Money & Banking
Lending to MSMEs by banks: Some bitter truths

MSMEs being the backbone of economy have been in need of funds to grow themselves but banks have adopted an approach which has failed to meet their needs

When it comes to lending for business activities, banks tend to prefer large business entities to small players. This bias comes from the fact that big businesses have better assets and the possibility of failure of these businesses is less compared to small business enterprises. In order to gauge this preference of banks conversations with a small business enterprise, often referred to as micro, small and medium enterprises (MSMEs) says it all. For a micro and small business, to get loan from a bank is nightmare. This has been happening in spite of dedicated MSME branches set up by various banks and MSME lending being a part of priority sector lending.

RBI data in this regard is an eye opener. More than 92% MSMEs run their business on self-finance and have no source of institutional finance. The chart below shows that:

It is obvious that small businesses require funds as they have limited source of self-financed capital. Idea of schemes such as Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) came from this but somehow could not acquire acceptance from the banks in general. Though loans were given under CGTMSE, the number has been very insignificant compared to the size and scale of MSME business operations.

But this is not all.


There has been always a demand and supply gap in lending to MSMEs. MSMEs being the backbone of economy have been in need of funds to grow themselves but banks have adopted an approach which has failed to meet their needs. The chart below shows the demand supply gap which seems to be narrowing in days to come but still very sizeable by any stretch of imagination:

What is extremely surprising is that MSMEs don’t perform badly compared to the big business houses when it comes to performance on the payment of loans. The data available in this regard shows that percentage of impaired assets have been rising for medium and large business while it has been relatively stable for micro and small business.

So, there is no apparent reason for banks to show preference for large businesses as their performance on impaired asset front has been growing bad to worse. What is it that is preventing banks from lending to MSMEs? Most apparent reason is that banks to play safe and don’t want to add to their non performing assets (NPAs). The unfounded fear comes again from the fact that small business will default. But this logic gets weakened in some cases. Even in cases when credit guarantee is available through CGTMSE, banks are wary of funding of MSMEs because of the fact they don’t want any hassle in claiming guarantee benefit in event of a default by a micro or small enterprise.

Recently, while delivering a keynote address at the Training Workshop on Credit Scoring Model with support from IFC for MSE Lending in Mumbai on 29th November, Dr KC Chakrabarty, deputy governor, Reserve Bank of India (RBI) said that credit scoring model will go a long way in promoting credit facility to MSMEs. But the key question is can lack of will to fund MSMEs will addressed by a strong statistical model. There is a need to fix accountability for lack of funding of MSME business by banks. For instance every bank can be asked to offer collateral free lending first to MSMEs under CGTMSE before the bank asks for security for any lending.

Last but not the least, let MSMEs also understand their responsibility towards lending done by banks. They must act with full responsibility to ensure that loans are paid on time on them and wilful default does not become order of the day.

(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)



Jerin Chacko

3 years ago

Forget collateral for loans, Banks insist on collateral even for issuing a Bank Guarantee to the average firm!

nagesh kini

3 years ago

Vivek is bang on!
The repayment record of the Tiny and SME sectors are far better as the borrowers are more particular about their reputation and credibility issues that the big ticket willful defaulters give a go bye and the MOF/RBI choose to conveniently overlook.
The banks drag the small borrowers to DRT/SAFRESI at the drop of the hat including locking up and attachments. Why nothing whatsoever for the top defaulters?
I know of a genuine SME harassed by the Saraswat Coop. Bank by hyping up highly inflated unsubstantiated demands and the matter has been dragging on and on. The unit is among the 92% self financed now!



In Reply to nagesh kini 3 years ago

I agree - the SARFAESI act was one of the first nails in the SME coffins.


3 years ago

In spite of the CGTMSE scheme which underwrites all loans to the SME sector, banks insist on collateral for all loans. So that makes a mockery of the scheme, the bank charges you for providing you a loan under that scheme, takes collateral from you, and actually can show the entire loan as doubly secured - one with your collateral and one because GOI has underwritten it under the scheme !

Sad but this is the truth - as is the case with the USA and other economies, the banks are playing a significant role in ensuring that this sector which provides maximum employment due to their semi-skilled nature will die out.

New allegations describe chaotic workplace at New York Fed

The Fed has denied allegations by Carmen Segarra, who says she was wrongly terminated after refusing to back off findings that were critical of Goldman Sachs

An amended lawsuit by fired bank examiner Carmen Segarra describes a chaotic work environment at her old employer, the Federal Reserve Bank of New York, alleging that lines of authority were unclear and bad behavior by a supervised bank went unexamined.

A spokeswoman for the New York Fed said the bank was reviewing the new allegations from Segarra, who was dismissed seven months after being hired in late 2011 as part of a push to beef up supervision of so-called Too-Big-to-Fail financial institutions.

Segarra claims she was terminated for refusing to change her finding that Goldman Sachs did not have appropriate policies for handling conflicts of interest in its business dealings. Her complaint alleges that the senior supervising officer for the Fed at Goldman, Michael Silva, and his deputy, Michael Koh, obstructed her examination of Goldman on several occasions.

Silva, who had worked at the New York Fed since 1992, left last month to take a job as the chief regulatory officer and compliance leader of GE Capital. That firm is one of the Too-Big-to-Fail financial institutions regulated by the New York Fed. Silva did not respond to a request for comment.

A Fed official said Silva’s departure had nothing to do with Segarra’s lawsuit, which was filed in October.

The New York Fed, which has jurisdiction over many of these complex firms, recruited experts like Segarra to act as “risk specialists” to review different aspects of bank operations. Segarra, an Ivy League-trained lawyer with work experience at some of the nation’s top banks, was tasked with examining the legal and compliance policies at Goldman.

Segarra’s lawsuit alleges that she was never given a complete job description and describes tensions that existed between Segarra and Fed staff embedded at Goldman who had previously performed aspects of her job. Some of the embedded staff, including Silva, did not agree with Segarra’s interpretations of Goldman’s activities regarding conflicts, according to the complaint.

In legal papers, the Federal Reserve has said Segarra was an at-will employee who was legally terminated. Goldman, which is not a defendant in Segarra’s lawsuit, has told ProPublica that it has the required conflict-of-interest policy.

Both Silva and Koh are named as defendants in the lawsuit along with the NY Fed. According to her complaint, their job was to “manage the relationship” between Goldman and the Fed, not to perform examinations.

While at the New York Fed, Segarra had a direct supervisor, Jonathon Kim, who oversaw legal and compliance specialist examiners stationed at several banks. According to the amended complaint, Kim, also a defendant, told Segarra that the Fed “had failed to clearly articulate the different roles of [the relationship managers] and bank examiners.”

When Segarra complained about the obstruction, the complaint says, Kim told her she needed to learn “the critical skills of ‘absorbing and diffusing.’”

“They allowed this lack of clarity to interfere with Carmen’s bank examining activity,” said Segarra’s attorney, Linda Steagle. “In fact we are saying that this amorphous structure exists, in large part, so they can do exactly that.”

The New York Fed’s website broadly describes how the supervisory structure is supposed to work. Oversight of large, complex institutions is "led by a senior supervisory officer" who leads "the development and execution of the supervisory program for the firm" and "is responsible for interactions with the board of directors and senior management."

Additionally, team specialists "interact directly with members of the firm's management across various business lines and control functions, including the control functions responsible for managing credit risk, market risk, liquidity risk, operational risk, and legal and compliance risk."

In an addition to the amended complaint, the parties this week filed a joint letter detailing a trial schedule that is expected to stretch into next year. The letter discloses that Segarra possesses "audio recordings of several meeting with defendants" and suggests that they might assist the Court if there are disputes over facts in the case.

The New York Fed is one of 12 regional reserve banks that form the Federal Reserve System. It is the largest such bank in terms of assets and volume of activity, according to its website. While the New York Fed is a private bank, the Federal Reserve’s Board of Governors in Washington, D.C., delegates a public regulatory function to it.





nagesh kini

3 years ago

Great report indeed!
Our own Regulators are no better!
There are many skeletons right here but not enough whistle blowers.
Sucheta has been writing relentlessly about the happenings at top levels but surely there are many more waiting to be exposed ?

End to stimulus in the offing?

While it is always possible that the Fed and the Chinese government could continue to inject money into the system, there are very good reasons why they might refrain. An uncoordinated tightening by the worlds' two largest economies appears to be a definite possibility, which may have very unfortunate consequences

Since the beginning of the recession monetary policy around the world has been very similar: the more money the better. Without any particular agreement the US, Japan, Eurozone and China have all been flooding their economies with stimulus. This may soon change.


As I wrote last week, the Federal Reserve has been considering tapering since May. Until recently most market pundits have predicting that put the beginning of the taper off would not occur until next March. The Fed and Janet Yellen have specifically stated on many occasions that the beginning of the taper will be data dependent, and the data has been rather good. The numbers definitely puts the probability of a taper closer perhaps December or January. The best indication of an earlier taper is the yield on the 10 year US Treasury note. It reached a high of 2.97% at the beginning of September only to fall back to 2.48% a month later. Since then it has been rising. It is now up to 2.86% a level not seen since the Fed declined to taper in September. The jobs report and the unemployment numbers were also very good and within what the Fed once described as its goal for ending quantitative easing (QE).


The Fed constantly tries to remind the markets that a taper is not tightening. Certainly the bond buying program will go on for months after the taper starts. It might even change to the purchase of short term two and three year notes as the Fed policy changes. In fact unlike the 10-year, the rates on the shorter term notes have declined over the past few weeks. Still as it did in June any taper is likely to have an impact on overheated global markets.


A rate increase by the Fed would be bad enough, but it might get worse. Apparently the Chinese are also tightening. The process is far from transparent, but there is no doubt that recently interest rates in China have been going up. The yield on the government 10-year is at 4.6% the highest since 2008. The Chinese government recently auctioned $3.3 billion worth of 50 year bonds at a yield of 5.31% the highest since 2009 and over a hundred basis points above the yield in the last auction. The seven day repo rate rose 25 basis points. Last month money market rates jumped to their highest level since June when the People’s Bank of China (PBOC) drained a net 15 billion yuan ($2.4 billion) from the system.


While it is always possible that the Fed and the Chinese government could continue to inject money into the system, there are very good reasons why they might refrain. Recently there has been a lot written about bubbles. This is really beside the point. It is always difficult to determine a bubble. It is not hard to determine risk. The Federal Reserve has been clear about this. They wanted to encourage risk. Sure enough if you flood the world with money, a lot of it will be lent to people who might not pay it back. The Fed and the PBOC may not worry about bubbles, but I am sure they are concerned with excessive risk and there is a lot of that.


The record stock market is just one indication in the US. There are many others. They include mREITs, which I discussed in my last piece, plus record issuance of securitized assets, so called cov-lite loans, a record margin debt and a new record for the issuance of triple C rated junk bonds. Janet Yellen and her colleagues are concerned about unemployment, but they are also concerned about excessive risk as illustrated by Fed Governor Jeremy Stein famous speech last February.


The concerns of the Fed are small compared to those of China. No one knows exactly, but the best guesses place Chinese municipal authorities’ debt at 9.7 trillion yuan ($1.6 trillion) or 14% of all loans. According to a November report by Moody’s only 53 percent of the 388 municipalities had enough cash to cover debt payments and interest this year without refinancing.


Much of the money for municipalities and real estate development was raised through the Chinese shadow banking system. The size of the credit in this system has exploded. It grew by roughly 14 trillion yuan ($2.3 trillion) in the first 10 months of 2013. Nearly half of all new credit creation is from non-bank institutions.


China’s banking system is more dependent on regulations than market interest rates. This is supposed to change, but until it does, the PBOC is also tightening by changing the rules. In a regulatory move that will help dry up credit, the PBOC has placed new limits on interbank lending. Interbank lending exploded because it has allowed banks to avoid regulator limits. Interbank assets have increased 140% over the past three years and has more than tripled for mid tier banks. The new rules could reduce the tier one capital by 1% and lending by 5%.


Recently when either the Chinese or the Fed either started to tighten or even hint that they would soon pull back, there was an immediate strong reaction. Not just in the US and China, but also in the emerging markets. This reaction might have sapped their resolve. However the markets did not learn any lessons from the temporary pull backs. When stimulus was resumed or tightening no longer threatened, the speculation resumed with a vengeance.


While neither the Fed nor the Chinese seem concerned about bubbles, they surely are not blind to the unintended consequences of their actions. Janet Yellen has even complained about the Fed as a prisoner of its own policies. So an end to stimulus seems definitely in the offing.


Perhaps either the Chinese or the Fed might be able to slow down their stimulus programs without a crash, but it appears though that they might be doing it at the same time. Since neither institution has been particularly good at revealing their intentions, it is not only the market that is in the dark. Both institutions are not totally cognizant about the other’s intent. So an uncoordinated tightening by the worlds’ two largest economies appears to be a definite possibility, which may have very unfortunate consequences.


(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)


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