Suggestions for stimulating financing under

small and micro sector

[Type the document subtitle]
5/26/2011
Kulbhushan Sing Baghel

Contents
Executive Summary ..................................................................................................................... 2
1. Introduction ............................................................................................................................ 3
2. Definition of MSME Sector ....................................................................................................... 3
3. Role of MSME sector in Indian Economy ................................................................................... 3
4. Major Issues concerning the MSME sector ............................................................................... 4
5. Issues faced by Banks in lending to SME sector ......................................................................... 7
6. Scope for SME lending ............................................................................................................. 8
7. Challenges and Approaches along the SME banking Value Chain ............................................... 9
8. Risk Management .................................................................................................................. 12
9. How to begin engaging the SME market .................................................................................. 13
10. Initiatives undertaken by Government to strengthen the MSME sector ................................. 17
11. Suggestions for strengthening MSME sector.......................................................................... 18
12. Suggestions for increasing financing for MSMEs .................................................................... 20
References................................................................................................................................. 23

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Executive Summary
Small and Medium Enterprises (SMEs) play a very significant role in the economy in
terms of balanced and sustainable growth, employment generation, development of
entrepreneurial skills and contribution to export earnings. However, despite their importance
to the economy, most SMEs are not able to stand up the challenges of globalisation mainly
because of difficulties in the area of financing. Lack of access to financing is consistently
cited by SMEs as one of the main barriers to growth. Often considered by commercial banks
and financial institutions as risky and costly to serve, SMEs are largely under-served when it
comes to basic financial services. With such limited access to financing, SME owners
struggle to make the investments they need to increase productivity and competitiveness of
their business, develop new market and hire new people. With the opening up of the Indian
economy, it has become necessary to consider measures for smoothening the flow of credit to
this sector.
According to report by CRISL, there exist a lending opportunity of Rs 500 billion for
SME sector. To effectively serve the SMEs, banks need to shift from their traditional method
of banking and adapt to new innovative approaches to meet the unique needs of SMEs. By
analysing each stage in SME banking value chain, banks can take steps to overcome the
existing challenge in each stage. Banks need to understand the unique needs of SME sector
and should focus on providing wider range of standard products and service by adopting
beyond-lending attitude. They should develop innovative modelling for credit risk
management and should utilise IT and MIS effectively in order to serve SMEs in cost
effective manner.

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1. Introduction
Small and Medium Enterprises (SMEs) play a very significant role in the economy in
terms of balanced and sustainable growth, employment generation, development of
entrepreneurial skills and contribution to export earnings. This sector contributes 8 % of
countrys GDP, 45% of industrial output and 40% of its exports. The MSMEs provide
employment to about 60 million persons through 26 million enterprises. However, despite
their importance to the economy, most SMEs are not able to stand up the challenges of
globalisation mainly because of difficulties in the area of financing. Lack of access to
financing is consistently cited by SMEs as one of the main barriers to growth. Often
considered by commercial banks and financial institutions as risky and costly to serve, SMEs
are largely under-served when it comes to basic financial services.
2. Definition of SME sector
Despite its relevance, SME sector has for long faced various obstacles to growth. In
recognition of these difficulties and succumbing to long sustained lobbying, the Government
of India passed MSME Development Act 2006 which brought about major changes in this
sector. The basic achievement was a clear and decisive definition of units that fall under
micro, small and medium category. The definitions are based on total investment in plant and
machinery for manufacturing units and investment in units in equipments for service units.
Currently, the definition used by the Ministry of Micro, Small and Medium
Enterprises is described in Table 1.
Manufacturing Sector
Micro
Small
Medium

Investment in Plant & Machinery

Less than Rs. 25 lakh
Rs, 25 lakh to Rs. 5 crore
Rs, 5 crore to 10 crore

Service Sector
Micro
Small
Medium

Investment in Equipments
Less than Rs. 10 lakh
Rs, 10 lakh to Rs. 2 crore
Rs, 2 crore to Rs. 5 crore
Table 1 : Definitions of Micro, Small and Medium Enterprises

3. Role of SME sector in Indian Economy

The role of micro, small and medium enterprises (MSMEs) in the economic and
social development of the country is well established (MSMEs). The MSME sector is a
nursery of entrepreneurship, often driven by individual creativity and innovation. Small and
medium enterprises play a vital role for the growth of Indian economy. This sector has often
been termed as engine of growth for developing economies. This sector contributes 8 % of
countrys GDP, 45% of industrial output and 40% of its exports. The MSMEs provide
employment to about 60 million persons through 26 million enterprises. This sector produces
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more than 8000 quality products for the Indian and international market. The labour to capital
ratio in MSMEs and overall growth in the MSME sector is much higher than in the large
industries. The geographic distribution of the MSMEs is also more even. Thus, MSMEs are
important for national objectives of growth with equity and inclusion.
The MSME sector in India in highly heterogeneous in terms of the size of the
enterprises, variety of products and services produced and levels of technology employed.
While one end of the spectrum contains highly innovative and high growth enterprises, more
than 94% of the MSMEs are unregistered, with a large number established in the informal or
unorganized sector. Besides the growth potential of the sector and its critical role in
manufacturing and value chains, the heterogeneity and the unorganized nature of the Indian
MSMEs and important aspects that need to be factored into policy making and programme
implementations.

Figure 1: Total number of MSMEs and employment generated by them over the years

Figure 2: Fixed Investment in MSMEs and MSME's production and contribution to exports

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NOTE: In above two graphs, data for the period up to 2005-06 is of small scale industries4(SSI)

4. Major Issues concerning the MSME sector

Although Indian MSMEs are a diverse and heterogeneous group, they face some
common problems. The problems faced by MSMEs are quite unique to the nature of the
sector. These problems concern several institutions and departments of the Government.
Some of the common problems faced by MSME sector are discussed below.
i.

Lack of availability of adequate and timely credit

Access to adequate and timely credit at a reasonable cost is the most critical
problems faced by this sector. The major reason for this has been the high risk
perception among the banks about this sector and high transaction cost for loan
appraisal. While the quantum of advances from public sector banks to SMEs has
increased over the years in absolute terms, from Rs. 46,045 crore in March 2000 to
Rs, 1,85,208 crore in March 2009, the share of the credit to the SME sector in the Net
Bank Credit has declined from 12.5% to 10.9% during the same period.

ii.

High cost of credit

Because of the high risk perception among the banks and associated high
transaction costs, the cost of credit available for MSME sector is usually higher.

iii.

Collateral requirements
Because of the high risk perception among banks, banks demand for collateral
for providing line of credit to this sector. Since, these are small enterprises, therefore
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they are not able to provide any collateral most of the time. This further deters
MSMEs sector from availing the credit from banks.
iv.

Limited access to equity capital

Access to Equity capital has been another major problem. At present, there is
almost negligible flow of equity capital into this sector, despite the fact that overall
capital inflows have witnessed the significant increase in the recent years. Absence of
equity capital may pose a serious challenge to development of knowledge-based
industries, particularly those that are sought to be promoted by the first generation
entrepreneurs with the requisite expertise and knowledge.

v.
vi.
vii.
viii.
ix.

Problems in supply to government departments and agencies

Procurement of raw material at competitive cost
Problems of storage, designing, packaging and product display
Lack of access to global market

Inadequate infrastructure facilities including power, water, roads etc.

In the present global environment, the MSMEs have to be competitive to
survive and thrive. To ensure competitiveness of MSMEs, it is essential that
availability of infrastructure, technology and skilled manpower are in tune with the
global trends. MSMEs are located either in industrial estates set up many decades ago
or are functioning within urban areas or have come up in an organized manner in rural
areas. The state of infrastructure including power, water, roads etc. in such areas is
poor and unreliable.

x.

Low technology levels and lack of access to modern technology

SME sector in India, with some exceptions, is characterised by low technology
levels, which acts as a handicap in emerging global market. As a result, sustainability
of a large number of SMEs will be in jeopardy in the face of competition from
imports.

xi.

Lack of skilled manpower for manufacturing, services, marketing etc.

Although India has the advantage of the large pool of human resources, the
industry continues to face deficit in manpower with right skill set for specific areas
like manufacturing, service, marketing, etc.

xii.

Multiplicity of labour laws and complicated procedure associated with compliance

of such laws

xiii.

Absence of suitable mechanism which enables the quick revival of viable sick
enterprises and allows unviable entities to close down speedily
Worldwide, MSMEs are credited with high level of innovation and creativity
which also leads to higher level of failures. Keeping this in view most of the
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companies have put in place mechanisms to handle insolvencies and bankruptcies.

The present mechanism available in India for MSMEs is archaic. It does not focus on
revival. Hence, business failure in India is viewed as stigma, which adversely impacts
individual creativity and development in the country.
xiv.

Issues relating to taxation, both direct and indirect, and procedures thereof.

5. Issues Faced by Banks in lending to SME sector

There are number of issues faced by banks in lending to SME sector because of which
the lending to SME sector is not adequate and these issues contribute for high cost of credit.
Some of the major issues faced by banks are outlined below.
a) Information Asymmetry
Accurate information about the borrower is critical input for decision-making
by banks in the lending process. Where information symmetry (a situation where
business owners or managers know more about the prospects for, and risk facing their
business than their lenders) exists, lender may respond by increasing lending margins
to levels in excess of that which the inherent risks would require. In such situations
banks may also curtail the extent of lending even when SMEs are willing to pay a fair
risk adjusted cost of capital. The implication of raising interest rates and/or curtailing
lending is that banks will not be able to finance as many projects as otherwise would
have been possible.
b) Granularity
Granularity refers to a situation where the risk grading system at banks does
not have the requisite capability to discriminate between good and bad risks. This
results in tightening of credit terms. From the borrowers perspective, this leads to an
outcome where the bank is over-pricing good risks and under-pricing bad risks.
c) Pecking Order Theory
As a result of above two issues, pecking order theory flows which means that
SMEs, which face a cost of lending that is above the true risk-adjusted cost, will have
incentives to seek out alternative sources of funding.
d) Moral Hazard
Even when loans are made to SMEs, it so may happen that the owners of these
SMEs take higher risks than they otherwise would without lending support the banks.
One reason for this situation is the owner of the firm benefits fully from additional
returns but does not suffer disproportionately if the firm is liquidated. This is referred
as moral hazard, which can be viewed as creating a situation of over-investment.
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e) Switching Costs
It is known fact that smaller the business, the more significant the switching
cost (cost incurred in switching the banks) are likely to be and, therefore, it is less
likely that the benefits of switching outweighs the costs involved. Because of this
SMEs find it harder to switch banks if faced with any issue. This situation results in
SME lending becoming a sellers market, which may not be attractive to SME
borrowers.
6. Scope for SME lending
According to a recent study conducted by CRISIL on funding pattern of small and
medium enterprises (SMEs) in India reveals that there is scope for banks to increase their
lending to SMEs by Rs.500 billion. Against the banking practice of financing 75% of an
SMEs incremental working capital requirement, on an average, only around 60% was funded
between 2006-07 and 2008-09. The SMEs meet the bulk of their residual funding pattern
from their own funds. According to this study, bank branches situated in urban areas have
greater scope than their counterparts in the semi-urban and rural areas to increase funding
support to SMEs; the headroom for lending to the small SMEs is greater than that to the
larger SMEs.
The difference between actual bank funding and maximum permissible levels of
funding is defined as incremental
funding
opportunity
(IFO).
According to the study conducted,
smaller the SMEs scale of
operation, greater the IFO. Figure
indicates, SMEs with low turnover
(less than Rs.500 lakh) have much
larger IFO than those with larger
turnover, indicating that the
opportunity in financing smaller
enterprises is much larger than that
of financing larger enterprises.
Increased support will boost growth of smaller SMEs and enhance the effectiveness of
various government initiatives to support SMEs.
SMEs in urban areas have significantly higher IFO as compared to those in semiurban and rural areas. This is surprising, given the general perception that SMEs in urban
areas have greater access to bank funding than those in semi-urban and rural areas, where
banking penetration is lower. The reason for this urban-rural divide in bank funding for
SMEs may be that urban banks spread their funds over a wider basket of large, medium and
small companies in urban areas whereas in the semi-urban or rural areas, the key customer
are restricted mainly to SMEs only.
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7. Challenges and Approaches along the SME Banking Value Chain

There are many challenging aspects to SME banking. To understand how to address each
challenge, it is helpful to analyse these challenges in the context they occur. The banking
value chain or the chain of activities provides the framework for analysing these challenges in
a systematic manner. There are five stages in this banking value chain: i) Understanding the
market, ii) Develop product & service, iii) acquire & screen clients, iv) Serve SME clients,
and v) Manage information and Knowledge.

Figure 3: Key activities at each of the five stages of the SME banking value chain

i.

Understanding the market

Since SME sector is very diverse and heterogeneous, it warrants segmentation
to understand this sector. The segmentation within the SME sector is important
because not all SME clients have the same banking demands, nor do they respond to
the same baking practices. Since majority of the enterprises in SME sector is
unregistered, therefore information on SMEs may be limited or unreliable. In such
scenario, banks must be creative in developing their understanding of the sector. They
may need to conduct primary research through market surveys or direct observation
and interaction with SMEs in their place of business. Banks most effectively serving
SMEs usually have a strategic focus on the sector at the highest level of bank decision
making.

ii.

Developing products and services

The breadth of the product and service offerings is important because it impacts a
banks SME market share by drawing in new clients or by securing more business
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from existing clients. The design of products and services also impacts the
profitability of serving the SME market. There are three main challenges in
developing a product or service offering geared towards the SME client.
a) Develop a set of products that bundled in a compelling way that persuade the
SME client
b) Ensure overall profitability across the offering, recognizing that SME-specific
data is difficult to gather, particularly at the product level
c) Strike the right balance between increasing ones offering to appeal to a
broader market and recognizing ones limitations in the banks capabilities
Banks should adopt the beyond-lending attitude by offering SME clients
products & services that meet full gamut of needs. Banks have found that SMEs are
more likely to loyal clients when they feel that breadth of their needs have been
understood and met. Increasing wallet share and customer loyalty, therefore, depends
in many cases on raising the number of products used by each SME customer. To
effectively maximize and retain the business of SME clients, banks need to i) develop
a wide range of products suited to different SME needs and ii) learn to bundle product
& services.

Figure 4: Various Products & Services that bank could offer to SMEs

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iii.

Acquiring and screening the clients

Two main challenges bank face in acquiring clients are i) cost effectively
marketing their product offering, and ii) managing credit risk by effectively screening
for profitable borrowers despite incomplete information.
First, outreach to SMEs can be
difficult because many SMEs lack basic
knowledge of how they can benefit from
banks. Secondly, in addition to providing
information to SMEs, banks must also find
ways to information from SMEs, in the
case of borrower screening. One of the
most effective ways to reach new clients is
through existing clients. And for screening
clients, some approaches include i)
separating credit underwriting from sales
and other bank function ii) Utilizing credit
rating and scoring tools, and iii) relying on transparent external data on the enterprise
or owner.

iv.

Serving clients
Servicing SME clients include meeting the needs of the existing clients,
cultivating new business through cross selling, and managing risk by addressing
problem loans. Two key challenges in effectively servicing SME clients are i) SMEs
have unique demands and value personal and attentive service, and ii) meeting these
demands can be costly given the frequency of contact required and potentially lower
revenue earned per client. Given these two challenges, banks must balance the
importance of keeping operating cost down with the risk of under-investing in service
which could lead to customer attrition, higher default rates and lost sales
opportunities.
To overcome the above challenge banks should adopt the following
approaches to cost-effectively meet the unique demands of SME clients.
a) Using direct delivery channels
b) Segmenting and redefining relationship management
c) Turning demands into opportunities through cross selling

v.

Managing information and knowledge

Sustainable SME banking requires banks to effectively manage information
and knowledge banks must continuously learn from experience and feed this
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learning back into its strategic planning cycle for the SME business. The primary
tools for facilitating this learning are banks information technology (IT) and
management information system (MIS).
There are two main challenges in managing information and knowledge: i)
developing the infrastructure (tools and systems) to collect and analyse information,
and ii) developing the capacity (skills and process) to turn information into knowledge
and adjust operations accordingly.
Bank approaches to managing information and knowledge can be divided
according to key functions. Some of the most important key functions are i) risk
modelling and portfolio monitoring ii) client relationship monitoring, and iii)
profitability analysis. Excellence in managing information and knowledge is
demonstrated when information is directly linked with improved operations at all
levels of an organization. In other words, the information for the key decisions must
be available and the staff must know how to use it.
8. Risk Management
Risk management is a critical bank function in each of the five stages of SME banking
value chain. In case of SME banking, with potentially higher frequency and lower value
transaction adds to the complexity of managing risk. There are two main categories of risk to
prioritize in case of SME banking: a) credit risk and b) the risk of excessive cost to serve the
client.
a. Credit Risk
Credit risk is the risk of lost revenues and assets from delayed payments or
non-payment of loans or other credit products. It is important concern in SME
banking because unlike larger corporations, SMEs often can not provide verifiable
financial information. As a result of this information asymmetry, most bank loans to
SMEs are secured, or in other words, require collateral. Banks that find other ways to
manager credit risk without requiring collateral have a potential competitive
advantage when serving SMEs.
b. Risk of excessive cost to serve the client
The risk of cost overruns results from bank uncertainty regarding the best
operating model for serving SMEs. Whereas corporate clients are characterized by
low-volume, high-value transactions, SMEs often require more transactions at lower
values.

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8.1 Managing the Risk

Figure 5: Common Approaches to Risk Management

9. How to begin engaging the SME market

Banks looking to enter the market of expand their SME operations will be able to draw
from the lessons of other banks experiences to date. These lessons apply to operations in five
key strategic areas.
i.

Strategy, SME Focus and Execution Capabilities

To have successful SME operations, banks need to develop business models
that explicitly recognize the unique characteristics of their SME market. This
recognition and how it plays in plays into banks service of SMEs from planning to
execution, is the basis of the first strategic area. To develop these business models,
banks must:
a. Define and SME-specific strategy
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An SME-specific strategy and implementation plan reflects an understanding

of banks goal and aspirations, target market segments, value proposition and
competitive advantage, internal capabilities required to implement and the
management systems to be set up. An important part of this strategy to create a
bank definition of the SME sector based on the target market segments.
b. Adapt the banks organization to serve SMEs
A strong SME focus may be achieved by dedicating units and staff to the need
the SME segment for all key functions- from origination to back-office.
c. Ensure bank leadership owns and execute the SME strategy
Successfully serving SMEs require a strategic investment of resources and
effort of the bank, which will require the buy-in and leadership of senior
management.
d. Acquire the necessary skills
SME banking involves higher volumes than corporate banking and deeper
levels of service than retail banking. The skills needed such as sales
management, SME knowledge, and client service often do not match those
of a traditional banker. Therefore, to serve SME effectively, banks need to
prioritize hiring, training and developing staff with the required SME-specific
skills
ii.

Market Segmentation, Products and Services

For serving SMEs effectively, SME banking models should recognize the diversity in
the market and segment clients accordingly, instead of being based on single model.
To achieve this, banks should:
a. Determine priority target segments
Depending on the banks own strengths and weaknesses, and the competitive
landscape, banks can serve some segment of the SME sectors more profitably
than other sectors. Therefore banks should prioritize target segments
accordingly.
b. Use segmentation to adapt processes
To maximize the service quality and cost-effectiveness, banks must become
adept at segmenting client type and value to the bank.
c. Offer a range of product, beyond lending

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Loans are just one part of the SME banking. Strong revenues come from
providing a suite of effectively bundled, value-added products including
deposits and transactional products.
d. Build product development skills
These skills are needed to create a strong value proposition in the product
offering to targeted clients.
iii.

Sales culture and delivery channels

To effectively serve the SME, banks need to shift from traditional relationship
management approach in delivery of banking services. Instead, they should adapt
mass-market approaches with a heavier emphasis on sales volume, by separating the
sales function from client service, as well as from underwriting. To further adapt the
sales culture and delivery channels, banks should:
a. Position the organization to emphasize sales
For successful SME banking operations sales orientation should be reflected in
management culture. And to achieve this, responsibilities for business
development and back-office functions are separated.
b. Proactively acquire clients
Sales oriented culture means that banks need to acquire clients proactively,
instead of waiting for walk-in clients. Success in this approach requires the
collection and mining of internal and external market data, and following a
well-organized process to make sure all potential clients are contacted.
c. Ensure efficiency of the branch network as a delivery channel
Most often, SMEs select their bank of the basis of branch proximity. Since
branches are important, but potentially costly delivery channel, banks need to
maximize by focusing branches on sales and client service, and centralizing
back-office functions, and specializing branches or staff for the needs of
priority target segments.
d. Utilize low-cost delivery channels
Low-cost delivery channels such as direct marketing, internet banking, call
centres, card centres, and point-of-sale banking are efficient and cost
effective ways to service clients. Banks should be able to develop these
channels and create incentives for clients to use them
e. Maximize cross-selling and leverage SME networks.

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Cross selling increases revenue per client. It is a cost-effective way to boost

sales because it relies on existing relationships rather than attempting to sell to
cold prospects. The networks linking SMEs and their owners are source of
sales synergies. Cross-selling emphasize a customer-centric rather than a
product-centric approach to profitability.
iv.

Credit risk management

Instead of relying solely on relationship lending or collateral to secure loans, banks
should come up with innovative approaches to manage credit risk. To effective
manage credit risk, banks should:
a. Segregate risk management from sales functions
Dedicate specific staff and processes to risk assessment, separated from sales.
b. Invest in underwriting capability
Learning how to determine the credit risk of SMEs in the absence of complete
information is a process that takes times and requires accumulation of data.
Underwriting loans to SMEs may often require a combination of data types,
including informal sources. As a bank builds knowledge (and statistical
models) of the sector, it ability to predict credit risk improves.
c. Automatic portfolio monitoring
Effective data systems can enable bank to reduce costs by monitoring
portfolios based on automated early warning signals.
d. Prioritize efficiency in bad debt management
Bank that can respond quickly to signs of problematic loans by viewing this
as an important function of good customer service can prevent significant
losses.
e. Develop and use risk modelling tools
Banks need to develop statistical models that enhance their ability to estimate
risk of SMEs. These tools help ensure consistent and objective credit
underwriting and are also used for pricing, incentives, delegated lending
authorities, profitability measurements, and economic capital allocation.

v.

IT and MIS (Management Information System)

In order to serve SMEs effectively, banks need to reconfigure or overhaul their IT and
MIS systems so that information they collect and analyze is useful for making
business decisions. IT systems should enable banks to assess profitability at the client
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segment, product level, and customer levels. To effectively use the IT and MIS for
SME banking, banks should:
a. Understand and value the role of IT and MIS
Since SME is volume-driven business, IT and MIS have become critical for
client service, product development, cost savings, and overall competitive
advantage.
b. Build adequate hardware and software architecture
Among other functions, a banks hardware architecture should facilitate the
central storage of client and accounting data, and efficient communication
between branches. Centralized and consolidated data is essential to
understanding clients and identifying opportunities.
c. Prioritize analytical capabilities
Data architecture is essential for supporting a performance-oriented culture; a
quantitative approach to risk management; and CRM capabilities, which
include segmentation, direct marketing, and optimization of distribution
channels. For these purposes, banks must be able to retrieve and analyze data,
and make data extracts and analysis available to operational staff.
10. Initiatives undertaken by government for strengthening the MSME sector
There are various programmes and schemes have been initiated to strengthen the
financing for MSMEs and to strengthen the MSMEs itself. Some of the various programmes
and schemes are outlined below.
i.

Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE)
This trust is established by Government of India and Small Industries
Development Bank of India (SIDBI). The objective of this scheme is to provide
availability of bank credit without the hassles of collaterals or third party
guarantee to the first generation of entrepreneurs.
Under this scheme, any collateral / third party guarantee free credit facility (both
fund as well as non-fund based) extended by eligible institutions, to new as well
as existing Micro and Small Enterprise, including Service Enterprises, with a
maximum credit cap of Rs.100 lakh (Rupees Hundred lakh only) are eligible to be
covered.
The guarantee cover available under the scheme is to the extent of 75% / 80% of
the sanctioned amount of the credit facility, with a maximum guarantee cap of
Rs.62.50 lakh / Rs. 65 lakh. The extent of guarantee cover is 85% for micro
enterprises for credit up to Rs.5 lakh.
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The extent of guarantee cover is 80%(i) Micro and Small Enterprises operated
and/or owned by women; and (ii) all credits/loans in the North East Region
(NER). In case of default, Trust settles the claim up to 75% (or 80%) of the
amount in default of the credit facility extended by the lending institution.
ii.

SME Rating Agency of India Limited (SMERA)

SMERA is a joint initiative by SIDBI, Dun & Bradstreet Information Services
India Private Limited (D&B) and several leading bank in country. It is the
countrys first rating agency that focuses primarily on the Indian MSME segment.
SMERAs primary objective is to provide ratings that are comprehensive,
transparent and reliable which would facilitate greater and easier flow of credit
from the banking sectors to MSMEs.

iii.

Schemes Implemented through National Small Industries Corporation

(NSIC)
NSIC has initiated many programmes in order to assist MSMEs. Some of the
schemes are mentioned below.
Export Credit Insurance
Marketing Intelligence Services
Organizing exhibitions
Marketing Assistance Scheme
Raw Material Assistance

iv.

Schemes implemented by the office of Development Commissioner (MSME)

The office of Development Commissioner (MSME) functions as the nodal
development agency under the Ministry of Micro, Small and Medium Enterprises
(MSME). There are various schemes implemented by the office of Development
Commissioner (MSME) such as
National Manufacturing Competitiveness Programme (NMCP) Schemes
Micro & Small Enterprises Cluster Development Programme (MSE-CDP)
Scheme for Capacity Building
Credit Linked Capital Subsidy Scheme for Technology Upgradation
Assistance to Entrepreneurship Development Institutes

11. Suggestions for Strengthening MSME sector

In order to stimulate financing for MSME sector, first of all it is necessary to
strengthen the MSME sector itself. Increased business activity and higher productivity in
MSME sector will help in reducing the high risk perception among the bank, and that will
result in increased line of credit to MSME sector. Apart from financing, MSME sector faces
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in other areas like acquiring raw material, technology up-gradation, marketing, product
designing and packaging, distribution and access to international market etc. Apart from
schemes already implemented for strengthening MSME sector, these are following some
suggestions to further strengthen MSME sector.
i.

Marketing
Marketing is one of the critical areas where MSEs face problems. In the global
arena, they do not have the strategic tools, and the means for their business
development, unlike the medium and large enterprises. Constant changes in
market dynamics due to technological changes and globalization has had a
profound impact on the competitiveness of the MSEs. The MSEs also face
problems in operations in the smaller markets due to ingress of branded products
backed by strong advertising campaign. Some of the suggestions to come over
these challenges are as following:
a) Setting up of Marketing Development Assistance fund
b) Need to undertake brand building for MSEs
c) Organization of Vendor Development Programme and Buyer-Seller Meets
for MSEs in targeted markets
d) Product design should be focus of attention.
e) Build and coordinate the efforts of various institutions ate state, regional
and cluster levels and also by involving MSME associations in the country
to undertake various marketing functions.

ii.

E-marketing through specialized MSME portals

E-marketing has emerged as one of the important marketing tools, through
which the companies can reach wider clientele in a fraction of time and cost
compared to the traditional methods of marketing. Awareness about the benefits
of e-marketing need to be created amongst the MSMEs and their
organizations/cluster groups/associations should be provided assistance for
creating e-marketing portals.

iii.

Assistance in product designing and packaging

iv.

Assistance in organizing domestic/international exhibitions in India

v.

Assistance in publicity and advertisement of MSME products

Advertisement is one of the main tools of marketing, through which
information about the products is disseminated amongst its users. While large
industries/enterprises have sufficient resource for advertisement and publicity,
MSMEs have scarcity of resources which restricts them for making them
publicity/advertisement of their products.

vi.

Implementation of Public Procurement Policy for MSEs

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The objective of this policy is to promote MSEs by enhancing their

competitiveness through
a) increased participation by MSEs in Government purchase
b) encouraging linkages between MSEs and large enterprises
c) increased
share
of
supplies
of
MSEs
to
Government
Ministries/Departments, their added institutions and PSUs.
vii.

Distribution of industrial raw material to MSME units

Sharp fluctuations in prices of critical raw material items affect MSMEs badly.
Therefore specific allocation of industrial raw material should be made by the
PSUs for distribution to MSEs to ease the problem of availability of raw material.

viii.

To overcome the problems relating to infrastructure, technology and skill

development, a targeted investment should be allocated for creating affordable
industrial areas with integrated facilities for MSMEs and some per cent of the land
in new industrial areas should be reserved for MSEs.

12. Suggestions for Increasing Financing for MSMEs

i.

Extending Moratorium Period during Economic Slowdown

During economic slowdown, banks should extend liberal moratorium on their
term loans and working capital to SME entrepreneurs. Banks should include
interest during first 6-12 months of operation as part of long term funding of the
projects of SMEs, since in most cases the projects do not start generating cash
flows immediately after commencement of the operation. This would allow them
to concentrate on stabilizing and achieving breakeven level of operations.

ii.

Increasing use of IT
Banks should put in place an electronic tracking system for ensuring timely
approval/rejection of loan applications of SMEs. SMEs should be informed about
reasons for reasons for rejection of their loan application within a definite period.

iii.

Banks should approve proposals for term loan and working capital simultaneously
for SME projects to avoid delay in tying up of funds by the SMEs. This would
avoid overrun in cost and time, which is a major problems for SMEs.

iv.

Cluster-based approach for Financing SMEs

Cluster-based approach for financing SMEs offers possibilities of reduction in
transaction costs and mitigation of risks. Each lead bank of a district may adopt at
least one SME cluster. Banks should also open more SME focused branch offices
at different SMEs cluster which can also act as Counselling Centres for SMEs.

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v.

Banks should encourage lending to pool of micro entrepreneurs who have been
financed by Micro Finance Institutions and are now ready for borrowing at higher
levels in the missing segment of Rs. 50,000 to Rs. 5 lakh.

vi.

Banks may be encouraged to use a scoring model to ensure speedy disposal of the
loan applications from micro enterprises.

vii.

Increasing Coverage under CGTMSE

Currently, RBI has made it mandatory for all banks to cover all SME loans up
to Rs.5 lakh under CGTMSE (Credit Guarantee Fund Trust for Micro and Small
Enterprises). RBI may consider increasing the above mandatory level to Rs. 10 lakh
for SMEs.

viii.

Banks may absorb one-time guarantee fee and annual service fee under the Credit
Guarantee Scheme to facilitate higher flow of credit to SMEs without
collateral/third party guarantee.

ix.

Training Programmes for Bank Executive

There is a need of increasing training programmes for bank executives to
sensitise them about the credit requirements need of SMEs. Banks should
encourage their officials to undergo specialized course run by Indian Institute of
Banking and Finance on the subject of SME finance for bankers by suitably
incentivising them. This would result in creation of cadre of trained officers in the
field.

x.

Bank branches should be encouraged to participate in organizing joint

programmes relating to entrepreneurship and skill development, rural
industrialization etc. and also look at partnering in setting up of institutions like
RUDSETI (Rural development and Self Employment Training Institute) at
different SME clusters.

xi.

Setting up of MSME Helpline

The Ministry of MSME should set up a MSME Helpline, which will act as a
one-stop source for all MSME related information. This helpline may provide
linkages to the SME Helpline of the banks for facilitating easy access to loan
related information.

xii.

Setting up of SME Exchange

One of the critical constraints on the growth of MSMEs is its inability to raise
equity funds/risk capital. Despite banks being selective and cautious in lending
them, the MSMEs have primarily relied on debt financing from banks and nonbank financial institutions. This is mainly because the Indian equity markets have
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been averse to funding smaller and early stage businesses. At present, the source
of equity funds/risk capital for the MSMEs are very limited.
One of the main reasons for this is the absence of a Stock Exchange for
MSMEs or a separate platform of an existing stock exchange for MSMEs. These
enterprises are, therefore, unable to access capital market. An exchange designed
for the needs of the Indian SMEs will have several advantages.
a) A dedicated SME Exchange shall lead to diversification of sources of
finance for the SMEs by paving the path for raising risk capital.
b) Growth in equity culture through this platform for SMEs will result in
greater shareholder activism. The public scrutiny of SMEs is expected to
raise productivity of the MSMEs by improving their governance processes
and practices.
c) An SME Exchange will also build the bridge between SMEs and private
equity and venture capital by providing an exit route.

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References:
1. The Macro, Small and Medium Enterprises Development Act 2006, accessed from
http://www.and.nic.in/C_charter/indust/msmeact2006.pdf
2. A report by CRISIL ratings on SME funding published on January 03, 2011 accessed
from
http://www.crisil.com/Ratings/Brochureware/News/CRISIL-Ratings_smefunding-pr_030111.pdf
3. The SME Banking Knowledge Guide by IFC, World Bank Group accessed from
http://www.ifc.org/ifcext/gfm.nsf/AttachmentsByTitle/SMEBankingGuidebook/$FIL
E/SMEBankingGuide2009.pdf
4. Report of Prime Ministers Task Force on Micro, Small and Medium Enterprises
accessed from http://msme.gov.in/PM_MSME_Task_Force_Jan2010.pdf
5. The Ministry of Micro, Small and Medium Enterprises http://msme.gov.in/
6. National Small Industries Corporation http://www.nsic.co.in/
7. The office of Development Commissioner (MSME) http://www.dcmsme.gov.in/
8. Annual Report 2010-11, The Ministry of Micro, Small and Medium Enterprises

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