The Micro, Small and Medium Enterprises (MSME) are a significant contributor to the equitable growth of the Indian economy. Several reports and studies available in public domain estimate that the MSME sector contributes nearly 8 percent of the country’s GDP and about 40 percent of India’s exports*. Moreover, such reports state that this sector generates the largest share of employment after agriculture with an estimated 48 million units including a phenomenal range of products and services. Importantly, a KPMG report – The New Wave Indian MSME estimates a considerable increase in the MSME contribution to India’s GDP, increasing up to around 15 per cent by 2020.
Despite this extensive contribution, several issues and hurdles sail this sector including limited access to funds / debt, high entry barriers for technology, competition for skills and branding etc. As a result, despite steady encouragement from the government in terms of financial and policy support, limited availability of timely and adequate funds at reasonable cost remains a challenge for the MSME sector..
Apart from this, cost of credit (both interest rates for non-collateral as well as collateral backed loans) is often very high and at times prohibitive. Traditionally, the finance providers have viewed the MSME sector with scepticism on account of typically low capitalization, paucity of financial and accounting records, lack of sufficient collateral, relatively higher risk perception of such businesses etc.
Available research studies on MSME sector financing reveal that demand for funds by the MSME sector, which is estimated at INR 32.5 trillion ($650 billion), is met by either formal or informal sources. Moreover, the financing is sourced from self-finance, informal sources and from the formal financing sector. It is interesting that informal sources and self-finance together make up most of the finance channelled into the sector at an estimated 78% of the total fund demand as stated above.
Among the formal sector, providers of Finances to MSMEs include Banks, governmental institutions, financial Institutions; NBFCs and even Micro Credit Lenders. The suite of financial products usually made available to MSMEs is summarized below.
Types of Key Fund-Based Products offered to the MSME Sector:
Based on Hypothecation of stocks/receivables with Additional Security (optional) – and / or Immovable property, allowing typical Loan to Asset Value of 50-60% with tenure of one year, renewable thereafter.
Secured by Mortgage land, building, factory, residence allowing upto 80% Loan to asset value with a tenure ranging from 1-15 years.
Secured by contracts, accounts receivable, invoice, letter of credit, inventory, machinery, equipment. Allowing Loan to Asset Value of up to 90% with a tenure of 1-7 years.
Revolving Credit based on Third-party Guarantee, hypothecation of stock receivables allowing maximum limit of 10 Lakhs allowing a tenure of up to 3 years;
Some Non-Fund Based Products Offered to MSME Sector by Banks and NBFCs include:
Letter of Credit is beneficial to export-oriented MSME units; Importers make use of products like ‘Buyer’s Credit’. Credit is available for procuring raw material, manufacturing the goods, packaging and shipping the goods.
Bank Guarantees are extended for making advance payment, giving tender money, security deposit, etc.
As is evident, there seem to be varied products available for MSME financing in the formal segment. Despite this, there is almost always a struggle by MSMEs to access funds as and when required. The imperative for a MSME owner has always been to actually get working capital or capital investment funds, at the right time and cost, despite the various constraints such firms have to work with. Hence, there is a need to move beyond the “abundant finance available for MSME” marketing rhetoric and understand what innovative yet customer centric and transparent financing structures are realistically available to facilitate funding for MSME firms, when it is required:
Many a times, MSME owners seek recourse to a home loan for funding a property acquisition. There is an innovative structure, whereby top-up funds could be sought at home loan rates by leveraging the mortgaged property and by clubbing an existing home loan of the owner along with the value of any other property which may be part of the Owners portfolio (such as an industrial or commercial property). For example, assume that a MSME owner Mr. A, has a residential property valued at 2 crores on which he has already a running home loan of 50 Lakhs. Now, he also has an industrial property say, valued at 4 crores, there are financing structures possible whereby, a loan top-up could be designed, whereby value of both these properties could be clubbed, allowing Mr. A to avail a much higher loan at competitive home loan rates. In this example, this would mean that Mr. A can achieve a combined value of 6 Crores, on which given standard LTV norms, of say average around 70%, would translate into a loan of up to 4 crores at prevailing home loan top up rates, which are presently ranging between 8.75%-9.0%^. These are comparatively cheaper than existing Loan Against Property (LAP) rates which may be ranging between 8.95%-10.50%.
Traditionally, MSMEs have had relationships with nationalised banks, which have had constraints in providing foreign currency lending. Though most such businesses have had the option of raising LIBOR based funding through banks that have foreign exchange positions, typically nationalized banks have limits for such funding. In the larger lending market however, the availability of such funds varies not only dynamically over time, but also from bank to bank, depending on respective foreign exchange positions. Moreover, there are many private sector banks, which are increasingly looking at providing Libor based funding. In order to tap into this source, it is imperative that MSMEs connect with intermediaries / arrangers who are in sync with the market, are hence are able to quickly identify lending banks to ensure relatively economical limits accessible to such firms.
It is a common grievance of the MSME sector that given their size and resources, many a times they are not able to secure adequate levels of credit rating. This translates into a funding hurdle as banks and financial institutions are cautious of MSME’s typical risks, high transaction deal costs and limited collateral. Hence, even though credit ratings are mandatory for loans beyond a particular limit when it comes to PSU banks, there could be options to source loans from other private sector banks where the credit rating requirements may not be as stringent.
Calculation of working capital gap on a monthly / quarterly basis and correspondingly arriving at Cash credit value is a formidable task. Usually, Cash credit limits require monthly or quarterly submission of stock statements which create hurdles for most MSMEs. In some cases these limits can be converted into overdrafts that are annually renewable or even Drop line overdrafts with tenure of sometimes as much as 15 years. Hence, this innovative way of converting MSMEs Cash Credit limits into an annually renewable overdraft, allows a MSME owner, to provide supporting documents of working capital gap, only once a year instead of providing monthly or quarterly statements of the same. Moreover, whilst the limits on Drop line overdrafts reduces every year, there are structures whereby further top ups could be made every two years to ensure continued liquidity.
Typically, working capital gap calculations done by some banks can be quite rigorous and formidable for applicants. However, there are ways of calculating such limits by surrogate methods which could help optimise the basis of the MSME’s fund requirements. For instance, most MSMEs may consider a straight approach for calculating loan amount, based on previous financial year’s net profit of the firm. However, there are several funding product programmes available with some banks, which evaluate eligibility based on other parameters such as strengths of MSME’s profile, repayment track record, strength of bank statements, future order books position, projection of future cash flows and receivables etc. Such eligibility calculations are broad based and hence, more favourable of evaluating MSMEs on their overall capability rather than just one figure dependent of previous few years profitability.
Being an MSME Business Owner is as much about entrepreneurship as it is about adopting innovations in marketing, management, finance, human resources and operations among others. It is quite evident from the innovative financing structures detailed above that there are several routes to securing the funding that is desired by MSMEs to meet their business and growth objectives. It only requires MSMEs to connect with trusted and experienced financial advisors, who are in sync with dynamic funding options and who can provide the solutions they require at the time when it’s needed.
Various Reports available on Internet on MSME, Including KMPG – The New Wave Indian MSME, Nimsme MSME at a GLANCE2016, CII Report on Energising MSMEs etc. among others
^ Interest rates mentioned are indicative and subject to change
MyMoneyMantra has a specialized MSME business vertical, which has over a decade arranged for funds for numerous MSME clients by innovative structures. We would be glad to assist MSME businesses in their financing quest.
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