MSMEs' Credit Rating Is Set for a Model Change
In the recent Cabinet reshuffle, new Union minister Narayan Rane for the micro, small and medium enterprises (MSMEs) took charge. Coming from the MSME-intensive state like Maharashtra, the sector has a lot to look up to from him. The first challenge today is enhancing the institutional share of credit to the sector to at least 50% from just 23% MSME units. The second challenge is, developing a public credit registry to provide dependence on secured data as the base for lending, replacing collaterals and guarantees. A few days before departing, his predecessor had announced that the sector will be provided with a credit rating tool.
 
Viewed as a strong pillar of India’s economic growth, the MSME sector has undergone definitional change in July 2020 with the modification that tourism and travel sectors, as services, can register as MSMEs, as long as they fulfil the turnover criterion. Several other progressive changes also occurred during the past two years with a number of portals directing MSMEs to avail the incentives and other services online. Even before a solution to such an imbroglio could emerge, the news that a rating tool for MSMEs, as is used in Japan, is getting constructed, comes as a surprise.
 
Earlier Credit Rating Efforts
 
In 2005, Small and Medium Enterprise Rating Agency (SMERA) was set up as a joint venture (JV) between the Small Industrial Development Bank of India (SIDBI) and Dun & Bradstreet, specifically to rate the MSMEs even as there were several other rating agencies like CRISIL, ICRA, and Fitch, whose focus was on large corporates. 
 
As an incentive, performance and credit rating scheme (PCRS) was simultaneously launched. The objective at that time was to incentivise banks to lend fast to the sector and also at preferential rates of interest. For the first credit rating availed by any MSME from SMERA, 75% of the rating fee was reimbursed under the scheme. 
 
All other rating agencies also quickly set up MSME divisions to enhance their pie in the rated portfolio of the banks with no value addition to either the lender or the borrower. Then, an 8-point rating scale was developed specifically for the MSMEs, considering their business, financial, operational and management risks, giving higher weightage to the operating capability of the enterprise and lower weight to the balance sheet ratios. 
 
In May 2018, SMERA changed its name to Acuité Ratings & Research Ltd to position itself as a full-service rating agency with a diverse client base, as SME ratings accounted for less than 50% of its clientele base. Visit to the enterprise is an imperative for all the rating agencies to record their direct observations on maintenance of records, stocks and machinery and related invoices. 
 
Going by the risk appetite of the banks for this sector, all these efforts were a damp squib. “Credit reporting is essentially a commodity business. That commodity is data and the credit rating companies (CRCs) found a lucrative niche for decades as information brokers that transform raw credit data into value-added credit information products for banks and other credit-granting entities.” (Rosse, 2017)
 
For MSMEs in India, the data requirements are huge because banks adopt the principle of ‘suspect and respect’ the client instead of the reverse. Every MSME is viewed with suspicion, as though they themselves are saints and know-alls in credit risk assessment. The use of analytics has been by far the lowest as all banks relied only on the annual balance sheets and tax payments data (income tax— I-T, goods, and services tax—GST) and this data reflects the situation on a particular day in a year and not cash-flows during the year. 
 
In the wake of the Equifax episode in the US, the credit rating agencies there were put on alert for resettling their risk models. This was not just a fallback of the 2008 recession. Irregularities in rating institutions have not been unique to the US. 
 
In India, most of the corporate ratings proved wrong and that reached a climax with the Infrastructure Leasing and Financial Services (IL&FS), Dewan Housing Finance Limited (DHFL) and many others, disproving even commercial banks’ basic credit risk assessment capabilities. 
 
Data on the entrepreneur, his or her family, enterprise, environment, customer behaviour, creditor response, credit behaviour and payment culture, plays an important role in insulating the credit risk assessment and view it as the security. When 98% of enterprises are owner driven, with fragile balance sheets either under proprietary or partnership status of a firm, it is such data availability that would play a crucial role. 
 
Such data requirements could expand when agri-food product chains require finance to the related crop, seasonality, production and price trends of the base raw material, storage capacity and life of the product. 
 
The latest thinking emerged from the open credit enablement networks (OCEN) prevailing in Japan, based on account aggregator framework. It has been made out that such a framework enables the creation of a credit risk data (CRD) pool involving banks and non-banking finance companies (NBFCs). Financial and default data of the sector is expected to be the basis. 
 
“The main benefits of CRD include the development of credit scoring models based on nationwide data and the availability of benchmarks for different segments of the MSME sector,” according to a working paper (March 2021) by Savita Shankar, School of Social Policy and Practice, University of Pennsylvania. 
 
The question remains: Where is this reliable nationwide data, as most data that is posted is rarely verified?
 
All this effort is directed to those who have access to institutional credit. Unless the effort results in making most MSMEs realise the need for registering on the existing data base, in the first place, and going digital in the second place, no useful purpose will be served by mere announcement of yet another effort in rating tool creation as a panacea for collateral and guarantee free credit flow to the sector. 
 
When credit growth since the pandemic broke, despite the Atma Nirbhar Bharat Abhiyan claims of the union finance minister, it is just hovering around 5% to 6%, and with the number of enterprises accessing institutional credit remaining almost static, delivery mechanisms for credit, if based on OCEN, would only take a longer time for the MSMEs to recover and for the Banks to embrace the tool.
 
(The writer is an economist and risk management specialist and author of the Story of Indian MSMEs.) 
 
Comments
ramalingam.ee
3 months ago
In the present pandemic economic situation, the rating of MSME will not allow to achieve Asthma Nirma policy of the government.As all accounts are linked with Aathar, the existing liabilities of the MSME will be known to creditor bank and they may decide credibilities of MSME. A third person shall not assess and give a fictitious number based on which the credit has to go means is illogical.Sibi, crisil ratings has nullified the growth of MSMEs in India.Economic reformation initiated during 1991 has drooping curve since 2020
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