Over reliance on credit rating: How Banks constrain SME Lending

The journey from conservatism to capital raising for banks is almost over. Balance sheet management and capital protection measures have been well addressed. However, is the capital being deployed equitably? Is leverage coming back into the economy. Well, not yet !

Banks are flush with liquidity, thanks to the regulatory push. The segment is grappling with twin issues – where to deploy the money and how to train thousands to officers to source the right credit which meets the stringent criterion. The top-down messaging within Banks seems quite straight jacketed- lend only to BBB+ and above credits and to COVID-proof segments, maintain granularity in exposures and extend limits to companies which have not availed moratoriums! With such templated approach and little room for judgement, large part of the economy remains under-served.

Professionally, having seen SME and mid-sized corporates for major part of my career, India’s most stable and credit worthy SMEs have been rated between BB+ and BBB+ segments. Despite having robust balance sheets for their size of operations, rating agencies by design are constrained in according small borrowers an investment grade rating. Seldom would there be a company with INR 100 crores or less turnover having a BBB rating.

Recently, witnessed a INR 100 crores company with EBIDTA of INR 35 crs and Debt/EBIDTA of 2x having free cash balance of 10 crs accorded a BB rating. The borrower has a squeaky clean track record since inception. While conservative rating approach keeps the default matrix of agencies intact, it precludes and deprives this category of borrowers from legitimate sanction of working capital finance, as attention of top management for individual accounts is not feasible and managements follow a portfolio approach with pre-defined parameters.

Because of subdued ratings, need based working capital finance is not adequately reaching the SME segment.  Such ratings colour the minds of bankers, since they have to keep 150% risk weight on such borrowers and are answerable to the investor community on sub-investment grade portfolio. Some of these borrowers, can’t strictly be bracketed in the MSME rating scale. The irony is that this category of borrowers are simply governed by templates and driven by portfolio approaches.

The government has nudged banks with various schemes for MSME and bank counters have been kept busy. But this has not changed the judgemental approach of lenders. Rating agencies too should distinguish small customers on the basis of vintage, ability to absorb losses and consistent debt servicing track record and look at investment grade ratings to deserving customers. The ability of MSMEs to bounce back is far better than asset heavy balance sheets – they are nimble footed and adapt quickly to the changing environment. Despite facing natural disasters, SME segment has been quite robust over the last decade. On the contrary, mortality and frauds in larger and better rated customers has been higher in the recent past. Such groups and companies thrive on accounting ingenuity and refinance from banks for long. This needs to be pondered over by the rating agencies.

In lending, common sense should prevail over templated approach. Handful of banks have completely distinguished themselves from the rest, where officers are trained across business segments and risk teams to look at visibility of cash flows for debt servicing;  credits are not be turned down purely on collateral coverage.

Leverage in the economy can be pushed through the NBFC and MFI segment, as 4x-7x Debt/Equity is an acceptable norm viz., with every one rupee of equity, they take seven rupees of debt. While the regulator has provided refinance and liquidity through repo transactions, loans are getting concentrated in the hands of better rated and institutionally backed borrowers. Regulatory policy may consider at least 50% of these subsidised loan for BBB- and A- category of borrowers. This will help evolve the secondary bond market for lower rated categories. Large NBFCs are sitting on large cash balances (and negative carry) to only manage their ALMs

Banking segment is entering its most crucial phase post pandemic, which is the post moratorium phase. However, they should not lose sight of the bigger picture – to lend equitably.