SME Financing – Opportunity for Alternate Channels

As I write, I am sure analysts are busy identifying the next winners in the small and mid-caps. Media channels have turned into discovery channels for MSME winners!

Ironically, a few months back, the very same people had written obituaries on the MSME sector. Professionally, having seen the SME & Emerging Corporates (ECG) from close quarters for over 15 years, I believe this segment to be very resilient, nimble and bounces back quickly. Their borrowings are far more controlled, owing to their own initiatives and further disciplined by close bank monitoring. Timely interventions by the government have also helped the unorganised MSME sector immensely, keeping the supply chain running.

Alternate channels or lending vehicles can fulfil the funding gap for this thriving segment. Below list explains some of the constraints faced by MSMEs. Resolving these presents a big a opportunity of sorts for these Alternate lending channels 

a. NBFC finance drying up – Because of stringent and templated approach of banks, SME & ECG borrowers were availing need based / growth capital from NBFCs at 12%-18%. The regulatory norms around end use, capital market exposures, etc have also been constraining bank finance to SMEs. Unfortunately, NBFCs do not have sufficient funds to cater to this demand, leaving a big void to fill.

b. Finance beyond assessed working capital – Banks assess working capital based on the level of current assets, once a year. The assessment period can range between 1 month to 6 months, which means the assessment cycle for incremental limits is 12-18 months. For a fast growing enterprise, this is long gap.

c. Any large order or business opportunity has to be passed by the borrower, since banks won’t be easily forthcoming. Elongated TATs of enhancements or short term support deprives the borrower of timely access to growth capital, which again presents a good opportunity for lenders.

d. Banks insist on maintaining a consistently high promoter margin for working capital – During growth phase, when companies have infused funds for capex, promoter margin for WC is not forthcoming. It is a chicken and egg story. Promoter margin is generated on successful implementation of fresh capacity.

e. Tenor and structure of Term Loans – Tenor of term loans is usually restricted to 4-5 years, with negligible moratoriums, regardless of the break even on capital expenditure programs. Banks show less flexibility in amortisation structures like step-up loans.

f. External Ratings Constrained – This space is under-served and India’s most stable and credit worthy SMEs have been rated between BB+ and BBB+ segments. Unfortunately, the rating agencies do not do justice to their creditworthiness because of their size.

g. Segment with turnover upto USD 65 M (~Rs.500 crs) is neglected by NBFCs and AIFs – Given the lack of understanding, this segment is perceived to be high risk. , This segment has far better credit discipline and low Loss given Default in the event of eventuality.

h. Banks do not readily share NOCs for additional limits – Banks generally have stranglehold over these borrowers, since they have control over cashflows and collateralised assets. Hence, the cross sell opportunities are good and for this reason they do want allow fresh lenders to enter the lending arrangement.

While, MSME is the flavour of the stock market, it gets beaten down in uncertain times. The money flow to this segment is still not smooth and regulators may consider allowing alternate vehicles to fulfil the demand of this segment. The opportunity should be exploited, before it gets wasted.