A PROJECT REPORTON

“EMERGING SMEs AND ITS FUTURE PROSPECTS”

Dissertation Submitted to the Padmashree Dr. D.Y. Patil University

In partial fulfillment of the requirements for the award of the Degree ofMASTERS IN BUSINESS ADMINISTRATION

Submitted by:SMRUTI PARAB

(FINANCE)

Department of Business ManagementPadmashree Dr. D.Y. Patil University

CBD Belapur, Navi Mumbai

2013-2015

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Acknowledgement

In my endeavor to learn the Emerging SMEs and its future prospects, I would like to thank Bank of Baroda for providing me an opportunity to work with their Regional Office (MMER) at Bhandup, Mumbai. It would have been a difficult task to give shape to the project without the guidance, and encouragement of certain very important people. I hereby, take this opportunity to thank my project guide Mr. Rohit Gupta, Manager (Credit) who has always been there to provide me with necessary inputs and keeping me motivated during the project. This project was possible purely because of his kind co-operation.

Further, I am extremely grateful to my Faculty guide, Mr. Kiran Khairnar who had been guiding me throughout the course of the project. He has always been approachable and helpful and has been kind enough to clarify all my doubts.

I would also like to thank the people at Bank of Baroda, Bhandup Regional Office for their co-operation and for giving me a platform to hone my skills. Special mention needs to made here of Mrs. Pragati Talwelkar, Manager (Credit), Mr. S. P. Shanmugam, Chief Manager (Credit) who shared their vast knowledge and experiences enabling me to reach to a solution to the problems faced during the project. Last but not least, all the managers and credit officers of the regional office whom I approached for my research deserve special thanks because without them it wouldn’t have been possible to do my project.

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Declaration

I, Smruti D. Parab student of MBA hereby declare that the project work presented in this report is my contribution and has been carried out under the supervision of Prof. Kiran Khairnar (faculty) in Padmashree Dr. D Y Patil College of Management Studies, Navi Mumbai.

The information given in this Document are based on my personal studies and observations which I made during my training program and it cannot be used as a proof for any further studies or Documents by the company or any other person.

The objective of training undertaken is to get practical knowledge in corporate field, which further enhance the skill and best utilization of my Talent in the corporate. All the information given in this document is brief and best up-to my knowledge.

Date :- Signature

Smruti D. Parab

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Certificate

This is to certify that the dissertation entitled “A Project report On Emerging SMEs

and its Future Prospects” is the bonafide research work carried out by Miss. Smruti D.

Parab, student of an MBA[Finance], at Padmashree Dr. D.Y. Patil University’s

Department of Business Management during the year 2013 -2015, in partial

fulfillment of the requirements for the award of the Degree of Master in Business

Management and that the dissertation has not formed the basis for the award

previously of any degree, diploma, associateship, fellowship or any other similar title.

_____________________ ___________________Signature of the Director Signature of the Guide

[Dr. R. Gopal ]

Director, Professor,

Dept of Buss Mgt, Dept of Buss Mgt,

Dr D Y Patil University Dr D Y Patil University

Place: Mumbai

Date:

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EXECUTIVE SUMMARY

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Executive Summary

The project undertaken is Emerging SMEs and its future prospects. SMEs in India are booming and contributing to 40% of GDP, many banks focus towards this sector.

Many SMEs in emerging markets often rely on informal sources of capital, such as borrowing from relatives, to meet finance needs. However, when a small or medium enterprise does access formal channels, it typically looks to a bank as its primary source of financial services. Banks have begun to turn their attention toward this untapped market and their service of SMEs is a major factor in increasing SME access to finance. Although, numerous issues surface when it comes to SME lending, banks, by employing a range of measures, such as risk adjusted pricing, credit scoring models, and SME-tailored non-lending products are developing ways to mitigate risks, lower costs, and increase the overall benefit accrued from SME banking.

This study aims to provide an assessment of the Micro, Small and Medium Enterprise sector (MSME) finance in India. The Micro, Small and Medium Enterprise sector is crucial to India’s economy. There are 29.8 million enterprises in various industries, employing 69 million people. The sector includes 2.2 million women-led enterprises (~7.4 percent) and ~15.4 million rural enterprises (51.8 percent). In all, the MSME sector accounts for 45 percent of Indian industrial output and 40 percent of exports. Although 94 percent of MSMEs are unregistered, the contribution of the sector to India’s GDP has been growing consistently at 11.5 percent a year, which is higher than the overall GDP growth of 8 percent. Poor infrastructure and inadequate market linkages are key factors that have constrained growth of the sector.

The lack of adequate and timely access to finance has been the biggest challenge. The financing needs of the sector depend on the size of operation, industry, customer segment, and stage of development. Financial institutions have limited their exposure to the sector due to a higher risk perception and limited access of MSMEs to immovable collateral.

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Table of Contents

Sr no. Particulars Page No.

A AcknowledgementB DeclarationC Executive SummaryD Table of Contents1. Overview of Indian Banking History 9

1.1 Definition 91.2 Introduction 91.3 Early phase 10

2 Types of Banks 133 Performance of Banking sector 144 History 155 SWOT Analysis 176 6.1 Introduction to SMEs 18

6.2 Definition 216.3 Micro, Small, Medium Enterprises in India 226.5 Differences in Industry of Operation 276.6 Differences in Geography of Operation 276.7 SME Contribution in Indian Economy 286.8 Distribution of MSME Enterprises in India 30

7 limitations 378 Micro, Small and Medium Enterprises Development Act,

2006.38

11 11.1 SME Banking and Bank of Baroda 4111.2 Growth of Business 5411.3 Facilities for SME Borrowers 5511.4 Principles of lending 5611.5 Cash Credit Facility 5611.6 Overdraft Facility 5711.7 Non-Fund Based Facilities 57

13 Schemes of Bank of Baroda 4414 Working Capital Assessment 4715 Financial Performance Assessment 4919 Credit Rating 5020 CRISIL 5122 22.1 Credit Appraisal Procedure 5123 23.1 Details collected from clients 55

23.2 Financial details Company’s promoters and Management 86

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details23.3 Financial details 8623.4 Non- Financial details 8623.5 Additional project details 8623.6 Pre-sanction inspection 8723.7 Post-sanction inspection 8723.8 CIBIL Report 8723.9 Dimensions of Credit Appraisal 8823.10 Security 9023.11 Documentation 92

24 Challenges of the SMEs 6225 Problem of SMEs in India 6327 Performance and Credit Scheme for Rating of Small Scale

Industries68

28 Lessons for India 6829 Recommendations and Strategies 6830 Conclusion 7131 Bibliography 73

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Overview of Indian Banking Industry

Definition of Banks

In India, the definition of the business of banking has been given in the Banking Regulation Act, (BR Act), 1949.

According to Section 5(c) of the BR Act, ‘a banking company is a company which transacts the business of banking in India’ Further, Section 5(b) of the BR Act defines banking as, ‘accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdraw able, by cheque, draft, and order or otherwise.’ This definition points to the three primary activities of a commercial bank which distinguish it from the other financial institutions. These are:

(i) Maintaining deposit account including current accounts,(ii) Issue and pay cheques, and(iii) Collect cheques for the bank’s customers.

IntroductionThe banking system in India was established in 18 th century. The first Indian bank which came into existence in 1786 was THE GENERAL BANK OF INDIA which is followed by BANK OF HINDUSTAN. Although both these banks does not exist today but these banks made the foundation of banking system in India. The oldest bank in existence in India is the State Bank of India being established as “The Bank of Bengal” in Calcutta in June 1806. The first fully owned bank was the Allahabad bank, which was established in 1865. By the 1990s the market expanded with the establishment of banks such as Punjab National bank in 1895 in Lahore and Bank of India in 1906, in Mumbai - both of which were founded under private ownership. The Reserve bank of India formally took on the responsibility of regulating the Indian banking sector from 1935 After India’s independence in 1947, the Reserve Bank was nationalized and given broader powers.

The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below:

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Early phase from 1786 to 1969 of Indian BanksNationalization of Indian Banks and up to 1991 prior to Indian Banking sector Reforms. New phase started of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991.

Phase 1.

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935.

During the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in India as the Central Banking Authority.

During those days public has lesser confidence in the banks. As an aftermath deposit mobilization was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders.

Phase 2.

Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale especially in rural and semi-urban areas. It formed State Bank of India to act as the principal agent of RBI and to handle banking transactions of the Union and State Governments all over the country.

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Seven banks forming subsidiary of State Bank of India was nationalizes in 1960 on 19 th July, 1969, major process of nationalization was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country were nationalized.

Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with the seven more banks. This step brought 80% of the banking segment in India under Government ownership.

The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country:

1949: Enactment of Banking Regulation Act.1955: Nationalization of State Bank of India.1959: Nationalization of SBI subsidiaries.1961: Insurance cover extended to deposits.1969: Nationalization of 14 major banks.1971: Creation of credit guarantee corporation.1975: Creation of regional rural banks.1980: Nationalization of seven banks with deposits over 200 crore.

After the nationalization of banks, the branches of the public sector bank India rose to approximately 800% in deposits and advances took a huge jump by 11,000%.

Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions.

Phase 3

This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalization of banking practices.

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The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money.

The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure.

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Types of Bank

There are several types of Bank in India and each has a specific role and function as well as Domain in which they operate. The Different types of Banks are as follows.

1. Financial Institutions2. Public Banks3. Co-operative Banks4. Private Banks5. Foreign Banks

Central Bank

The Reserved Bank of India was constituted under the Reserve Bank of India Act, 1934 and started functioning with effect from 1 April, 1935. RBI is the central Bank that is fully owned by the Government. It is governed by a central board (headed by a Governor) appointed by the Central Government. It issues guidelines for the functioning of banks operating within the country.

PUBLIC SECTOR BANKS

Public sector Banks are also called Nationalised banks Eg: SBI, Bank of India etc. These banks are wholly owned by the Government of India.

PRIVATE SECTOR BANKS

The private-sector banks in India represent part of the Indian banking sector that is made up of both private and public sector banks. The "private-sector banks" are banks where greater parts of stake or equity are held by the private shareholders and not by government.

For eg. Federal Bank, KarurVysya Bank etc. But all these Banks comes under the preview of Scheduled Bank since these banks are included in the Schedule of the Government of India.

CO-OPERATIVE SECTOR BANKS

The co-operative sector is very much useful for rural people. They are allowed to raise deposits and give advances from and to the public. Urban Co-operative banks are controlled by State Govt. The co-operative banking sector is divided into the following categories:-State Co-op Bank, Central Co-op Banks and primary Agriculture Credit societies.

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FOREIGN BANKS

Foreign banks are banks that do their operations and services at a foreign country that is rather not in close proximity to an individual. Eg. City Bank, Standard Chartered Bank.

Development Banks/ Financial institutions

Financial institutions are institutions that provide financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries. Most financial institutions are highly regulated by government.

Performance of Indian Banking Sector

Improved performance of the banking industry in India has helped the economy to bounce back to a positive growth level in 2012-2013. According to the Reserve Bank of India (RBI), the banking sector in India is sound, adequately capitalised and well-regulated. The Indian financial and economic conditions are much better than in many other countries of the world. Credit, market and liquidity risk studies show that Indian banks are generally resilient and have withstood the global downturn well. According to the Reserve Bank of India, the nationalised banks, as a group, accounted for 49.5 per cent of the aggregate deposits, while State Bank of India and its associates accounted for 24.1 per cent. The shares of other scheduled commercial banks, foreign banks and regional rural banks in aggregate deposits were 18.2 per cent, 5.2 per cent and 3.0 per cent, respectively. Nationalised banks held the highest share of 50.5 per cent in the total share. Foreign exchange reserves stood at, US$ 294.99 billion in January 2013 wherein the value of gold reserves was recorded at US$ 27.21 billion and that of foreign currency assets (FCAs) was at US$ 261.06 billion. The value of special drawing rights (SDRs) was US$ 4.40 billion and the country's reserve position with the IMF was at US$ 2.30 billion. The number of mobile banking transactions in India has also increased in 2012-2013, wherein the total amount transacted showed a boost of 8.3 per cent growth.

About the Company

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Bank of Baroda

Head office: Bank of BarodaSuraj Plaza-1, Sayaji Ganj, Baroda-390005

Corporate Office: Bank of Baroda, Baroda Corporate Centre,

Plot No-C-26, G-Block, Bandra-Kurla Complex, Bandra (East),

Mumbai-400051

Website:www.bankofbaroda.com

Mission

“To be the top ranking National Bank of International Standard committed to augmenting stakeholders value through concern, care and competence.”

The bank was founded by Maharaja Sayajirao Gaekwad (also known as Shrimant Gopalrao Gaekwad), the then Maharaja of Baroda on 20th of July 1908 with a paid capital of Rs. 10 Lacs. From its introduction in a small building of Baroda, the bank has come a long way to achieve its current position as one of the most important banks in India. On 19th of July 1969, Bank of Baroda was nationalized by the Government of India along with 13 other commercial Bank.

History

It has been a long and eventful journey of almost a century across 25 countries. Starting in 1908 from a small building in Baroda to its new hi-rise and hi-tech Baroda Corporate Center in Mumbai, it is a saga of vision, enterprise, financial prudence and corporate governance.

It is a story scripted in corporate wisdom and social pride. It is a story crafted in private capital, princely patronage and state ownership. It is a story of ordinary bankers and their extraordinary contribution in the ascent of Bank of Baroda to the formidable heights of corporate glory. It is a story of ordinary bankers and their extraordinary contribution in the ascent of Bank of Baroda to the formidable heights of corporate glory. It is a story that needs to be shared with all those millions of people- customers, stakeholders, employees & the public at large-who is ample measure, have contributed to the making of an institution.

Prior to independence from the British rule, the ancient India was ruled by princely states, scattered over the width and breadth of the large Indian nation. The Maharajas of the inner, States of colonial India contributed to the welfare of their respective regions as well as the Indian nation as a whole. Their vision and foresight in founding various financial, charitable, social and philanthropic

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organizations during their time is still cherished by any one going into the history of modern India and its achievements in every walk of life.

The Maharaja of Baroda, a princely state of British India, by name Sir Sayyajirao Gaekwad 3, had the same vision in establishing a bank for servicing the public at large and the citizens of Baroda State, a Gujarathi population in particular. On 20th July 1908, Bank of Baroda was established under the rules of Companies Act 1897, in a small building at Baroda, by the Maharaja with a paid up capital of Rs. 10 lakhs. The guidelines set by the Maharaja for the bank was to serve the people of the State Baroda as well as the neighbouring regions with money lending, saving, transmission and encouraging the development of arts, science, commerce and trade for the people.

Even during the worst financial disaster caused by the First World War, during the period 1913 to 1917, when as many as 87 banks closed their shutters, Bank of India survived the turbulence with its clear vision, ethical standards and financial prudence to grow from strength to strength. There were heroes to sustain development of this bank to its present glory, from ordinary people as customers and the heirs of the Royal family of Baroda.

The success story of the Bank of Baroda is studded with many a leaps and strides it made in the International presence, apart from establishing branches all over the Indian nation, by acquisition of already popular banking entities, as also commencing new commercial banking establishments, in the unique Gujarathi style. During the years of 1908 to 2007(and the century year being round the corner) Bank of Baroda’s growth owes to the excellence in rendering financial products and services to the national and international population. Countries beginning from America to Zambia, in the alphabetical order have been enjoying the services of Bank of Baroda as of today.

SWOT Analysis

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Strength: Liquidity of the Bank, Market Share, Brand, Customer relations.

Weakness: High Non-Performing Assets, Low marketing strategies.

Opportunities: Advanced technology, cost cutting through E-Banking.

Threats: Retirement of Experience staff and Retention of New Employee, Customer Dissatisfaction, Competitors Major competitors are ICICI bank and Punjab national Bank.

INTRODUCTION TO SME

Small and Medium Enterprises (SMEs) have played a significant role world over in the economic development of various countries. Over a period of time, it has been proved that SMEs are dynamic,

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innovative and most importantly, the employer of first resort to millions of people in the country. The sector is a breeding ground for entrepreneurship. The importance of SME sector is well-recognized world over owing to its significant contribution in achieving various socio-economic objectives, such as employment generation, contribution to national output and exports, fostering new entrepreneurship and to provide depth to the industrial base of the economy. Small and medium-sized enterprises (SMEs) are the backbone of all economies and are a key source of economic growth, dynamism and flexibility in advanced industrialized countries, as well as in emerging and developing economies. SMEs constitute the dominant form of business organization, accounting for over 95% and up to 99% of enterprises depending on the country. They are responsible for between 60-70% net job creations in Developing countries. Small businesses are particularly important for bringing innovative products or techniques to the market. Microsoft may be a software giant today, but it started off in typical SME fashion, as a dream developed by a young student with the help of family and friends. Only when Bill Gates and his colleagues had a saleable product were they able to take it to the marketplace and look for investment from more traditional sources. SMEs are vital for economic growth and development in both industrialized and developing countries, by playing a key role in creating new jobs. Financing is necessary to help them set up and expand their operations, develop new products, and invest in new staff or production facilities. Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business. But if they are successful, there comes a time for all developing SMEs when they need new investment to expand or innovate further. That is where they often run into problems, because they find it much harder than larger businesses to obtain financing from banks, capital markets or other suppliers of credit.

The importance of SME sector is well-organised world over owing to its significant contribution in achieving various socio-economic objectives, such as employment generation, contribution to national output and exports, fostering new entrepreneurship and to provide the depth to the industrial base of the economy. India has a vibrant SME sector that plays an important role is sustaining economic growth, increasing trade, generating employment and creating new entrepreneurship in India.

Small and medium enterprises (SME) have not kept pace with the country’s economic growth because of their inability to access finances, industry experts point out. According to Mr. David Emery, President, International Partnerships & Asia Pacific, Dun & Bradstreet, said: “Recent research at the World Bank has re-established that inability to access finance may be one of the reasons why we do not see a robust correlation between SME prevalence and economic growth. Therefore, the increasing strength of the financial system in the country will help Indian SMEs continue on their growth path.

Another important aspect in this journey would be to ensure enhanced global visibility to these SME firms”. Lack of access to Finance has seriously affected the success of SMEs, impacting the sales of those enterprises. High cost of funds and lack of working capital finance

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reduces the expansion opportunities of these units. In addition, lack of training among bankers dealing with SMEs has impacted on the services provided to SMEs. There are also non-financial issues facing SMEs in India including lack of adequate infrastructure, international competition for exports and national regulations as well as social constraints (education), which inhibit the growth of SMEs.

Of all the elements that go into small business, Credit support is perhaps the most crucial for success. The best of plans can come to naught if adequate finance is not available at the right time. SMEs need credit support not only for running the enterprise & operational requirements but also for diversification, modernization/ up gradation of facilities, capacity, expansion etc. In respect of SMEs, the problem of credit becomes all the more critical whenever any episodic event occurs such as; a large order, rejection of consignment, inordinate delay in payment etc. In general, SMEs operate on tight budgets, often financed through owner’s own contribution, loans from friends and relatives and some bank credit. Finance being a major obstacle in SME development, needs to be examined and addressed at all levels. There are several reasons for low SME credit penetration, key among them being insufficient credit information on SMEs, low market credibility of SMEs (despite their intrinsic strengths) and constraints in analysis.

Small and medium enterprises (SMEs) are critical for the economic and social development of the emerging markets. They play a major role in creating jobs and generating income for low income people; they foster economic growth, social stability, and contribute to the development of a dynamic private sector. As, such access to financial services is vital in developing a vibrant SME sector in the economy. In many emerging markets, however, access to financial services for SMEs remains severely constrained. Most financial intermediaries (FIs) have hesitated to target this sector. Banks which have traditionally served the corporate and large segments of the market, view SMEs as a challenge because of information asymmetry, lack of collateral, and the higher cost of serving smaller transactions. However, as corporate banking margins continue to shrink and increasing fiscal restraint lower yields on government borrowings, banks have begun to access the opportunities offered by SMEs. Providing banking services to this underserved SME market segment can increase their access to financial services and generate more employment opportunities and income.

Small and medium enterprises (SMEs) are major contributors to GDP and employment in many parts of the world. Empirical studies vote that SMEs and informal enterprises account for over 60 percent of GDP and over 70 percent of total employment in low-income countries. The financial needs of SMEs are underserved and continue to be a constraint to their growth. Banks which have

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traditionally served the corporate and large business of the market view SMEs as a challenge due to information asymmetry, lack of collateral and higher costs to serve smaller transactions. However, as corporate banking margins continue to shrink and as increasing fiscal restraint lower yields on government borrowing, banks have begun to access the opportunities that SMEs offer in growth and portfolio diversification.

Worldwide, the micro small and medium enterprises (MSMEs) have been accepted as the engine of economic growth and for promoting equitable development. The major advantage of the sector is its employment potential at low capital cost. The labour intensity of the MSME sector is much higher than that of the large enterprises. The MSMEs constitute over 90% of total enterprises in most of the economies and are credited with generating the highest rates of employment growth and account for a major share of industrial production and exports. In India too, the MSMEs play a pivotal role in the overall industrial economy of the country. In recent years the MSME sector has consistently registered higher growth rate compared to the overall industrial sector. With its agility and dynamism, the sector has shown admirable innovativeness and adaptability to survive the recent economic downturn and recession.

As per available statistics (4th Census of MSME Sector), this sector employs an estimated 59.7 million persons spread over 26.1 million enterprises. It is estimated that in terms of value, MSME sector accounts for about 45% of the manufacturing output and around 40% of the total export of the country. Below diagram shows how SME is contributing worldwide to GDP and Employment which helps in the Economic development of the Country.

Definition

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Through the definitions are not parts of the terms of reference for the Working Group, a clearer definition of the SME sector vis-à-vis conventional SSI and Tiny sectors was felt necessary.

At present small scale industry is defined as one having original investment in plant and machinery not exceeding Rs. 1 crore. While recognizing need of larger investment in some of the more important segments of SSI, the Government of India has enhanced this to Rs. 5 crore in respect of certain specified industries. A process of graduation of several SSIs into medium enterprises, having larger investment is a natural progression of successful units. Therefore, it was agreed that a separate category of medium enterprises (ME) needs to be recognized. While SME mat not qualify for priority sector lending, it must be seen as contiguous with SSI.

The SME definition, adopted by other countries is generally based on number of employees, capital investment or turnover. The existing definition of SSI adopted in India, based on investment in plant and machinery, excludes the rapidly growing service sector. The past decade has witnessed the services sector contributing almost half of the GDP. The Working Group strongly recommends the adoption of turn over as a measure for defining the SME sector. Based on turn over, Tiny, Small and Medium enterprises may be redefined as under:

1. Tiny: Turn over up to the financial limit of Rs. 2 Crore,

2. Small: Turn over up to the financial limit of above Rs. 2 Crore and up to Rs. 10 Crores,

3. Medium: Turn over above the financial limit Rs. 10 Crores and up to Rs. 50 Crores.

Till the Government of India takes a view regarding turnover as suggested above, the Working Group recommends that a medium enterprise may be defined as an undertaking where the original investment in plant and machinery is more than Rs. 1 crore but less than Rs. 10 crore.

The term ‘MSME’ is widely used to describe small businesses in the private sector. Regulators and financial institutions across the world use parameters such as employee strength, annual sales, value of fixed assets, and loan size proxies to define the sector in the context of finance. For instance, businesses with employee strength less than 500 are considered MSMEs in Mexico. According to the World Bank definition, a business is classified as MSME when it meets two of the three criteria – employee strength, size of assets, or annual sales

Micro, Small and Medium Enterprises Sector in India

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The MSME sector plays a significant role in the Indian economy. A catalyst for socio-economic transformation of the country, the sector is critical in meeting the national objectives of generating employment, reducing poverty, and discouraging rural-urban migration. These enterprises help to build a thriving entrepreneurial eco-system, in addition to promoting the use of indigenous technologies. The sector has exhibited consistent growth over the last few years, but it has done so in a constrained environment often resulting in inefficient resource utilization. Of the many challenges impeding the growth and development of MSMEs, inadequate access to financial resources is one of the key bottlenecks that make these enterprises vulnerable, particularly in periods of economic downturn.

Financial Institutions and Definition of MSME

Although investments in plant and machinery are tangible and measurable, the current definition provides limited information on the financial appetite and financial performance of an enterprise. As a result, many financial institutions prefer using annual sales/revenue (turnover) to segment and target MSMEs, and as a key parameter for product development and risk management.

Economic Contribution of MSME

It is important to note that in addition to helping catalyze the growth of the economy, MSMEs feed large local and international value chains as well as local consumer markets as suppliers, manufacturers, contractors, distributors, retailers and service providers. They account for a large share of industrial units, and contribute significantly to employment in the country Growing at 11.5 percent a year, the MSME sector has been performing better than the overall GDP (8 percent growth per annum) and overall industrial output (measured by Index of Industrial Production-IIP). (Current estimates of MSME contribution to GDP do not take into consideration the contribution made by unorganized private enterprises, for which asset and sales data is not tracked by government agencies.

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MSMEs are also effective vehicles for employment generation. India’s cities have been experiencing the burden of a consistently growing population, comprising an ever – increasing proportion of migrants in search of employment and livelihood. City infrastructure is already stretched, and policy makers are seeking solutions to mitigate issues arising from migrant population growth. Rural MSMEs and those based outside of the large cities, offer a viable alternative for employment to local labor, hence presenting an opportunity for people to participate in productive, non-farm activities, without needing to migrate to urban areas.With adequate financial and non-financial resources, as well as capacity-building, the MSME sector can grow and contribute to economic development considerably higher than it is doing currently.

Source: MSME ReportHeterogeneity in the MSME Sector

The sector is classified into Micro, Small and Medium based on the size of the enterprise, as defined in Each of these segments however is extremely heterogeneous, due to differences in ownership structure, area of operation, type of industry, and the stage of development of an enterprise.

Differences in Ownership Structure

The type of ownership structure of enterprises determines the form of capital (equity or debt) these enterprises can access and absorb from external sources. For instance, proprietorship and partnership enterprises cannot accept any form of external equity other than owner contributions. This can significantly impact growth potential both at start-up stage as well as when the enterprise is in need of growth capital.

Below table indicates at least five different types of ownership structures. Proprietorship is the most commonly adopted ownership structure (94.5 percent of all MSMEs), primarily because this

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structure requires lower legal overheads. The other ownership structures adopted by enterprises include partnership, cooperative, private limited company and public limited company. Maturesmall, medium and new knowledge-based enterprises in the sector are mostly structured as private limited or public limited companies

Source: MSME Report

Distribution of Enterprises in the MSME Sector and Prevalent Ownership Structures

Source: MSME Report

The type of ownership structure of enterprises determines the form of capital (equity or debt) these enterprises can access and absorb from external sources. For instance, proprietorship and partnership enterprises cannot accept any form of external equity other than owner contributions. This can significantly impact growth potential both at start-up stage as well as when the enterprise is in need of growth capital.

Differences in Industry of Operation

Enterprises in the sector can be further classified into manufacturing and services. With more than 8000 products ranging from hand-made products to high precision machine parts, and numerous

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services catering to both industrial and consumer markets offered by MSMEs, there is clearly a huge diversity within the two categories.

The manufacturing sector accounts for an estimated 29 percent of total enterprises in theMSME sector, while the services sector accounts for the balance 71 percent • Manufacturing MSMEs feed supply chains of local large enterprises, global large enterprises or local consumer markets. Food processing is the key manufacturing industry. Further, a large number of small and medium enterprises in the food and textile industries are export-oriented and serve large global supply chains or global consumer markets.

• Service MSMEs operate in traditional transaction-based industries such as retail trade, small transport operations and knowledge-based industries such as information technology, humanresource consulting among others.

Although the services sector accounts for a larger number of enterprises, it is the top ten industries in manufacturing that account for 75 percent of the sector’s total output

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Share of top ten industries in Share of top 10 manufacturing

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The top ten services industries account for a total of 5 percent of the gross output by the MSME sector output

• The services sector is dominated by retail trade, repair and maintenance shops, small transportoperators among others, most of which typically contribute far lower compared to manufacturing

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sector enterprises.

• However, the services sector is witnessing a gradual increase in the number of knowledge-based enterprises, which tend to have a higher output per enterprise as compared to the traditional service enterprises.

Differences in Geography of Operation

There are significant geographical variations in India that impact the distribution of micro, small and medium enterprises. The availability of natural resources and other regional characteristics also determine the type of an enterprise and scale of operations. For the purposes of this study, the states in India are split into three broad regions:

• Low-Income States (LIS) [Bihar, Chhattisgarh, Jharkhand, Madhya Pradesh, Orissa, Rajasthan, Uttar Pradesh

• North-eastern States (NES) – Assam, Arunachal Pradesh, Nagaland, Manipur, Meghalaya, Mizoram, Tripura

• Rest of India – All states other than Low Income States and North-eastern States

SME CONTRIBUTION IN INDIAN ECONOMY

The SME’s alone contribute to 7% of India’s GDP. SME’s have increased from about 80,000 units in the 1940’s to about 10.52 million units. Their total employment is about 25 million and they produce about 7500 products including high technology products. In the sports goods and garments sector their contribution to exports is as high as 90% to 100%. They constitute 90% of the industrial units in the country and also contribute to about 35% of India’s exports. The Government of India since 1951 has encouraged and supported the SME’s through its various policy initiatives. Since 2005, The Government of India has identified 3,000 SME clusters of artisan-specific, village and small enterprises in the country and has taken up 1,150 such clusters for intervention and improvement. SMEs developed in a manner, which made it possible or them to achieve the following objectives:

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High contribution to domestic production Significant export earnings Low investment requirements Operational flexibility Location wise mobility Low intensive imports Capacities to develop appropriate indigenous technology Import substitution Contribution towards defence production Technology – oriented industries Competitiveness in domestic and export markets

The SMEs have made significant contribution towards technological development and exports. Some have been established in almost all-major sectors in the Indian industry such as:

Food Processing Agricultural Inputs Chemicals & Pharmaceuticals Engineering; Electricals; Electronics Electro-medical equipment Textiles and Garments Leather and leather goods Meat products Bio-engineering Sports goods Plastics products

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Computer Software, etc.

As a result of globalization and liberalization, coupled with WTO regime, Indian SMEs have been passing through a transitional period. With slowing down of economy in India and abroad, particularly USA and European Union and enhanced competition from China and a few low cost centres of production from abroad many units have been facing a tough time. Those SMEs who have strong technological base, international business outlook, competitive spirit and willingness to restructure themselves shall withstand the present challenges and come out with shining colours to make their own contribution to the Indian economy.

Below are a number of key economic factors that identify how the SME’s contribute towards a country’s economy:

Example SME’s are the growth engine behind most economies.

Generally this sector is the largest contributor of employment in most countries. This is especially relevant for new job creation. The SME sector is a major contributor to technical innovation and new product developments;

SME’s are essential for a competitive and effective market.Due to adaptability, SME’s play a major role in removing regional and sector imbalances in an economy. Easy entry and exit of SME’s make economies more flexible and more competitive. Due to the large number of SME’s competition is created in the market place. SME’s also play an essential role as subcontractors in the downsizing, privatization and restructuring of large companies; and

SME’s are important for poverty reduction.SME’s often employ poor and low-income workers. This is specifically relevant in rural areas where this may be the only sector offering any form of employment. When focusing on the small or micro organization, self-employment may be the only source of income for many of the poor. This poverty reduction is specifically relevant to developing countries where poverty is most severe.Example in various sector

Distribution of MSME Enterprises in India

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While this study is meant to address the challenge of finance to small and medium businesses across India, there is also a more specific focus on MSME activity in the LIS and NES regions. Regional characteristics such as infrastructure availability, investment levels and literacy determine the type and scale of these enterprises in the region. Consequently, the size and nature of finance demand by MSMEs tends to vary with geography

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Low-Income States (LIS) Region

The LIS region includes some of the largest states by population in India – Bihar, Chhattisgarh, Jharkhand, Madhya Pradesh, Orissa, Rajasthan and Uttar Pradesh. However, these states account for only 33 percent of small and medium enterprises in the country. About 28 percent of the units or 2.7 million enterprises in the region belong to the manufacturing category, while the dominant 72 percent of the enterprises or 7 million units) are into services. Some important facts about theMSME sector in this region are:

• While the LIS region comprises seven states, including the most populous state of Uttar Pradesh, the region as a whole, accounts for 26.5 percent of India’s total GDP. It should be noted that the GDP contribution of the LIS region is comparable to the GDP contribution of top three states in rest of India.

• MSMEs in the region are most active in industries like trade, hotels, transport, agro-processing and communications.• The LIS region connects northern, western and eastern India through trade corridors (40 percent of the National Highways are in LIS); hence a large number of these businesses in this region are in the transport industry.

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• LIS states have a considerable area (~25-30 percent) under agriculture; hence MSMEs are active in the food processing industry too. In Orissa, a large number of micro-enterprises are involved in businesses related to forest produce, such as trading and processing of tendu and kendu leaves and timber trade for paper industry. Similarly in Madhya Pradesh too, there are a significant number of small and medium enterprises in the bio-pharmaceutical space because of the forest produce.

• MSMEs are also active in trade and metal processing industries in Orissa, Jharkhand andChhattisgarh, which have a large concentration of mineral deposits.

Tourism, handicrafts and construction are the other major area of operation of the small and medium enterprises in the region.

• The region has been historically characterized by low access to infrastructure such as electricity and roads. With recent political stability, however, there is a focus on development of infrastructure sectors. Recent investments in electricity alone account for 30-50 percent of total government spending.Development of infrastructure in the region could potentially increase the industrial base in the region.

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North-eastern States (NES) Region

The NES region includes seven states in India – Arunachal Pradesh, Assam, Nagaland, Manipur,Meghalaya, Mizoram and Tripura – which account for 3.4 percent of MSMEs in the country. Cluster activity in NES region is mostly comprised of micro and small units in the handloom and crafts industry. 20 percent of the enterprises in the region belong to the manufacturing category, while the dominant 80 percent of the enterprises are into services. Some important facts on the MSME sector in this region are:

• Seven states in NES account for 2.6 percent of India’s total GDP, suggesting that the level of industrialization in the region is considerably lower compared to the Low-Income States and Rest of India. The state and central governments are taking steps to provide basic infrastructure such as electricity and roads, and provide fiscal incentives for more industries to step-up operations in the region.

• Due to abundant natural resources such as forest produce, fruits and vegetables, MSMEs in the region are mostly involved in handloom, handicrafts, food processing, tourism and sericulture (silk production)

• As the businesses use local natural resources as inputs, working capital demand tends to be lower on an average.

• Assam, the largest state in the region and regarded as the “gateway” to the north-east, hasthe largest network of national highway network in the region. As a result, a large number ofMSMEs in the north-eastern states are involved in transport services.

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Rest of India

The ’Rest-of-India’ region includes 15 states – Delhi, Uttarakhand, Andhra Pradesh, Goa, Gujarat, Haryana, Himachal Pradesh, Jammu & Kashmir, Punjab, Karnataka, Kerala, Maharashtra, Sikkim, Tamil Nadu and West Bengal – which together account for 64 percent of MSMEs in the country. Only 30 percent of the enterprises in the region are involved in manufacturing, while the dominant 70 percent operate in the services category. Among some of the important facts about the MSME sector in this region are:

• The Rest–of-India region accounts for 70.9 percent of the national GDP. Large-scale industrialization in the region is one of the key reasons for the high GDP contribution from these states. As a result of a more developed industrial environment, many MSMEs opt for manufacturing. Tamil Nadu and Andhra Pradesh, for example, have emerged as large textile processing centers, building an eco-system supporting micro and small enterprises.

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• The states in the region also have significant natural resources, and investment in infrastructure has made it possible for them to exploit these natural resources. Many of the MSMEs therefore operate in industries such as drugs and pharmaceuticals, biotechnology, mines and minerals, textiles, leather, and tourism.

• States such as Maharashtra, Karnataka, Kerala, Andhra Pradesh, Tamil Nadu and New Delhi – the National Capital Region as a whole – have a large pool of skilled workforce, encouraging many of these units to operate in the knowledge-based industries such as IT and ITeS. In fact, unlike the low-income states and north-eastern states, the services sector in Rest-of-India is largely comprised of knowledge based services industries.

• States such as Gujarat, Maharashtra, Kerala and Tamil Nadu are also major hubs of sea trade, which spurs the growth of small and medium transport services in the region.

MSME Growth impacted by Multiple Constraints

Although the MSME sector has been growing at a faster rate than the overall industrial sector, MSMEs experience multiple constraints that threaten to derail the sector’s growth trajectory. Some of key hindrances that MSMEs face :

Inadequate market linkages: Except in the case of cluster-linked and ancillary MSMEs that have natural linkages with large enterprises, MSMEs tend to have poor market access. The non-cluster MSMEs are fragmented, and as a result, are unable to organize themselves in order to reduce procurement cost from large enterprises or streamline the output supply chain. What is worse, in the absence of adequate market linkages, any demand disruption in the supply chain can severely impact operations because the enterprise capital of these businesses tends to be locked in illiquid inventory and receivables.

• Lack of infrastructure: Limited access to infrastructure such as power, water and roads increases operational costs for MSMEs and makes their businesses uncompetitive. Inadequate access to support infrastructure discourages these units from adopting newer technologies, where available. In addition, poor infrastructure forces small and medium businesses to operate in select geographies, increasing the demand for natural resources in that region.

• Inadequate finance: MSMEs consider challenges in access to finance as one of the biggest constraints in growth. A study on the MSME sector also suggests that the multiple growth constraints (like those mentioned above) can be largely linked to inadequate access to finance. The Report of Working Group on Rehabilitation of Sick MSMEs by RBI also finds lack of adequate and timely access to working capital finance is one of the key reasons for sickness in the sector.

• Lack of managerial competence: Micro and small enterprises in particular largely comprise first-generation entrepreneurs, who have had a limited structured training on resource planning, capital management and labor management. As a result, lack of managerial competence often shows in

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poor book-keeping and a limited knowledge of formal financial institutions, which further inhibits the growth of these enterprises.

• Obsolete technology: While industries such as automotive, forging, software developmentsector require advanced technologies in operations, the majority of the small andmedium enterprises do not have that kind of technological edge. A low technology base results in low productivity, which makes these enterprises uncompetitive. Financial institutions associate lack of technology with uncompetitive businesses and therefore are wary of financing enterprises which are not technologically up-to-date in operations. These enterprises too have limited awareness about new technologies, or the technology financing schemes.

The 2007 MSME Census indicated that only 5 percent of enterprises in the sector had access to some form of formal finance, while over 92 percent of the units lacked access to any form of institutional finance. (Studies on financing pattern in the sector and the MSME census suggest that MSMEs prefer self-financing, which not just includes the savings of the entrepreneurs, but also the finance availed from friends, family and relatives.

However, the situation has been changing in recent years. As a result of greater focus on the MSME segment by the government and the regulator as well as by the financial sector, institutional finance to MSMEs has increased considerably. Building on the 2010 data from the Reserve Bank of India (RBI), the study estimates that financial institutions serve, to some extent or the other, nearly (33 percent)[32] of the enterprises. However, despite the improved access, many micro and small enterprises remain unserved and underserved.

Policymakers in India have always retained a focus on MSME finance, as indicated by the Priority Sector Lending (PSL) norms for commercial banks that were established, and have been in place, for several decades now. Establishing programs such as the Credit Guarantee Trust in recent times has given a renewed thrust to that objective. However, despite the policy efforts anda clearly more responsive formal financial sector, the MSME sector continues to face a financing gap due to inherent demand and supply-side constraints. This study focuses on some of these key challenges.

Limitations:

1. Low capital Base.2. Concentration of function in one/two pesons.3. Inadequate exposure to International environment.

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4. Inability to face impact of WTO regime.5. Lack of professionalism.

Inspite of these limitations, the MSMEs have made significant contribution towards technology development and exports. MSMEs are established in almost all the major sectors in the Indian Industry such as:

1. Food Processing.2. Chemicals and Pharmaceuticals.3. Electro-medical equipments.4. Leather and Leather goods.5. Bio-engineering6. Plastic products7. Agriculture inputs.8. Engineering; Electrics; Electronics.9. Textiles and Garments.10. Meat Products.11. Sports goods.12. Computer Software etc.

Resulting from Globalization and liberalization, coupled with regime, Indian SMEs have been pasing through period. With the slowing down of the western economies, particularly USA and European Union and enhanced competition from China and a few low cost centers of production from abroad, many units in India have been facing a tough time. Those SMEs who have strong technological base, International business outlook, competitive spirit and willingness to restructure themselves shall withstand the present challenges and come out with flying colours to make their own contribution to the Indian economy.

Micro, Small and Medium Enterprises Development Act, 2006

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The Government of India vide its notification dated 16.06.2006 enacted an Act named “Micro Small and Medium Enterprises” Development Act, 2006” (MSMED act 2006). This act has been made effective from 2nd October, 2006 as per the notification dated 18th July 2006. In this Act, the word ‘Enterprises’ replaces the word ‘Industry’. The ‘enterprises In this act have been classified as micro, small and medium. Based on their activities, these enterprises have been further categorized as manufacturing enterprises and service.

The MSMED Act, 2006 has defined the Micro small and medium enterprises in both the manufacturing and service sector as follows.

‘Enterprises’ means an industrial undertaking or a business concern or any other establishment engaged in the manufacture or production of goods in any manner, pertaining to any industry specified in the first schedule to the industries (Development and Regulations) Act, 1951.Or engaged in providing or rendering of any service or services. The categories of Enterprises, Viz., micro, Medium, and small both under manufacturing and services sectors are described as in the table.

Description of Micro, Small and Medium Sectors

Enterprises Manufacturing Sector Service Sector

Micro Where the investment in Plant and machinery does not exceed Rs. 25 lakh. (currently called as Tiny Sector)

Where the investment in equipment does not exceed Rs. 10 Lakhs.

Small Where the investment in plant and machinery is less more than 25 lakhs but does not exceed Rs. 5 crore

Where the investment in equipment is more than 10 lakhs but does not exceed Rs. 2 crore.

Medium Where the investment in plant and machinery is less more than 5 crore but does not exceed Rs 10 crore

Where the investment in equipment is more than 2 crore but does not exceed Rs. 5 crore

The act seeks to facilitate the development of these enterprises as also enhance their competitiveness. It provides the first ever legal framework for recognition of the concept of ‘Enterprise’ which comprises of manufacturing and service entities. It defines medium entities for the first time and seeks to integrate the three tiers of these enterprises, namely micro, small and medium. The act also provides for the Statutory consultative mechanism at the national level with balanced representation of all sections of stakeholders particularly the three classes of enterprises, notification of Schemes/ programs for this purpose, progressive credit policies and practices, more

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effective mechanism for mitigating the problems of delayed payments of micro and small enterprises and assurance of all schemes for easing the closure of business by these enterprises are some of the other features of the Act.

The Ministry of MSMSE has also taken a view in the light of the liberalized provisions of MSMED act 2006, to do away in the restrictive 24% ceiling prescribed equity for holding By industrial holdings, whether domestic or Foreign, in the MSMEs. This coupled with an expected legislation on Limited Liability Partnership (introduced in the Parliament by the ministry of Corporate Affairs) should pave the way for the greater corporation of Small and Medium Enterprises-thereby enhancing their access to equity and other funds from the market of these products in keeping with global standards.

Policy Package for MSMEs-Credit Finance

Credit is one of the critical inputs for the promotion and development of MSMEs. Some of the features of existing credit policy and those evolving for the MSMEs are:

1. Credit to MSME is a part of the Priority Sector Lending policy of Banks. For the public and private sector banks, 40% of the net bank credit (NBC) is earmarked for the priority sector. For the foreign Banks, however, 32% of the net bank credit (NBC) is earmarked for the priority sector of which 10% earmarked for the MSME sector. Any shortfall in this by Foreign Banks has to be deposited in the Small Enterprises Development Fund(SEDF) set up the Small Industries Development Bank of India (SIDBI).

2. The SIDBI is the principal financial institution for the promotion, financing and Development of the MSME sector. After from extending financial assistance to the sector, it coordinates the functions of the institutions engaged in similar activities. SIDBI’s major operations are in the areas of

a. Refinance assistance b. Direct Lendingc. Development and support services

3. Commercial Banks are important channels of credit dispensation to the sector and play a pivotal role in financing the working capital requirements, besides providing term loans.

4. At the state level, State Financial Corporations (SFCs) and twin function State Industrial Development Corporations (SIDCs) are the major source of Long term funds.

5. Recognising the importance of the easy and adequate availability of finance in sustainable growth of the MSMEs sector, the government has announced a “Policy Package for Stepping up credit to

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MSMEs sector”, with the objectives of doubling the flow of credit to this sector within a period of five years and banks have been accordingly directed to ensure that there is at least a 20% year on year growth in credit to MSMEs in order to double the credit in five years.

6. The banks have also been directed that each rural and semi-urban branch should provide credit cover to at least five new micro/small/medium enterprises including agro-rural industries and artisans per year.

7. Faced with the increased competition on account of Globalisation. MSMEs are beginning to move from bank credit to variety of other specialised finances and options. In recent years, the sector has witnesses increased flow of capital in the form of primary/secondary securities market, venture capital and private equity, external commercial borrowings, factoring services etc. More advanced MSMEs have started realising the importance of these alternative source of finance and the consequent need for adopting better governance norms to take advantage of these funding sources.

8. Efforts are on to put in place Limited Liability Partnership Act so as to provide a thrust to MSMEs in their move towards corporatisation.

Delayed Payments

The MSMED Act has provisions to safeguard the interest of SMEs by putting penalty clauses on Delayed payments. When the buyer of goods fail to make the payment of the amount to the supplier with in the period of Forty Five days, the buyer shall be liable to pay the compound interest to the supplier on the amount with the monthly interest at three times of bank rate. The amount of Interest paid by the buyer is disallowed as deductions under the IT Act. The Act also has the provisions for the establishment of the MSE facilitation council for dispute resolution within a framework in ninety days. The Act has provisions/ Clauses for credit facilities (as per the guidelines or instructions issued by the RBI), procurement preference policy, funds, grants by the Central Government and administration and utilization of funds.

Performance and Credit Rating Schemes

As per the schemes approved by the Government of India and launched in April, 2005 for performance and credit rating of manufacturing MSEs, the National Small Industries Corporation (NSIC) empanels credit rating Agencies for rating of small enterprises engaged in manufacturing activities. The rating schemes aims at helping them in accessing credit from banks faster and at competitive terms. The Government of India also provides subsidy to these enterprises for getting rated to the extent of 75% of the charges/ fees paid to the rating agencies subject to a maximum of Rs. 40,000.

Growth and Performance of Micro, Small and Medium Enterprises (MSMEs)

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The micro, small and medium enterprises (MSME) sector contributes significantly to the manufacturing output, employment and exports of the country. It is estimated that in terms of value, the sector accounts for about 45 per cent of the manufacturing output and 40 percent of the total exports of the country. The sector is estimated to employ about 59 million persons in over 26 million units throughout the country. Further, this sector has consistently registered a higher growth rate than the rest of the industrial sector. There are over 6000 products ranging from traditional to high-tech items, which are being manufactured by the MSMEs in India. It is well known that the MSME sector provides the maximum opportunities for both self-employment and jobs after agriculture sector.

Product Contribution (in %)Food Products 22%Chemicals & Chemical Products 12%Basic Metal Industry 10%Metal Products 8%Electricals and Machinery Parts 6%Rubber & Plastic Products 6%Others 36%

SME Banking and Bank of Baroda

The Small and Medium Enterprises segment is a vital component of Indian Economy. This Sector accounts for around 40% of the Total industrial production, 34% of industrial exports and 95% of Industrial units and 35% of total employment in manufacturing and services sector within the SME segment is quite significant, especially the IT enabled services, Hospitality services, Tourism, Couriering, Transportation, etc.

To give a focused attention to emerging SMEs in India, the Bank has been considering other commercial units with a turnover upto Rs. 150 crore at par with the SMEs. To promote the growth of SME sector, the bank has launched a special and a novel deliver model, viz. SME loan factory, which at present, is made operational in 36 centres of the Bank and well accepted in the market place. The SME loan Factory is an innovative model for streamlining processes and for timely sanction SME loan proposals. The model Comprises of the Central processing cell for Speedy appraisal and sanctioning of proposals within the stipulated deadline and a sales team to follow up on leads generated by the branches. Going by the past success, the bank is planning to open more such loan factories in the issuing year. The bank has SME loan Factories at all major business centres across the country viz. Agra, Ahmedabad, Banglore, Bareilly, Bhilwara, Bhubaneswar, Bulsar, Chandigarh, Chennai, Coimbatore, Dehradun, two factories in Delhi, Hyderabad, Indore, Jaipur,

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Jamshedpur, Jamnagar, Jodhpur, Kanpur, Kolhapur, Kolkata, Lucknow, Ludhiana, 3 factories in Mumbai, Nagpur, Nashik, Pune, Rajkot, Raipur, Surat, Varanasi, and Vishakhapatnam. These SME loan factories together Sanctioned loans aggregating Rs 14530 crore during 2010-2011 lac against Rs 11071 crore in the previous year.

Products for SME Borrowers

Baroda Vidyasthali Loan Baroda Arogyadham Loan Baroda Laghu Udyami Credit Card Baroda Artisans Credit Card (BACC) Technology Upgradation Fund Scheme (TUFS) for Textile and Jute industries Collateral Free Loans Under Guarantee Scheme of Credit Guarantee Fund trust for Micro

and Small Enterprises SME Short Term Loans Baroda SME Gold Card Scheme for Financing Energy Efficiency Projects Baroda Overdraft Against Land and Building Prime Minister’s Employment Generation Programme (PMEGP) Composite loans Credit Linked Capital Subsidy Scheme (CLCSS) For SSI UnitsLoans under Interest

Subsidy Eligibility Certificate Scheme of Khadi & Village Industries Commission (KVIC-ISEC)

ROLE OF PUBLIC SECTOR BANKS IN SME FINANCING

Banks are playing a major role in financing SMEs in India. Nearly 82% of the total SME financing in year 2006-07 is through banks. And among them the major share is of public sector banks i.e. 57%. Thus it is clear that the most common source of finance for SMEs is Bank Financing. There is no. of banks that help in assisting the SMEs for financing. The main channel used by the SMEs via Banks is Specialized loans by various Banks. The Main reason for choosing bank loans by SMEs compared to other sources of financing like venture capital, PE funding etc is that is only interest to be paid no stake is to be diluted thus the whole command of the SME is with the owner only. There are a number of Private as well as Public sector banks who assist SME in Financing

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OTHER - 18%

PUBLIC SECTOR BANK - 57%

PRIVATE SECTOR BANK - 25%

Sources of SME Finance

The role of Banks, in general, has become very important in the above context The SME sector’s demands were comprehensively taken care of by the Public sector Banks through several initiatives such as:Single Window dispensation,Quick decision with least Turnaround Time through specially constituted SME Cells, and above all,Better service. Cluster-based Schemes are also on the list of the Bank’s initiatives. The Bank prioritized the following more particularly:-

Provision of timely and adequate credit to the SMEs, Encouraging Technology Up gradation, for better quality and competitiveness of their product(s), and Proactively detecting sick and viable units in time so as to nurse them back to health through appropriate re-structuring. Financing of Clusters with adequate and concessional Bank finance on liberal terms in several pockets for specified activities concentrated in these pockets, which would result in reducing transaction cost and greater economies of scale.

Some Public sector Banks offering SME financing schemes are as follows:State bank of India and its subsidiaries IDBI BankCentral Bank of India Bank of IndiaAllahabad Bank Punjab & Sind BankOriental Bank of Commerce Canada BankBank of Baroda Indian Bank

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Schemes for Capital Investment

· Term loan for acquisition of fixed assets· Standby credit for capital expenditure· Standby term loan scheme for Apparel Exporters· Loan scheme for reimbursement of investment made in fixed assets by SMEs· Soft loan scheme for Solar Water Heaters· Scheme for Energy Savings for SMEs· Technology Up gradation Fund scheme (TUFS) for textile & jute industries in SME sector· Credit linked capital subsidy scheme (CLCSS)· Loans under Interest Subsidy Eligibility Certificate (ISEC) Scheme of Khadi & Village Industries Commission (KVIC) to eligible institutions

Schemes for Working Capital

· Simplified Open Cash Credit (SOCC)· Open Cash Credit (OCC)· Micro financing joint liability groups (Handloom weaver & Agarbathi manufacturer groups)· Laghu Udhyami Credit Card (LUCC)· Bill of Exchange discounting facility to Small Entrepreneurs at concessional rate of interest (BE-SE)

Working Capital Assessment

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Apart from financing for investing in fixed assets, every business also requires funds on a continual basis for carrying on day to day operations.

The working capital comprises of:

Amount for raw materials of various kinds Amount for stock in process Amount for all finished goods in stores in transit Amount of receivables or sundry debtors Other routine expenses

While part of the raw material may be purchased by credit, the business would still need to pay its employees, meet manufacturing & selling expenses (wages, power, supplies, transportation and communication) and the balance of its raw material purchases. Working capital refers to the source of financing required to by businesses on a continual basis for meeting the short term needs.

Means to finance the working capital are-

Credit available on purchases

Surplus of long term funds over the long term uses (NWC)

Assessment of working capital requirement

Maximum Permissible Bank Finance (MPBF) Method

Under this method the borrowers requirements are assessed based on the past practice/holding levels while the projections should be reasonably conform with the past trends, deviations can be accepted subject to satisfactory justification. This method is called as Tandon Committee Method of lending. It is applicable for working capital requirement of the borrowers coming under the following categories:

For SSI borrowers: Rs. 5 crores and above but less than Rs. 50 crores

For non SSI borrowers: Rs 1 crore and above but less than Rs. 50 crores

Method to calculate Maximum Permissible Bank Finance (MPBF)

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Particulars AmountTotal Current Assets (1)Less: Current Liabilities(Other than Bank Borrowings)(2)Working Capital Gap(3)Actual/projected bank borrowing(4)Total Current liabilities(2)plus(4) {5}25% of total current assets{6}Actual/projected NWC(1)-(5) {7}Minimum stipulated margin 25% of Current Assets/Projected NWC (whichever is higher){8}MPBF(3)-(7)Excess borrowings, if any

Financial Performance Assessment

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Balance sheet Analysis

Key points to be checked in financial statement:

Type of statement: Examine whether financial statement is audited or unaudited. If the report is audited study the auditor certificate.

Nature of activity: Engaged in trading or manufacturing activity or services, what kind of the products the company dealt in. If it is a software industry does it have a technical component and skilled manpower.

Series of statement: Examine the financial statements important factor to note the trend has taken place from one year to another year for the last 2 to 3 years to know about the trend in the performance of the firm.The Accounting policy which the organization is following. Whether depreciation is charged on WDV {written down value} method or using SLM {straight line method}

Qualities of assets/ liabilities: a financial statement, which is based on accounting standard, however not shows the quality of assets and liability. The banker should therefore to check on periodical checking, quality control certification like ISO certification.

Unit wise result: the company which has diversified business should ask to produce activity wise financial statement for the better understanding.

Director’s report: finally a director report of the company should study which shows the company future plans, new initiative taken by the company etc.

Credit Rating

What is Credit Rating?

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An assessment of the credit worthiness of individuals and corporations. It is based upon the history of borrowing and repayment, as well as the availability of assets and extent of liabilities.

R.B.I. has given considerable emphasis on having a proper risk rating in place as a credit rating system is considered as an instrument that helps the bank in:

Measuring the Credit Risk at the transaction level. Pricing the Credit Risk Providing triggers for action on Portfolio Management. Frequency of inspection.

Govt/ RBI had advised that banks may indicate necessary steps to rationalize the cost of loans to SME sector by adopting a transparent rating system with cost of credit being linked to the credit rating of the Enterprise.

a.) Large Corporate model (Domestic/ ECBs/ Syndicated Loans) (Funds/ Non- Fund based limits of Rs. 100 lakhs and above or turnover Rs. 5000 lakhs);

b.) Mid-segment model (Fund / Non-fund-based limits of Rs. 100 lakhs and above but not exceeding Rs. 500 lakhs and turnover below Rs. 5000 lakhs);

c.) SBS/SSI Model (Fund / Non-fund-based limits of RS. 10 lakhs and above but not exceeding Rs. 100 lakhs) scoring model)

The rating given by Credit rating agencies namely SMERA, CRISIL, Dun & Bradstreet (D&B), ONICA, ICRA, FITCH which have been approved by the National Small Industries Corporations, is also considered.

The credit rating technique used by the banks differs from bank to bank. As stated in the Basel committee reports the top management is responsible for framing the policy of bank. The common parameters, which are taken into consideration before preparing the credit rating module, are below.

Operational performance of unit. Sales trend during last 3 years. Profit trend during last 3 years. Achievement of sales projections. Achievement of profit projections. Net worth

CRISIL

Credit Rating and Information Services of India Ltd. (CRISIL) is India’s leading Ratings, Research, Risk and Policy Advisory Company based in Mumbai. CRISIL is India’s leading Rating’s, Research, Risk and

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Policy Advisory company and it make markets function better, and Help clients mitigate and manage their business & financial risks Help shape public policy.

External Credit Rating System (NOT ELIGIBLE UNDER BASEL II NORMS OF CAPITAL ADEQUACY)

Small Enterprises borrowers are rated by few external credit rating agencies. In Case of MEs , some of the borrowers are getting their accounts rated by external credit agency like CRISIL etc. M/s. CRISIL, the pioneer of independent credit rating agencies in India, has entered into an agreement with M/s. National Small Industries Corporation who has recently introduced a credit rating scheme for encouraging units to get them rated by reputed credit rating agencies. Our Bank has entered into MOU with credit rating agencies viz: M/s CRISIL, Dun & Bradstreet, SMERA to get our SME borrowers rated.

External Credit Rating System (UNDER BASEL II NORMS OF CAPITAL ADEQUACY)External Credit Rating should be carried out in all SME loan accounts with credit Limits of above Rs 5 crores by any one of the RBI approved external credit rating agencies. Presently ICRA, CARE, CRISIL and FITCH are the only Reserve Bank of India approved external credit rating agencies in India. The exposure to SME borrower rated by any of these rating agencies will be recognized as rated exposure for the purpose of computation of Risk Weighted Assets under Standardized Approach of credit risk under Basel II guidelines. Pricing be continued to be linked to our internal credit rating system. However due weightage will be given for the external credit rating by the external rating agency. Detailed guidelines on credit rating are covered under Loan Policy.

Credit Appraisal Procedure

1. Details from clients2. Pre-sanction Inspection3. Preparation of Proposal4. Sanction5. Documentation & creation of charge6. Credit process audit7. Post sanction Pre Disbursement Insp.8. Disbursement9. Repayment10. Monitoring/ review

The project undertaken is lending to Indian SMEs. The project emphasizes on understanding the procedure and process used by the Bank of Baroda to assess the credit worthiness of the borrower. Small scale industry in India is booming and contributing to 40% of GDP, many banks are focusing

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their attraction towards this sector. The credit appraisal process is the scientific way of giving the credit to corporate client by analyzing the credit worthiness of the company through different parameters.

The advances to SME starts with Understanding the need of loan to the borrower i.e. for which purpose the loan is required. After this next step is to analyses the financial statement of the company to whom the loan is to be sanctioned. The main things which are taken into consideration which analyzing the financial statement are type of statement, nature of activity, accounting policy, qualities of assets and liabilities, unit wise performance result of the company & director’s report. After analyzing the financial statement the second step is to study the principle given by Basel committee on banking supervision which basically Indian banks have to be followed as per the order by Reserve Bank of India. The third step is to analyze the key financial ratios of the company such as: Leverage ratio, liquidity ratio, profitability ratio, turnover ratio, inventory norms.

The next step is to understand the methodology used to determine the credit rating. Since the credit rating methodology differ from bank to bank in term of the weight age given to the parameters but the parameter used by the banks to assess credit worthiness are almost same to all company.

The banks mainly provide two types of credit facility known as term loan and working capital loan. The working capital loan is given by MFBF method. Term loan is the loan given by the company for a long term generally more than one year and less than 10 years to company.

The sensitivity analysis is used to check the company ability to pay back the loan by changing the independent variables and consequently monitoring the effect on dependent variables. The last step is to understand the classifications of NON PERFORMING ASSET and the provision to recovery of NPA. The research report contains the whole procedure & process which is used by the bank to give credit to SMEs.

Credit Process Audit

The objective of CPA is to ensure that the disbursing officer, before parting with the Banks funds, has taken all necessary measures for creation of security and safety. Further, the

purpose of CPA is to ensure verification of compliance of pre-disbursement terms of sanction by an independent officer, not connected with the sanction/ disbursement who is expected to point out deficiencies, if any, in compliance at right time so that corrective measures can be taken immediately to avoid possible damage.

Scope of CPA

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Credit Process Audit shall be carried out in all accounts – existing as well new accounts with aggregate fund based and non-fund based limits of Rs. 50 lakhs & above before disbursement of new/additional limit. However, it will not be applicable for release of adhoc/ over limit/ one time facility unless otherwise specified by the sanctioning authority. Review proposals with same limits/ reduction in limits without any other change in major terms shall not fall within the purview of CPA.

Credit Process Audit shall be carried out by a Credit Process Officer. The designated CPO could be an officer fairly acquainted with credit & may be drawn from Zonal Office/ Branches or even from audit office.

Risk Associated with Bank Lending

Banks mainly faces three kinds of risk which has impact on profitability of the bank. These risks are:

Credit risk Market risk Operational risk

Credit risks basically is the major risk which is faced by the bank on account of their business activity, which including the lending to corporate world, individual bank, another bank or financial institution.

Credit risk is of two types

Borrower risk Portfolio risk

Borrower risk may be the possibility of that a borrower will fail to meet his financial obligations in accordance with agreed term.

Portfolio risk arises due to credit concentration / investment concentration i.e. most of the credit is given to only one type of group and the possibility of default.

Market risk is the variability in the profitability of the firm due to change in market variables. This is mainly of three types.

Interest rate risk

Exchange rate risk

Interest rate risk: the risk in the erosion of earning due to variation in the interest rate within the time period is referred as interest rate risk.

Exchange rate risk: this risk is of two types:

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Transaction risk Translation risk

Transaction risk is the risk basically arises due to fluctuation in the price of a currency, upward or downward ; result in a loss on a particular transaction.

Translation risk in a situation of a translation the balance sheet of a bank affected adversely due to exchange rate movement and change in the level investment or borrowing in foreign currency even without having translation at a particular time.

Liquidity risk arises out of the possibility that would not be able to meet its financial obligation as they become due for the payment. The risk basically arises due to mismatch between the cash inflow or outflow of the funds or funding the long term asset by short term liability. Surplus liquidity also is the loss to the banks as the money is not used to raise the income to the bank.

There are many indicators of Credit Risk Problems which show the risk in bank lending. Generally, high level of non-performing assets of the bank or Heavy provisions shows the greater risks. This can be also assessed through the balance sheet and p/l account of the company. It is red indicator to the bank which shows that bank has one of the problems with the credit policy.

1. Generally an indicator of poor quality of a credit portfolio.2. Implies poor risk selection and/ or poor credit monitoring.3. Very rapid expansion of credit portfolio size.

It is not necessary that an above indicator of problems always be true but it often reflect future problem.

Details collected from clients

Opening of New A/C (new or existing in other banks) and Review of Existing A/c

Company’s Promoters and Management Details

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Bio-data of promoter/s and guarantor/s. Details of Managerial Personnel: Names of Directors/ Partners, their addresses and their

PAN, Customer-IDs, if any. (Minimum of ten directors/ partners). Statement of Assets and Liabilities, certified by a Chartered Accountant, for past 3 years in

respect of promoter/s and guarantor/s.

Financial Data of the Company

Audited balance sheets and Profit & Loss Account of the proponent concern for past 3 years. Equity / capital details Credit facility sanctioned / availed by/ from other banks/ Financial institutions. Projected profitability and balance sheet details (min for the next 2* years) Projected cash flows & fund flow

Non- Financial Details

Copies of Memorandum of Association and Articles of Association (for limited companies).

List of shareholders holding 5% or more in equity. Note on Company’s tax payment status. Copies of letters of sanction from Banks/ Financial Institutions participating in financing

the project and working capital requirements.

Additional Project Details

Project Feasibility Report. Installed and licensed capacities Date of commencement of business/ project Competitor’s details Industry trends

Pre-sanction Inspection

Visits:

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Along with the collection of information and documents from the borrower. The bank official conducts a pre-sanction inspection at the borrower factory and office site. The purpose of this inspection is to view the operations of the borrower company and to verify the accuracy of the details provided by the borrower. The observations during the visit include the following.

General working of factory / tempo of activity. Power / fuel supply. Idle machinery. No. of shift worked. Labour / Employee situation. Pollution Control Certificate. Details provided by the borrower during the discussion. Other observations during the visit.

CIBIL Report

Another Important thing in Pre-sanction Inspection is the CIBIL Report which is been issued by the Credit Investigating Bureau. The aim of CIBIL’s Commercial Credit Bureau is to minimize instances of concurrent and serial defaults by providing credit information pertaining to non-individual borrowers such as public limited companies, private limited companies, partnership firms, proprietorships, etc. CIBIL will maintain a central database of information as received from its Members. CIBIL will then collate and disseminate this information on demand to Members, in the form of Commercial Credit Information Reports (CIR) to assist them in their loan appraisal process.

CIBIL primarily gets information from its Members only and at a subsequent stage will supplement it with public domain information in order to create a truly comprehensive snapshot of an entity’s financial track record.

The CIBIL Report contains the following information:

Basic borrower information like:

Name Address

In case of individuals:

Identification numbers Passport ID Voters ID

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Date of birth

In case of non-individuals

D-U-N-S® Number Registration Number Legal Constitution Records of all the credit facilities availed by the borrower Past payment history Amount overdue Number of inquiries made on that borrower, by different Members Suit-filed status.

Verification of Documents:

The due diligence report about the documents submitted is also made. In this report all the documents are verified and thoroughly checked and authenticated. It is important to see that all the necessary documents submitted are true. The Bank officer checks with the respective authorities that the document submitted initially are true and okay. Also the validity and dates of the document are to be noted.

THE DIMENSIONS OF CREDIT APPRAISAL

Managerial Appraisal Technical Appraisal Commercial Appraisal Financial Appraisal

Managerial Appraisal

Bank ascertains that proponent has requisite experience and strong desire for entrepreneurship.

Following items should be noted when assessing management:

1. Quality and depth of management, particularly the promoters.2. Experience, qualifications, and capability.3. Succession and back up plans.

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4. Management style i.e. conservative centralized/ decentralized approach, organization culture, and corporate strategy.

5. Career progression, training and development policies.6. Personnel policies & Training, motivation, morale, besides staff quality.

Technical Appraisal

Whether the necessary physical facilities – like machinery, raw material, utilities, etc.; which are required for production are available and the best possible alternative is selected to procure them. Technical appraisal of a project will ensure that the necessary physical facilities required for production would be available and the best possible alternative is selected to procure them.

Commercial Appraisal :

Ascertains marketability of product at a profitability price. It ensures that there exist demand for the product and product can be profitably sold.

The gateway to profits is sales. The success of the business depends on whatever we produce should be converted we can sell. A unit with excellent facilities of production may incur losses if it is not able to sell its product.

It is rightly said, “It is easier to own a factory, but different to own a market.”

Many entrepreneurs come to bank with the proposal to produce whatever they can; without giving due consideration to the marketability of the proposed product. In most of cases the proponents do not proved sufficient and reliable information and the project report appears with general and vague remarks like ‘market is good’ and ‘demand is plenty’. This statement may be acceptable when the product is in initial stage of industrialization or when the product is in initial stage of industrialization or when the product is substituting imports. However, in case of product with highly competitive market, such approach would only result in lending or supporting wrong investment decision which would in turn lead to problems both to the entrepreneurs as well as term lending banks and also it will lead to misuse of scare resources.

So, a project is commercially viable only if it able to sell its production at a profit. In order to have proper appraisal of the demand forecast made by borrowers the lending institutions would require information regarding demand, supply distribution, and pricing and external forces.

Financial Appraisal

Ensures availability of financial resources in time, it also ascertains that business generate sufficient funds to service the debt and other stakeholders.

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To evaluate a project from the financial angle, the availability of following information is requires:

1. The cost of the project.2. The source of finance.3. Estimation of sales and production.4. Cost of production.5. Working capital requirements.6. Break-even point.7. Projected cash flow statements.8. Projected balance sheet.9. Ratio Analysis.

Security:

Along with above dimensions, Security, alternate resource of payment is also evaluated while making investment decision.

If after such evaluation, project is accepted, a final letter of sanction is issued to the borrower. This communicates to the borrower the assistance sanctioned and terms and conditions relating thereto and when they are accepted loan amount is disbursed as per the requirement.

Preparation of proposal

There is an immense competition amongst Banks/ financial institutions to grab quality credit portfolio which has resulted in Borrowers seeking speedier decisions on credit requests.

Important points for making a proposal are as under:

1. Latest audited financials with details of performance during current year is required.

2. Value of security-collateral: Details of collateral proposed i.e. valuation, basis, and ownership. In case of proposed mortgage availability of original title deed and necessary

permissions to create mortgage. Fresh valuation in case the existing valuation is old more than 3 years.

3. Position on account with asset status with other banks needs to be checked.

4. Latest worth of partners/ directors/ guarantors (separate details of assets, liability and net worth) and basis for the same.

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5. Satisfactory reasoning / comments in case of performance vis-à-vis estimates.

6. Credit rating exercise should be done in proper format and allotting the correct marks.

7. All the facilities provided to the borrower by the bank should be mentioned with existing and proposed limits. The outstanding amount, overdue (if any) and Rate of interest is to be mentioned.

8. Comments in brief on financial position / Audit Report / Contingent Liabilities.Comments on Net sales, net worth/capital, and profitability (net profit/ net sales), current ratio, debt-equity ratio, debt-service coverage ratio, interest service coverage ratio are important to know the borrowers’ conduct of the business

9. Security: Principal security can be hypothecation of book debts, machinery and equipments, TDR etc. Collateral security can be the mortgage of the flat, shop, factory etc.

10. Repayment schedule of the facility provided needs to be written in the proposal with details like No. of instalments, amount, Initial moratorium period and date of commencement.

11. Valuation of security is done and is valid up to 3 years, date of valuation and whether the charge is pari-passu / second charge over should be mentioned.

12. Scores from CIBIL (Credit information bureau (India) Ltd) of the borrower is taken to get the information about enquiries and facilities taken. Here, if any of the account is written off then bank needs to enquire about it.

13. Insurance policy is to be obtained of the hypothecated security/ mortgaged security.

14. Auditors report and their comments also form part of the proposal.

Documentation

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Once the credit limits are sanctioned main documents are obtained from the client concerned. The nature of documents varies depending upon the type of facility sanctioned and terms of sanction. They may include one or more of the following-

Statement of Assets and Liabilities

Demand promissory note

Pay bearer letter

Instalment letter- stating that the borrower will pay the EMIs regularly

A document for request for lending the facility, the borrower agrees that he has no relatives working in this (lending) bank.

Unstamped letter of set-off and appropriation of TDR/ Cash Margin

General counter guarantee and indemnity covering several guarantees within sanctioned limit.

A document stating that the borrowed amount will be used for the same purpose as requested.

Hypothecation cum loan agreement (Plant & machinery, stocks & book debts)

A term loan agreement

Acknowledgement of debt and security from borrower/s, guarantor/s

Stamped L/C application form

Exchange control copy of Import license

Enter guarantee if guarantees issues on casual basis

Personal guarantee of the borrower and guarantor (if any)

Search report form an Advocate indicating a clear title for the last fifteen years as per the land records.

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Approved building plans in case of constructed property.

Insurance / contingency insurance policy.

CHALLENGES OF THE SMEs

Most SMEs die within their first five years of existence. Another smaller Percentage goes into extinction between the sixth and tenth year thus only about five to ten percent of young companies survive, thrive and grow to maturity.

Many factors have been identified as to the possible causes or contributing factors to the premature death. Key among this include insufficient capital, lack of focus, inadequate market research, over-concentration on one or two markets for finished products, lack of succession plan, inexperience, lack of proper book keeping, lack of proper records or lack of any records at all, inability to separate business and family or personal finances, lack of business strategy, inability to distinguish between revenue and profit, inability to procure the right plant and machinery, inability to engage or employ the right caliber staff, plan lessness, cut-throat competition, lack of official patronage of locally produced goods and services, dumping of foreign goods and overconcentration of decision making on one (key) person, usually the owner.

Other challenges which SMEs face in India include irregular power supply and other infrastructural inadequacies (water, roads etc) unfavorable fiscal policies, multiple taxes, levies and rates, fuel crises or shortages, policy inconsistencies, reversals and shocks, uneasy access to funding, poor policy implementation, restricted market access, raw materials sourcing problems, competition with cheaper imported products, problems of inter-sect oral linkages given that most large scale firms source some of their raw material outside instead of sub contracting to SMEs, insecurity of people and property, fragile ownership base, lack of requisite skill and experience, thin management, unfavorable monetary policies, lack of preservation, processing and storage technology and facilities, lack of entrepreneurial spirit, poor capital structuring as well as poor management of financial, human and other resources.

Their characteristics and the attendant challenges not withstanding, it is the consensus that SMEs, which globally are regarded as the strategic and essential fulcrum for any nation’s economic development and growth have performed rather poorly in India. The reason for this all-important sector’s dismal performance have been varied and convoluted depending on who is commenting or whose view is being sought. For sure it has nothing to do with government’s appreciation of the vital central role of the sector as evidenced by how well SMEs have been acknowledged and orchestrated

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in various government’s budget, with the imperativeness of SMEs as the bulwark for employment generation, poverty reduction and technological development being highlighted. While many attribute the relatively poor performance of SMEs in India when compared with the significant roles which SMEs have played in developed economies such as the United Kingdom, Germany and the United States and even developing countries of the world like India to the challenges outlined above, some others hinge the reasons on the fair share of neglect on the sector by the government. The latter group argues that government’s appreciation of the SMEs in capacity building has always been restricted to the pages of the budget presentations and submissions at various fora.

Essentially, they argue that poor budget implementations over the years account for the unsavoury impacts of SMEs on the India economy, which has had a record sluggish growth and declining future as measured by the population of India becoming literate, having more access to better health care, shelter, food, and other necessities of life such as access to more and better paying jobs as well as declining per capita income. Other parameters usually used to measure the performance of SMEs include percentage of working population employed by the SMEs in a given country or economy, the percentage contribution to the country’s GDP, managerial and technical capacity building, percentage of revenue internally generated or percentage of total PAYE accruing to the government from the SMEs employees, years increases in average household income, etc.

This research is intended to critically appraise and analyse the operating environment and circumstances of SMEs in India with a view to actually identifying why they (SMEs) are not playing the vibrant and vital roles in the Indian economy as they (SMEs) do in other economies such as Nigeria which has so many similarities with Nigeria in terms of population and other demographic variables. This is even more disturbing if one recalls that Nigeria remains the largest market in the African continent where investment opportunities are beckoning to be exploited.

21. PROBLEMS OF SMEs IN INDIA:-

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1. Inadequate, inefficient, and at times, non-functional infrastructural facilities, which tend to escalate costs of operation as SMEs are forced to resort to private provisioning of utilities such as road, water, electricity, transportation, communication, etc.

2. Institutional and Legal Factors

In the case of many developing countries, the abovementioned obstacles to SME financing are exacerbated by institutional and legal factors. First, many developing countries still have highly concentrated and uncompetitive banking sectors. This is often the result of restrictive government regulations. This reinforces the tendency to adopt very conservative lending policies or to charge high interest rates. If banks can thrive with a stable pool of well-established clients, they have no real incentive to improve the range of financial products— and, in particular, no incentive to go down market, to meet the needs of small businesses. The same is true if banks can make hefty profits simply by buying government debt—as is often the case in Latin American countries—which results in the ‘crowding out’ of small-scale lending. Second, insufficiently developed legal systems effectively prevent the development of certain financing instruments, including the use of collateral as a risk-mitigating element. For instance, legal provisions regarding security interests (how the collateral is protected, how the collateral priority is determined, etc.) are of crucial importance in determining the efficacy of collaterals.

Likewise, if company laws offer only limited protection to minority shareholders, the development of venture capital and angel financing is inevitably negatively affected. These problems were particularly severe at the beginning of the transition period in former socialist countries, when even the memories of certain fundamental market institutions had disappeared. Third, even when adequate legislation is available, there are often problems with enforcement. Today, transitional and developing economies often have cadastres and registers of movable assets. Nevertheless, their functioning is often less than ideal. Records are frequently missing or misplaced. There are lengthy procedures for filing mortgages and pledges, and for ascertaining the status of certain assets. There are often cases of corruption among personnel. Fourth, the “information infrastructure” is still largely undeveloped.

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There is a lack of credit bureaus and other mechanisms for collecting and exchanging information on payment performance. This inevitably exacerbates the informational asymmetries between enterprises and lenders/ investors. While some of the above institutional constraints apply to all enterprises, it is clear that small businesses are likely to suffer disproportionately from their presence.

3. Transaction Costs

Irrespective of risk profile considerations, the handling of SME financing is an expensive business. The cost of appraising a loan application—or of conducting a due diligence exercise in view of a possible equity investment—is largely independent from the size of the financing under consideration. For all practical purposes, the following costs are fixed: (i) administrative costs; (ii) legal fees; and (ii) costs related to the acquisition of information, such as the purchase of a credit profile from a specialized agency. In the case of smaller loans or investments, it is more difficult to recoup these costs. Similar considerations apply to the costs that outside financiers must incur after disbursement, when conducting field inspections, or attending board meetings. Again, the problem is more severe in developing countries for the following reasons:

(i) the lack of adequate management information systems in financial institutions; (ii) the undeveloped state of the economic information industry; and (iii) the poor state of certain public services, such as the registration of property titles and collaterals. To some extent, the problem can be solved by raising the cost of financing through a higher interest rate or closing fee. This is indeed theapproach adopted by many micro lending schemes, but it is possible only up to a certain point

4. Discrimination from banks, which are averse to the risk of lending to SMEs especially start-ups because of Lack of CollateralIn the case of debt financing, lenders typically request collateral in order to mitigate the risks associated with the ‘moral hazard’. The lack of collateral is probably the most widely cited obstacle encountered by SME in accessing finance. The amount of collateral required in relation to the loan size is a measure frequently adopted to empirically assess the severity of the financing gap. In some cases, the enterprise may be unable to provide sufficient collateral because it is too new—because it is not firmly enough established. That problem is closely related to the ‘higher risk’ argument presented above. In some cases, the lender may deem the collateral insufficient in view of the size of the loan requested. In other words, the proposed expansion project may be too large in comparison with the current size of the firm. Again, this is an issue related to the ‘higher risk’ argument presented above. In other cases, the collateral may be insufficient simply because the managers-owners tend to siphon off resources from the company for personal or other purposes. Again, this is closely related to the risk profile and the moral hazard issues. Lack of collateral can be viewed more as a symptom than as a direct cause of the difficult relations between SME and providers of finance. Whatever the sequence of causes and effects, it is widely acknowledged that in developing countries the issue of collateral is comparatively much more severe. The following

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section examines how the undeveloped state of institutional and legal frameworks, prevents the possibility of pledging the owned assets as collaterals.

6. Another approach ascribes the difficulties faced by SME in accessing finance to their higher risk profile. Suppliers of external funds regard SME as riskier enterprises for a number of reasons. First, SME face a more uncertain competitive environment than larger companies—they experience more variable rates of return and higher rates of failure. Second, SME are comparatively less equipped in terms of both human and capital resources to withstand economic adversities. Third, there is the problem of inadequate accounting systems, which undermines the accessibility and reliability of information concerning profitability and repayment capacity. In developing countries, there is the added problem of a more volatile operating environment, which has a negative impact on the security of transactions. There is a greater risk that lenders/investors will not get paid, or that assets will not be properly registered.

7. Lack of access to appropriate technology as well as near absence of research and development

8. High dependence on imported raw materials with the attendant high foreign exchange cost and scarcity at times

9. Weak demand for products, arising from low and dwindling consumer purchasing power aggravated by lack of patronage of locally produced goods by the general-public as well as those in authority.

10. Unfair trade practices characterized by the dumping and importation of substandard goods by unscrupulous businessmen. This situation is currently being aggravated by the effect of globalization and trade liberalization, which make it difficult for SMEs to compete even in local/home markets. A good example can be given of chinese product which are very cheap in price as compare to Indian product that are dumped into the Indian market . This unfair trade practice because it is reuning the Indian product and giving tough competition .

11. Weakness in organization, marketing, information-usage, processing and retrieval, personnel management, accounting records and processing, etc. arising from the dearth of such skills in most SMEs due to inadequate educational and technical background on the part of the SME promoters and their staff.

12. High incidence of multiplicity of regulatory agencies, taxes and levies that result in high cost of doing business and discourage entrepreneurs. This is due to the absence of a harmonized and gazette tax regime, which would enable manufacturers to build in recognized and approved levies and taxes payable.

13. Widespread corruption and harassment of SMEs by some agencies of government over unauthorized levies and charges

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14. Absence of long-term finance to fund capital assets and equipment under project finance for SMEs

15. The lack of scientific and technological knowledge and know-how, i.e. the Prevalence of poor intellectual capital resources, which manifest as:

i. Lack of equipment, which have to be imported most times at great cost (capital flight) and which would require expatriate skills to be purchased at high costs.

ii. Lack of process technology, design, patents, etc., which may involve payment of royalties, technology transfer fees, etc. and heavy capital outlay.

iii. Lack of technical skills in the form of technological and strategic capability

iv. Inability to meet stringent international quality standards, a subtle trade barrier set up by some developed countries in the guise of environmental or health standards. A relevant example is the impending ban of marine foods, vegetables, fruits and other agricultural products from Africa into the United States of America markets.

v. The inability to penetrate and compete favourably in export markets either because of poor quality of products, ignorance of export market strategies and networks or lack of appropriate mechanism and technology to process, preserve and package the products for export.

16. Lack of initiative and administrative framework or linkage to support and sustain SMEs’ development, which to a large extent, is also a reflection of poor technological capability or intellectual resource

17. Lack of appropriate and adequate managerial and entrepreneurial skills with the attendant lack of strategic plan, business plan, succession plan, adequate organizational set-up, transparent operational system, etc on the part of many founders and managers of SMEs in India. As fallout of this, many of the SME promoters purchase obsolete and inefficient equipment thereby setting the stage ab initio for lower level productivity as well as substandard product quality with dire repercussions on product output and market penetration and acceptance.

18. Lack of suitable training and leadership development. In spite of the fact that training institutions abound in India, they rarely address the relevant needs of SMEs especially in the areas of Accounting, Marketing, Information Technology, Technological processes and development, International trade, Administration and management of Small and Medium Enterprises. Essentially, SMEs are left most often on their own to eke out success amidst the avalanche of operational difficulties inherent in the India environment as well as the Operational shortcomings, which characterize institutions, set up to facilitate SME businesses

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Performance & Credit Scheme for Rating of Small Scale Industries

BACKGROUND

The Small Scale Sector occupies an important position in any developing economy the world over. Fast changing global economic scenario has thrown up many opportunities and challenges to the Small Scale Industries in India. While, on the one hand, many opportunities have opened up for the small scale sector to enhance productivity and look for new markets in other countries, it has also put an obligation on them to upgrade their competence in terms of technology, management & financial strength to successfully meet the global competition. Therefore, there is a need to create awareness amongst Small-Scale Units about the strengths and weaknesses of their existing operations and to provide them an opportunity to enhance their organizational strengths.

As a step in this direction, a need was felt for introducing a Rating Scheme for the Small Scale Industries. It is expected that the Rating Scheme would encourage SSI sector in improving its contribution to the economy by way of increasing their productivity, since a good rating would enhance their acceptability in the market and also make access to credit quicker and cheaper and thus help in economizing the cost of credit. Besides, the rating would also infuse a sense of confidence amongst the buyers for taking a decision on the options of sourcing material from Small Scale Units. With above background, a Performance & Credit Rating Scheme for Small Scale Industries has been formulated in consultation with various stakeholders i.e. Small Industries Associations, & Indian Banks’ Association and various Rating Agencies viz. CRISIL, ICRA, Dun & Bradstreet (D&B) and ONICRA. It has the approval of the Government.

Hardware necessities at branches slashed to a healthy minimum

IT infrastructure needs at each branch, for each of the disparate systems, across the various geographies was eating into the bank’s bottom line. On deployment of Finacle, the solution’s SOA-based architecture has enabled Bank of Baroda to transition processing from the branch to its common processing facility, eliminating the mandate for back-up infrastructure at branch level data centers. Today, the central processing center services the needs of the entire business. This has a clear positive cost implication for the bank’s multi-country new branch openings, as it looks at the world to map its presence rapidly and profitably.

Expediting branch-to-corporate reporting

Manual MIS reporting and the ensuing delays at Bank of Baroda’s branches, was increasingly being viewed as a deterrent for agile senior management response. The bank leveraged Finacle’s common application network to ensure branch-to-head office MIS reporting, in real time. An activity that consumed weeks is now complete within minutes, arming business decision-makers with timely data ammunition from across its transcontinental locations, to drive the bank towards greater success. Finacle reporting infrastructure also ensures that uniformity and consistency in reporting logic is maintained across the bank’s branches. A forward thinking flat world-ready bank will not lose an opportunity to harness technology to orchestrate its processes and enhance its agility. Bank of Baroda is exemplary in its strategy and operational tactics.

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Facilitating cross-country product introduction

Bank of Baroda has a rich repository of offerings that it constantly innovates with a bid to engage customers and grow market share. In a decentralized solution environment, these product offerings driven by a branch-specific solution were limited in scope to the country where they were first generated, and porting them to other countries posed several challenges. Bank of Baroda effectively deployed the unified solution environment that Finacle offered to migrate products from one country to another, easily and profitably. The bank leveraged the flexibility and agility that Finacle promised to port ‘ready-to-deploy’ products from one country. Today, Finacle implementation has played a pivotal role in the rapid introduction of an exhaustive product line and robust retail portfolio for Bank of Baroda in several geographies, like UK, Hong Kong, Singapore, and Johannesburg. This has helped the bank to respond to new opportunities presented by rapidly evolving customer segments, globally, and create entirely new customer experiences too.

Direct India remittance to delight customers

With its expanding global presence, Bank of Baroda leveraged its international network to service the remittance needs of NRIs, the world over. Disparate solutions across geographies often translated into seemingly unavoidable delays in remittance. The bank capitalized on the advantage that Finacle’s common technology platform offered to streamline and expedite its domestic payments channels for direct remittance to India. The STP from various countries to domestic Bank of Baroda branches in India has reduced the time of an average India remittance to just a few hours, today. The Rapid Funds Transfer services ensure an overseas customer’s reach to the remotest part of the home country. The proud provider of one of the fastest India remittances system, the Bank of Baroda has taken another crucial step towards offering increased value to its customers.

Bank of Baroda UK – the challenge

Bank of Baroda UK is the flagship territory, among the bank's international offices with 10 branches, and is a major treasury hub for the Europe region. The operations, quality expectation, regulatory requirements, business scenarios, all presented a daunting set of milestones that were to be covered to bring home the ‘UK advantage’ and then gear it up for further technology leverage. Correspondent banking operations on SWIFT was a major requirement that was to require minimal manual intervention. A straight-through processing (STP) module was implemented, which was specifically worked upon for UK. For treasury, a third-party solution went live along with Finacle. Interface for STB, the regulatory reporting partner with Finacle and treasury to take care of the stringent reporting requirements, added to the complexity of the entire implementation. The UK operations went live on November 12, 2007 on Finacle Core, and with each step the global implementation methodology playing a pivotal role in further enhancing the level of IT capability available to the operations. With IT operations shifting to the data center, the local host system was done away with, bringing UK in the loop of the one-solution advantage. The never-before visibility into the UK operations sitting from home presents the bank with the base to get all the pieces on board and be ready for the next level of banking transformation in the Europe region, or to take the Europe advantage into any of its international operations.

Bank of Bahrain: Straight out of the box

Bank of Baroda is charting a path of extensive global expansion for itself. The bank realized early on, that it had to leverage technology effectively to cut the risks, costs and time investment associated with initiating new

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branches. With the centralized ready-to-deploy Finacle solution rolled out across countries, technology infrastructure management was simplified. No additional hardware was required for Finacle deployment at a new branch. All parameters were easily based on the business requirements of the branch, taking into account country-specific mandates. Parameterization of the solution was completed offshore. The entire implementation operation was anchored by offshore staff in Mumbai. Bank of Baroda in Bahrain is a vivid showcase of this implementation strategy. A fully operational bank, powered by Finacle, was up and running in 19 days flat.

Reaping the benefits

A centralized robust technology platform, with a rich palette of features and proven scalability, is a non-negotiable prerequisite for a bank to thrive in the flattening world.

Banks with the vision to harness their technology strategy to drive their business goals will be the ones with the prowess and agility to respond to changing business dynamics in the flat world. Finacle has provided Bank of Baroda the positioning to effectively leverage technology, to accelerate its transition towards the flat world readiness.

Lessons for India

The exposure programme provided an opportunity to participants to look at SME financing from a different perspective. After noticing that in these developing countries, though SMEs face similar problems and banks also consider financing to them as risky proposition, banks and government are earnestly trying to promote, support and develop SMEs, the participants have formed an opinion that in India also banks have to provide them handholding services in addition to extending financial services. The other major take away for the bankers from India is that survival of SMEs during initial years of set up is more important than their profitability. They noted that it is not a compulsion under priority sector to finance to this sector, but a business opportunity for banks. Some of the important recommendations for effective SME Financing include establishment of SME unit in all banks, applying appropriate and simple evaluation techniques, promoting greater linkages and dialogues between FIs/banks/trade associations/and government agencies, improving information access to SMEs, promoting informal debtor-creditor workout mechanism for SMEs, developing alternative markets for SME financing , etc.

RECOMMENDATIONS AND STRATEGIESThe following are some of the practical recommendations that may be appropriate for adoption.

A. STRATEGIES FOR EXPANSION OR DIVERSIFICATION OF APPROPRIATE FINANCING FOR SME

1. Improve outreach of credit guarantee mechanismIn many of the countries with successful SME financing programmes (such as Japan, Chinese Taipei, Germany), credit guarantee mechanisms are a strong feature of the development framework. These guarantee schemes are usually well supported by government or industry funds. In Japan for instance, the credit guarantee corporations are present in every prefecture thus ensuring a wide outreach and there is a reinsurance mechanism to ensure their viability. Such strong support mechanisms are lacking in credit guarantee schemes in Thailand, Vietnam and India. Governments can look into improving the scope and outreach of their credit guarantee schemes. The credit guarantee schemes could be made available to all institutions involved in SME

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financing and sufficient funding of the schemes should be a key priority. One important element though is that successful credit guarantee schemes require appropriate risk sharing.

2. Promote greater engagement of Non-Bank Financial Institutions (NBFI) in SME lendingIn most countries, efforts to improve SME financing are still being pushed through the larger commercial and development banks. This is because these bank institutions generally dominate the banking sector. While these bank institutions may have greater resources, they do not necessarily have the outreach or inclination to lend to SME. Moreover, many of the larger bank institutions are too entrenched with corporate lending practices, have little experience in the middle and lower end segment of the credit market and have a biased view with regard to SME. On the other hand, non-bank financial institutions such as finance companies, rural or thrift banks and cooperatives may be more suited to SME lending as these NBFIs have more experience in lending to the SME sector given their traditional focus on retail and small business segments of the credit market. Moreover, many of the facilities available at NBFIs (such as factoring and leasing) are more suited to SME’ funding needs. Hence, promoting greater engagement of NBFIs in SME lending may bring about increased lending to SME. Authorities in the individual countries could facilitate greater involvement of NBFIs by providing them incentives such as tax deductions for certain expenses, branching privileges and capital allowances. At the same time, these incentives could also be provided to banking institutions to encourage greater SME lending. The authorities could also encourage banking institutions to link up with NBFIs where the latter can act as conduits in promoting bank facilities to SME.

3. Develop alternative markets for SME financingCountries, which have more developed financial markets, can look into developing the debt and equity markets as alternative sources of funding for SME. The existing listing requirements of equity exchanges catering to smaller companies are hardly SME-friendly. Debt markets in the region too are closed to SME. Access to these markets could be facilitated by relaxing requirements and lowering transaction costs for smaller enterprises. Alternatively, governments could assist institutions involved in SME financing (such as the credit guarantee corporations) to access 25 capital markets for funding. If the government could provide support such as direct or indirect guarantee, subordination or liquidity lines for bond transactions, these institutions would be able to raise long-term funds at a competitive rate to fund SME loans. Venture capital financing is another viable channel especially for start-up companies. However, in these countries, the venture capital industry is not well promoted as such. Perhaps, more incentives could be provided to venture capital companies whether public or private sector owned, to play an increasing role in SME financing.

B. STRATEGIES FOR INSTITUTIONAL STRENGTHENING OF FINANCIAL INSTITUTIONS

1. Improve credit evaluation skills of bank officersThe feedback of most bank respondents and regulatory agencies is that bank credit officers lack understanding of SME and do not have the requisite skills to evaluate SME. Many banking institutions apply the same techniques of evaluating large companies to smaller ones without any adjustment for the inherent differences. Moreover, banks are more stringent with SME on documentation requirements. For a start, there needs to be a paradigm shift in mindset – SME have unique characteristics that differentiate them from large established corporations. Credit officers or analysts in banks must realise this. Secondly, the techniques and appraisal methods appropriate to evaluate large corporations are not relevant for small enterprises. This means that banks must adjust their evaluation techniques accordingly and apply relevant ones to suit each group of borrowers. A good reason for applying relationship banking to small and medium enterprises is that SME are not as well structured and are more opaque than larger firms. To improve their skills, banks could provide more training on SME to their credit officers. Banks should tap on internal personnel or consultants who have long experience dealing with retail and small scale lending (especially at branch level).

2. Promote greater linkages and dialogue between financial institutions and SME/Trade associations/SME centres

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Financial institutions typically do not have strong linkages with SME/Trade associations or chambers of commerce. As a result, the financial services provided by financial institutions may not be adequate or appropriate to meet the needs of SME. Forging greater linkages and dialogue between financial institutions and SME associations would promote better understanding and facilitate financing for SME. In this respect, banks (as a group or individually) could organise road shows to various SME associations or chambers of commerce to introduce their services. Conversely, seminars or trade exhibitions held by industry associations could include banking institutions. The authorities could support these activities with their presence and/or sponsorships.

C. STRATEGIES FOR CHANGES TO THE LEGAL AND REGULATORY ENVIRONMENT TO IMPROVE SME FINANCING

1. Consistent and legalised definition of SMEIn countries that do not have consistent or legal definitions of SME, it would greatly improve the effectiveness of development and financing programmes (especially if implemented by different lineagencies or institutions) if different definitions can be standardised and legalised. This would also facilitate better planning and targeting of sectors by financial institutions. This step has already takenplace in both Thailand and Vietnam.

2. Improve information access to SMEAlthough the information infrastructure in Thailand is better than in Vietnam, there is little in the way of sharing and access to the available information by the different stakeholders. Credit or trade information developed by government agencies, central credit bureaus, national registries and financial institutions are not freely shared due to regulations restricting access to such information. The lack of information access is a significant barrier to initiatives to improve SME financing. For instance, the ability of banks to develop good credit models for the SME segment is impaired by the lack of data. In this respect, one recommendation to improve information access is for central banks (who are usually owners of credit information databases) to facilitate disclosure of data on a composite or group basis and without disclosing the identity of the SME. The availability of such data would greatly assist studies, model calibration and research by financial institutions and others in developing a better understanding and risk profile of the SME sector.

3. Conduct studies and publish information on SMEAt present, there is a dearth of information in respect of SME financing in both countries. More studies on SME financing should be commissioned by governments and regulatory authorities in charge of SME financing and the findings should be made available to the public. Research and surveys on sources of funding, funding trends, facilities utilised, cost of capital, problems with financing etc should be conducted and published on a regular basis. This information would be very valuable for all those involved in SME financing.

4. Provide incentives for banks to lend to SMETo promote greater SME lending, the regulatory authorities could consider granting certain incentives to financial institutions that actively promote SME financing and have achieved a sizable SME loan book. To maintain prudential banking standards, such incentives could be for a certain period of time and in non-financial form e.g., branching privileges, tax deductions on certain expenses etc.

5. Promote informal debtor-creditor workout mechanism for SME

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Various countries have commercial courts and arbitration centres to settle commercial disputes. However, the process is not necessarily less time consuming or onerous than the court process. Many financial institutions are reluctant to lend to SME not only because of lack of creditors protection and enforcement of collateral rights, but also due to the lengthy process of arbitration and settlement. This skews the profitability of a small loan against its potential risks. Perhaps the attractiveness of SME lending can be enhanced by establishing informal workout mechanisms for SME loans. Such a mechanism could be implemented through a special agency that is empowered to act to an intermediary between debtor and creditor.

6. Establish SME Accounting StandardsOne of the most common problems faced by SME is the difficulty in preparing financial statements and to comply with the requirements set out by the respective accounting standards in each country. Many small businesses struggle with understanding the complex requirements of the accounting standards and have little means to engage professional accountants to prepare proper accounts. As a result, lending institutions have to rely on other means to verify the financial health of the SME and this could lead to a higher risk premium being charged on the loan. In South East Asian countries, they require SME to comply with the same accounting standards that apply to all registered companies. Simplifying or amending current standards to suit small businesses wouldallow more SME to comply with disclosure requirements and increase the level of their transparency.

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Conclusion

As access to finance is a product of both supply and demand side constraints, all of these recommendations would work best in the context of a comprehensive framework. Solutions to resolve financing constraints must be addressed in conjunction with supportive development polices for improving market access, industrial linkages, information facilities, harnessing technology and enhancing knowledge and skills of SME. Often, one of the key factors of success of countries with a successful SME sector is the presence of a comprehensive, well-coordinated framework and pervasive support mechanisms for SME development. In addition, the legal and regulatory framework poses significant barriers to SME financing and is in need of updating and reform.

Globalization and regional integration require the healthy and sustainable existence of SMEs and their development in the region

In India SMEs has achieved steady growth over the last couple of years. The role of SMEs in the industrial sector is growing rapidly and they have become a thrust area for future growth. The Indian market is growing and Indian industry is making rapid progress in various industries like manufacturing, food processing, textile and garments, retails, information technology, agro and service sectors. Under the changing scenario, the SMEs have both opportunities & challenges before them.

The MSME sector is vital for the nation’s economic progress and hence, needs to be carefully nurtured and supported. MSMEs are the best vehicle for inclusive growth in the country, to create local demand and consumption. Besides supporting employment generation activities, they also act as feeder lines for the MNCs and large corporates of tomorrow.

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BIBLIOGRAPHY

NEWSPAPERS

TIMES OF INDIA

THE ECONOMIC TIMES

MAGAZINES

BUSINESS WORLD

BUSINESS TODAY

INDIA TODAY

WIKIPEDIA

INVESTOPEDIA

MSME REPORT

ANNUAL REPORT MSME

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