Banks’ economic apartheid towards SMEs must end

By Sridhar RamachandranOnce my mathematics teacher told me, “Don’t worry boy that you failed – I will help you out.” He never threw me out of the class. This approach is required today for the small and medium enterprises (SMEs) with less than Rs 500 crore revenue. MSMEs contribution to GDP is around 30 per…

By Sridhar Ramachandran

Once my mathematics teacher told me, “Don’t worry boy that you failed – I will help you out.” He never threw me out of the class. This approach is required today for the small and medium enterprises (SMEs) with less than Rs 500 crore revenue.

MSMEs contribution to GDP is around 30 per cent and they generate over 80 per cent of jobs in India though with a paltry investment size of 20 per cent. The SME sector is facing some sort of economic apartheid from lenders which means “separateness”.

Real issues: At the time of putting up the project, overambitious projections are made to meet the banking norms, underestimate working capital (WC) cycle and all with a view to reduce equity infusion. Subsequently, due to underperformance, they bloat their sales, inventory and debtors to retain the WC facilities as banks and stock markets don’t like losses on books. Short-term funds get used for long term, thereby creating asset-liability mismatch. This goes on for some time until the system gets choked and then mayhem breaks out. All these are internal issues.

Then comes the external disequilibrium. SMEs depend on large companies for their survival. When large ones are hit due to economic slowdown, misgovernance, working capital stretch, etc, SMEs bear the brunt first.

The impact: Traditionally, SMEs depended on the banking system for financing their term loan and WC facilities. Our lending mechanism is always dependent on collaterals of not only the asset financed but also promoters’ personal assets and guarantees rather than the business viability and cash flows. They assumed that they will be able to carry on forever, but as the new norms and regulations come in to play at the time of economic downturn, it becomes impossible to explore alternative means of finance as no banker is willing to cede charge in favour of the new lender even though they may be holding more than 3-4x security cover.

With risk aversion being the new guiding principle of the Indian banking industry, banks have started to reduce WC limits, increase risk premium thereby charging effective interest of over 16 per cent, insist on additional security, etc, when these SMEs are not even generating positive EBITDA. These result in delays in debt service and subsequent fall in credit ratings. Even large public sector banks, once the backbone of economic development and now rightly concerned about non-performing assets, are avoiding lending to companies that are less than investment grade.

A quick analysis of over 1,150 listed companies with a revenue of Rs 50-500 crore during FY15-19 indicates a CAGR of sales revenue at 8.28 per cent while the short-term debt grew at 1.21 per cent. The main reason can be attributed to poor ST credit rating (A3 and below) of over 600 (over 50 per cent) companies whose limits either have been reduced or are facing bankruptcy due to default. There maybe several such stories in the private sector. In a nutshell, all productive assets are languishing and resulting in unemployment.

The main question is, can the government and RBI afford to allow all these SMEs to rot and take the economy down along with them when all actors on the economic stage are equally culpableRs The answer is ‘No’ as it would threaten the lofty economic targets and result in economic apartheid.

Don’t spare ill-intentioned promoters, but identify good businesses and promoters who are affected by external factors and provide oxygen to revive the SMEs.

Unorthodox thinking: It is easy to recite rules and regulations and say, “what can we doRs ” When a crisis strikes, the greatest damage to an economy is often the result of poor management of the crisis rather than the crisis itself. We need unorthodox thinking and find solutions urgently to save the viable SMEs who are not in default but with low credit matrix.

Identify WC drawing power deficit or additional WC funding and insist on the promoters’ equivalent amount of equity or dilute their stake in favour of PE funds within 12 months beyond which time banks should be at liberty to reduce their WC exposure. Until then, existing limits should continue if 1.25x security cover is available for their exposure. This will deleverage balance sheets and improve governance standards.

Review WC margin and reduce margins from 40 per cent to 25 per cent, thereby freeing liquidity wherever possible.

Review the high spread or risk premium charged by banks and make it affordable for survival.

Banks to be encouraged to cede excess security held in favour of new lenders that can help in derisking the exposure.

RBI can tweak necessary guidelines and take additional steps that would surely attract many buyout and turnaround domestic and foreign funds.

Author and CIO of IndiaNivesh Renaissance Fund (Views are personal)

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of

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