. As figure 2 shows, we again find that small firms are more likely to find interest rates too high. Collateral requirements as a reason for not taking loan is less likely to be a binding reasons. For example only about 10% firms with annual turnover less than Rs 1 crore claimed high collateral requirement to be a problem.

Contractual/Procedural Factors

Non-monetary factors could also pose as barriers in credit uptake. For example, firms have to prove creditworthiness which may require lengthy paperwork. Alternatively, contract terms, such as a short repayment term, may be prohibitive. About 11% of small firms reported this to be a problem. This proportion falls for firms with higher annual turnover.  Such a pattern is consistent with inability of smaller firms to convince lenders of their repayment abilities. 

Implications

Our findings have several implications for policymakers.

1. Credit policies on their own provided limited support to small firms during the pandemic years.  They need to be complemented by other policies.
2. Both small and large sized firms are unwilling to take credit, but for different reasons. Small sized firms are demand constrained while large firms already have adequate capital. The problem for small firms would have worsened in the Q1: 2021-22 as more States imposed lockdowns. In such an environment, opening new demand venues for firms through e-commerce may be a more suitable policy option. The N-BES Round 116 showed that 32.2% of firms had used e-Commerce at one point or another in 2020-21 to sell goods & services. In contrast only 9.2% of firms had taken only loans and 9.7% had used e-Commerce & taken loans. Further, only 15% of firms had taken loans for new investment during 2020-21. Thus, large firms may be incentivised to invest their surplus capital. This may create a positive loop of high investment and high demand for small firms, as well.
3. How can small firms improve creditworthiness? This appears to be a classic market failure problem where absence of useful signals may make creditors wary of lending to borrowers. The solution could be in incentivizing small firms to enroll with fintech service providers which can utilize large amounts of information of the borrowers to estimate a measure of repayment.
4. Interest rates are considered high by small firms (Figure 2). This is puzzling since many schemes provided loans at zero interest rates or a moratorium on new loans. A possible explanation is the lack of awareness among potential beneficiaries of these schemes, which is consistent with our finding that only one in five firms had taken loans under Emergency Credit Line Scheme. Alternatively, firms may have overlooked short run benefits of no moratorium on loans against long term costs of repayment. To what extent policymakers can distort market signals such as interest rates is a debatable subject.
5. Alternative Monetary Transfers: As firms incur cost in credit uptake, there can be scope for other means of monetary transfers. As per the N-BES Round 116 data, 26% of small firms reported finding it very difficult to get their dues on time. Thus, there may be a need to smoother dues to all firms.   Additional measures may include wage support schemes for MSMEs registered in Udhyam portal, releasing input tax credit under GST, reducing customs duty etc. 

Capital availability is crucial during times of distress, such as the current environment. By understanding what keeps credit disbursal low, our analysis can sharpen the effectiveness of credit disbursal policies for the current business disruptions and potential ones such as a third wave.

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Bornali Bhandari is Senior Fellow, NCAER. Samarth Gupta and KS Urs are Associate Fellows, NCAER. AK Sahu is Senior Research Analyst, NCAER. 

Views are personal.