Nirmala Sitharaman’s Budget 2020 must make MSME lending a core business activity of banks

The Union Budget 2020 should focus on creating a coherent and viable policy framework for lending to MSMEs, including making it a core business activity for banks.

File photo | Union Defence Minister Nirmala Sitharaman speaks in the Rajya Sabha during the ongoing Winter Session of Parliament | RSTV | PTI Photo

The International Monetary Fund has just cut India’s growth forecast for financial year 2020 to 4.8 per cent. That isn’t good news for a country that is seeing an economic slide and manufacturing slowdown. Nirmala Sitharaman’s Budget 2020 must provide measures to rekindle the animal spirits in the MSME sector.

While the MSME sector – micro, small and medium enterprises – has made notable contributions to labour–intensive employment and exports, issues with regard to limited availability and usage of formal credit have gone unaddressed. The Narendra Modi government has been trying to revitalise the sector with interventions such as the 59-minute loans and other technological and cash flow support programmes. The aim has been to incentivise formalisation and ease access to institutional credit.

Issues in financing the MSME sector

Formal credit channels such as banks and non-banking financial companies (NBFCs) must play a greater role in financing this sector. As per the RBI’s data released in 2019, MSME credit is only a small proportion of the total outstanding bank credit. Large industries’ share of total credit was highest at 27.84 per cent, followed by the micro and small enterprises at 4.34 per cent. The medium enterprises accounted for the lowest share at 1.23 per cent.

The latest MSME Pulse Report, by Transunion CIBIL and SIDBI, has further noted that credit growth to the sector has been declining. The report also notes that the overall NPA (non-performing asset) rate of lending to this sector rose from 11.7 per cent in September 2018 to 12.2 per cent in September 2019.

Public Sector Banks (PSBs), which are the largest lender to the sector, focus 60 per cent of such lending at the micro-segment. Such lending is spurred by Priority Sector Lending (PSL) norms and government schemes such as the Pradhan Mantri MUDRA Yojana. Under PSL guidelines, banks are required to allocate a percentage of their credit to priority sectors, including 7 per cent for micro-enterprises. Such target setting is rigid because it does not allow banks to innovate with lending strategies and exercise due diligence before lending. Onerous responsibilities to meet lending targets lead to fast and irregular loan disbursals, leaving greater room for such loans to spiral into NPAs.

Target-setting approach could result in potential NPA creation along the lines witnessed in the case of Kisan Credit Cards, a similar collateral-free initiative for the agriculture sector, driven by the PSBs.

MSMEs in Budget 2020

The Economic Survey 2019 had noted how the existence of ‘dwarf’ firms needs to be contained, especially when it is clear that perverse incentives to remain small (and informal) firms are embedded within the system.

In the context of the upcoming Budget, we discuss what the government could do to enable this sector formalise more, such that the benefits of formalisation outweigh the costs.

An MSME census has been long overdue. An Expert Committee on MSMEs, in June 2019, noted that the fourth and the last MSME census was conducted way back in 2006-2007. The upcoming Budget may plan and initiate this exercise because details are currently scattered across data sets, such as the Udyog Aadhaar Memorandum, the MSME Databank and the Goods and Services Tax Network (GSTN). While the first two contain unverified and voluntary information, the GSTN only captures details of those firms that have a higher turnover of Rs 40 lakhs and more. It is imperative that policy measures be undertaken on the basis of recent and reliable information available with these establishments.

The Modi government needs to pre-empt loans disbursed under the MUDRA scheme from turning into NPAs, which have in fact doubled within the last one year. The government must avoid a target-driven approach in loans disbursal under this scheme. Banks may perform risk profile assessments whereby financial information, historical and projected cash flows of customers are reopened. Recovery feasibility must also be examined. MSME lending needs to transform into a core banking business. The bulk of outstanding bank credit lies with larger corporates, who should ideally borrow from the bond market and not the banks.

Linking platforms

Payment delay is a huge issue for the MSMEs. Large corporate buyers not paying smaller enterprises on time leads to a financial crunch in conducting business. While the Trade Receivables Discounting System (TReDS) platforms that operate today have proven beneficial in enabling access to quick credit from a range of financiers, the usage of this platform is deemed to be low. The government should create awareness of the availability and benefits of such a platform.

Additionally, linking TReDS with GSTN was first announced in Budget 2018, but this has not been operationalised yet. Such linkage would reduce financiers’ fears of fraudulent invoices and generate better credit discipline. Vendors will have to be GST-compliant in order to be eligible for bill discounting via TReDs. This cash flow information database would also aid banks take quick decisions regarding lending to smaller enterprises. Given these multiple benefits, the process of TReDS-GSTN linking must be expedited via this forthcoming Budget.

Role of fintech lenders

Finally, the government should encourage more fintech lenders to permeate the market. Digital finance lending platforms offer unsecured loan products and are found to be much more comfortable with higher risk profiles. They use sophisticated credit assessment tools to determine enterprise potential not just on the basis of historical cash flows and general financial information but also by calculating future potential to scale and be productive. It has been suggested that traditional lending channels such as the PSBs collaborate with fintech lenders to apply the tools that they use to measure credit worthiness of their customers.

The Union Budget 2020 should focus on creating a coherent and viable policy framework for lending to the MSMEs, including making it a core business activity for banks. Policy hindrances in linkages between platforms must be addressed immediately. Utilising the expertise of fintech lenders to address the credit constraints of MSMEs must be actively encouraged.

Radhika Pandey and Amrita Pillai are Fellow and Research Fellow, respectively, at the National Institute of Public Finance and Policy (NIPFP), New Delhi. Views are personal.