Why it makes sense for banks to lend to MSMEs

‘In times of recovery, we may see a rural-urban divide with the urban pockets affected more by COVID-19, but the MFI business model should encourage banks to handhold them in this hour of crisis,’ notes Tamal Bandyopadhyay.

Everyone and her aunt is concerned about the impact of COVID-19 on micro, small and medium enterprises (MSMEs) — the second-biggest employer in the country with a 31 per cent share in India’s GDP.

Section 7 of the Micro, Small and Medium Enterprises Development Act, 2006 specifies the size of the MSMEs on the basis of investment.

Among manufacturing units, micro enterprises are those that have invested up to Rs 25 lakh in plant and machinery.

The comparable figure for small units is Rs 25 lakh to Rs 5 crore and for medium units, Rs 5 crore to Rs 10 crore.

For services, the investment thresholds are lower — up to Rs 10 lakh, Rs 10 lakh to Rs 2 crore and Rs 2 crore to Rs 5 crore.

Unlike big industries, the MSME’s resilience during the current crisis is lower; many of them are probably eating into their capital to stay afloat.

While everyone was expecting a relief package from the government for the sector, the Reserve Bank of India asked banks to offer a three-month moratorium on loan repayments by such units besides opening a window from where banks can borrow money and lend to the sector.

Banks are afraid of loans given to these units turning bad.

The latest study of TransUnion CIBIL Ltd, a credit information company, should give the banks some food for thought.

Based on available information, exposure to the banks and past payment history, the study has found that 74 per cent of the close to 8.9 million units are creditworthy.

Their exposure to the financial system in December 2019 was Rs 11.04 trillion.

Of these, the share of very small businesses (up to Rs 10 lakh exposure) is Rs 54,000 crore.

In December, the pie of commercial credit (excluding agriculture and retail) was a little over Rs 64 trillion.

Of this, the share of MSMEs (up to Rs 50 crore exposure) was Rs 17.94 trillion, a little less than 28 per cent.

The maximum loans were in the Rs 1 crore to Rs 15 crore basket (Rs 8.74 trillion), followed by Rs 15 crore to Rs 50 crore (Rs 4.68 trillion).

The corpus of less than Rs 10 lakh loans was the smallest — Rs 93,000 crore.

Loans to the MSME segment had grown 4.7 per cent between December 2018 and December 2019.

Indeed, the bad loans in the segment have been on the rise over the past few years and reached 12.6 per cent in December 2019.

The TransUnion study has kept the Rs 2.32 trillion MSME exposure of banks in the highest risk bracket (of this, the micro units’s share is just about Rs 13,600 crore) but there are millions of creditworthy borrowers outside this.

The banks must grab this opportunity with both hands to fuel growth in the economy as well as their loan books.

Maharashtra has the maximum share of MSME credit, 17.36 per cent; followed by Tamil Nadu (10.77 per cent), Gujarat (8.85 per cent), Delhi (7.13 per cent) and Uttar Pradesh (6.5 per cent).

At the bottom of the pyramid

While the banking system is the main source of money for the MSME segment, microfinance institutions (MFIs) meet the credit needs of retail borrowers at the so-called bottom of the pyramid.

They are not suffering from risk aversion but most of them do not have the money to lend.

Initially, the banks were reluctant to offer moratorium to the MFIs and non-banking financial companies (NBFCs), many of which are in the business of micro loans, on their repayment of loans to the banks.

They had felt that it was meant for the loans given for productive purposes and not to financial intermediaries.

Now, most banks are offering the moratorium to MFIs too, but two government agencies, the Small Industries Development Bank of India and Micro Units Development and Refinance Agency Ltd are not that liberal.

Between them, they have around Rs 3,000 crore of exposure to the MFIs.

Going by Equifax Credit Information Services data, as of February 2020, the portfolio of micro loans was close to Rs 2.24 trillion.

This includes exposure of private banks and eight of the 10 small finance banks as well.

The exposure of pure play MFIs, NBFCs and NBFC-MFIs is around Rs 94,000 crore.

Overall, the number of loans are over 102 million.

There is not much stress in such loans.

Less than 1 per cent of the loans are not being serviced for 90 days and less than 2 per cent for 30 days.

A loan turns bad when it is not repaid for 90 days.

There are five large NBFC-MFIs with at least Rs 5,000 crore loan books; around 16 of them have a loan book of over Rs 1,000 crore and 37, more than Rs 100 crore; 86 of them are really small, with less than Rs 100 crore loan portfolios.

Overall, these entities and the small finance banks and private banks have over 56 million customers in this segment.

The median loan amount is around Rs 25,000.

Tamil Nadu has the largest share of micro loans (Rs 31,522 crore), followed closely by West Bengal (Rs 31,060 crore).

Three other states among the top five are Bihar, Karnataka and Maharashtra.

The NBFCs and MFIs borrow primarily from banks and on-lend to their customers.

If the banks close the tap, they cannot survive.

The banks should not do that as the micro borrowers’ business model is very different from even MSMEs.

For instance, the cash flow of a vegetable vendor and a tailor starts from day one.

The turnaround time is fast and they can start repaying loans the moment they get back to their businesses.

Which is why most of them can be given fresh loans.

In April, more than 70 per cent of the micro borrowers were not planning to avail of the moratorium facility but in May, this figure has come down to 20 per cent.

Either they have used up the cash they had or want to conserve cash in times of uncertainty.

Typically, micro loan instalments are paid once in a fortnight.

Of the total micro loan portfolio, about 50 per cent exposure is in semi-urban pockets, 40 per cent in rural and 10 per cent in urban India.

In times of recovery, we may see a rural-urban divide with the urban pockets affected more by COVID-19, but the MFI business model should encourage banks to handhold them in this hour of crisis.

Tamal Bandyopadhyay, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd.

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