Suggestions to Stimulate Financing under Micro and Small Enterprises

transcript

SUGGESTIONS TO STIMULATE FINANCING UNDER MICRO AND SMALL ENTERPRISES

Yasha Singh, 4113007007

Suggestions to Stimulate Financing under Micro and

Small Enterprises

Summer Training Project submitted to Indian Institute of Finance in partial

fulfilment of requirements

Management of Business Finance

Yasha Singh

(4113007007)

Under the Supervision of

Mr. Ashwini Kumar Sharma

Chief Manager

Bank of Baroda

Greater Noida

INDIAN INSTITUTE OF FINANCE

DELHI & G-NOIDA

June, 2014

TABLE OF CONTENTS

Certificate 1

Declaration 2

Preface 3

Executive Summary 4

Objective of the Project 5

Source of Data 6

Limitations 7

Company Profile 8

LIST OF TABLES

Table I Types of loan sought during 2000 50

Table II Cost of funds in select Institutional Informal Source 69

Table III Annual real GDP growth rate 93

Table IV MSMEs performance 94

Table V Growth rate of MSMEs Sector and overall Industrial sector 95

Table VI Contribution of MSEs in total industrial production and GDP 96

Table VII Increase in credit flow between 2007-2008 98

Table VIII Bank advances channeled 102

Table IX Performance under annual credit plan 106

Table X Sector wise breakup under annual credit plan 107

Table XI Credit deposit in north India vis-à-vis south India 109

Table XII Performance of small scale industries in India 112

Table XIII Region wise data related to small scale industries 115

LIST OF FIGURES

Figure 1 Overall finance gap in MSME sector 54

Figure 2 Equity demand in early and growth stages in MSMEs Sector 62

Figure 3 Supply of finances to MSME Sector 66

Figure 4 Share of non-institutional informal source of financing 68

Figure 5 Structure of formal debt supply to the MSME sector 70

Figure 6 Structure of Banking Institution Supply to the MSME Sector 73

Figure 7 Overall Finance Gap in MSME sector 83

Figure 8 Finance Gap in Micro, Small and Medium Enterprises Segments 84

Figure 9 Debtors day in small and medium enterprises segments 87

Figure 10 credit deposit ratio 110

1. Introduction 37

1.1 Need for the study 39

1.2 Background 40

1.3 Objective of the study 45

1.3.1 Primary objective 46

1.3.2 Sub Objective 47

1.4 Loan guarantee program 50

2. Literature review and synthesis 51

2.1 Theoretical rationale for loan guarantee program 52

2.2 Measures of incrementality 54

3. Research Methodology 58

3.1 Research Process 60

3.2 Significance of MSMEs in Indian Economy 62

3.3 Performance of MSMEs 63

3.4 Credit flow to MSMEs 66

3.5 Hypothesis framed 69

3.6 Advances channelized by banks 70

3.7 Credit Deposit Ratio 77

3.8 Relationship between institutional finance and 80

growth of small enterprises

4. Analysis 94

4.1 Financing problems 96

4.2 Operational and administrative problems 97

4.3 Sales and debtors problems 98

5. Conclusion 99

6. Recommendations 102

6.1 Minimum government regulations and tax 103

6.2 Better Access to finance 104

7. References 106

DECLARATION

I, Yasha Singh bearing En. No. 4113007007, declare that the study on

SUGGESTIONS TO STIMULATE FINANCING UNDER MICRO

AND SMALL ENTERPRISES is pursued by me as a part of the

requirement of MANAGEMENT OF BUSINESS FINANCE. This

study is being submitted for approval to the Indian Institute of

Finance.

I declare that the form and content of the above mentioned project is

original and have not been submitted in part or full, for any other

degree or diploma or any other programme of this or any other

Organisation/Institute/University.

Yasha Singh

4113007007

PREFACE

I have to peruse a summer training project under the guidance

Corporate and Academic Guide. I have had the privilege of

undertaking project on ‘SUGGESTIONS TO STIMULATE

FINANCING UNDER MICRO AND SMALL ENTERPRISES’.

My project is divided into 5 Chapters and they are given as under.

1. Chapter one of the study contains, concept of Micro and Small

Enterprises and importance of the subject in the present

scenario.

2. Chapter two deals with review of literature on suggestions to

stimulate financing under micro and small enterprises.

3. Chapter three deals with objective of the study, research

methodology and brief review of other related literatures.

4. Chapter four deals with analysis and interpretations. Main

analysis and interpretation is Micro and Small Enterprises is

struggling for financing.

5. Chapter five deals with summary of major findings, discussions

suggestions and limitations of the study.

I would like to thank Chairman, Vice Chairman, Chief Manager and

the staff of Bank of Baroda; and IIF for their support.

Yasha Singh (4113007007)

EXECUTIVE SUMMARY

In the growing global competition, the productivity of any business

concern depends upon finance. This topic deals with the financing

problem faced by micro and small enterprises and suggestions to

stimulate financing in micro and small enterprises. This project report

contains 5 different chapters.

The report begins with the first chapter which consists introduction to

the problem, background of micro and small enterprises, objective of

the project etc.

The second chapter is the introduction to the literature review which

gives a brief idea regarding theoretical rationale for loan guarantee

programs in micro and small enterprises.

The third chapter is about research methodology adopted in preparing

this report. It covers the sample procedure, types of data used and the

data collection method.

The fourth chapter comprehensive coverage of forecasting concepts

and techniques which shows the analysis of data through tabulation,

computation and graphical representation of data collected from

survey.

The fifth chapter deals with the findings, suggestion and conclusion.

As we know that only analysis and conclusion is not the end of a

project, therefore, in the sixth chapter, I searched, reviewed books on

the subject and also latest research works and their recommendations.

In each of the six chapters as described above, every chapter has been

scheduled in a manner so as to easily enable the reader and I also tried

to keep the contents simple as far as possible. The contents of this

project are based on the assumption that the reader has a basic

knowledge of finance. The report is supported by figures, facts and

data wherever necessary with a view to assist and help the reader to

develop a clear cut understanding and clarity of the topic.

I hope this report will certainly be useful for those who are in the field

of finance. I would be pleased to receive any comments, suggestions

and advice that readers may have in order to improve and maintain

the relevance of this project at my e-mail ID- i.e.

ysingh49@yahoo.com

OBJECTIVE OF THE PROJECT

To study the financing policy and the financing appraisal system

as a whole.

To understand the financing system as being used in Bank of

Baroda (BoB), Alpha-1, Greater Noida.

To study procedure adopted in evaluating financing proposal by

using case analysis in BoB.

To understand the commercial, financial and technical viability

of the proposal proposed and it’s finding pattern.

After learning, analysis and evaluation of the whole finance

system at BoB provided certain suggestions and

recommendations which may helpful to improve the finance

system in BoB group.

SOURCES OF DATA

There are mainly two sources of data.

• PRIMARY DATA:

Data provided by bank.

• SECONDARY DATA:

Bank reports

Banks loan circulars on micro and small enterprises

Bank and ministry of MSE website

Books and Journals

LIMITATIONS

• This study is limited to business loan alone, personal loans

are not taken into consideration during study.

• Bank cannot provide secret information as business terms and

conditions are not permitted to BoB. And hence, I am not in a position

to disclose the identity.

COMPANY PROFILE

Bank of Baroda (BoB) is an Indian state-owned banking and financial

services company headquartered in Vadodara (earlier known as

Baroda) in Gujarat, India. It is the second-largest bank in India,

after State Bank of India, and offers a range of banking products and

financial services to corporate and retail customers through its

branches and through its specialised subsidiaries and affiliates. During

FY 2012-13, its total business was 8,021 billion. In addition to its

headquarters in its home state of Gujarat, it has a corporate

headquarters in the Bandra Kurla Complex in Mumbai.

Based on 2012 data, it is ranked 715 on Forbes Global 2000 list. BoB

has total assets in excess of 3.58 trillion (short scale), 3,583 billion

(long scale), a network of 4283 branches (out of which 4172 branches

are in India) and offices, and over 2000 ATMs.

The bank was founded by the Maharaja of Baroda, H. H. Sir Sayajirao

Gaekwad III on 20 July 1908 in the Princely State of Baroda,

in Gujarat. The bank, along with 13 other major commercial banks of

India, was nationalised on 19 July 1969, by the Government of

India and has been designated as a profit-making public sector

undertaking (PSU).

Bank of Baroda is one of the Big Four banks of India, along

with State Bank of India, ICICI Bank and Punjab National Bank.

HISTORY

1908-1959

In 1908, Maharaja Sayajirao Gaekwad III, one of the knights of

the Maratha Kingdom, set up the Bank of Baroda (BoB), with other

stalwarts of industry such as Sampatrao Gaekwad, Ralph

Whitenack, Vithaldas Thakersey, Tulsidas Kilachand and NM

Chokshi. Two years later, BoB established its first branch

in Ahmadabad. The bank grew domestically until after World War II.

Then in 1953 it crossed the Indian Ocean to serve the communities

of Indians in Kenya and Indians in Uganda by establishing a branch

each in Mombasa and Kampala. The next year it opened a second

branch in Kenya, in Nairobi, and in 1956 it opened a branch in Dar-

es-Salaam. Then in 1957 BoB took a giant step abroad by establishing

a branch in London. London was the center of the British

Commonwealth and the most important international banking center.

In 1958 BoB acquired Hind Bank (Calcutta; est. 1943), which became

BoB's first domestic acquisition.

In 1961, BoB merged in New Citizen Bank of India. This merger

helped it increase its branch network in Maharashtra. BoB also

opened a branch in Fiji. The next year it opened a branch in

Mauritius. Bank of Baroda In 1963, BoB acquired Surat Banking

Corporation in Surat, Gujarat. The next year BoB acquired two banks:

Umbergaon People’s Bank in southern Gujarat and Tamil Nadu

Central Bank in Tamil Nadu state.

In 1965, BoB opened a branch in Guyana. That same year BoB lost its

branch in Narayanjanj (East Pakistan) due to the Indo-Pakistani War

of 1965. It is unclear when BoB had opened the branch. In 1967 it

suffered a second loss of branches when the Tanzanian government

nationalised BoB’s three branches there at (Dar es Salaam, Mwanga,

and Moshi), and transferred their operations to the Tanzanian

government-owned National Banking Corporation.

In 1969 the Indian government nationalised 14 top banks, including

BoB. BoB incorporated its operations in Uganda as a 51% subsidiary,

with the government owning the rest.

In 1972, BoB acquired Bank of India's operations in Uganda. Two

years later, BoB opened a branch each in Dubai and Abu Dhabi.

Back in India, in 1975, BoB acquired the majority shareholding and

management control of Bareilly Corporation Bank (est. 1928)

and Nainital Bank (est. in 1954), both in Uttar Pradesh. Since then,

Nainital Bank has expanded to Uttarakhand state.

International expansion continued in 1976 with the opening of a

branch in Oman and another in Brussels. The Brussels branch was

aimed at Indian firms from Mumbai (Bombay) engaged in diamond

cutting and jewellery having business in Antwerp, a major center

for diamond cutting.

Two years later, BoB opened a branch in New York and another in

the Seychelles. Then in 1979, BoB opened a branch in Nassau, the

Bahamas.

In 1980, BoB opened a branch in Bahrain and a representative office

in Sydney, Australia. BoB, Union Bank of India and Indian

Bank established IUB International Finance, a licensed deposit taker,

in Hong Kong. Each of the three banks took an equal share.

Eventually (in 1998), BoB would buy out its partners.

A second consortium or joint-venture bank followed in 1985. BoB

(20%), Bank of India (20%), Central Bank of India (20%) and

ZIMCO (Zambian government; 40%) established Indo-Zambia

Bank in Lusaka. That same year BoB also opened an Offshore

Banking Unit (OBU) in Bahrain.

Back in India, in 1988, BoB acquired Traders Bank, which had a

network of 34 branches in Delhi.

In 1990, BoB opened an OBU in Mauritius, but closed its

representative office in Sydney. The next year BoB took over the

London branches of Union Bank of India and Punjab & Sind

Bank (P&S). P&S’s branch had been established before 1970 and

Union Bank’s after 1980. The Reserve Bank of India ordered the

takeover of the two following the banks' involvement in the Sethia

fraud in 1987 and subsequent losses.

Then in 1992 BoB incorporated its operations in Kenya into a local

subsidiary with a small tranche of shares quoted on the Nairobi Stock

Exchange. The next year, BoB closed its OBU in Bahrain.

In 1996, BoB Bank entered the capital market in December with

an Initial Public Offering (IPO). The Government of India is still the

largest shareholder, owning 66% of the bank's equity.

In 1997, BoB opened a branch in Durban. The next year BoB bought

out its partners in IUB International Finance in Hong Kong.

Apparently this was a response to regulatory changes following Hong

Kong’s reversion to the People’s Republic of China. The now wholly

owned subsidiary became Bank of Baroda (Hong Kong), a restricted

license bank. BoB also acquired Punjab Cooperative Bank in a rescue.

BoB incorporate wholly owned subsidiary BOB Capital Markets Ltd.

for broking business.

In 1999, BoB merged in Bareilly Corporation Bank in another rescue.

At the time, Bareilly had 64 branches, including four in Delhi. In

Guyana, BoB incorporated its branch as a subsidiary, Bank of Baroda

Guyana. BoB added a branch in Mauritius and closed its Harrow

Branch in London.

2000: BoB established Bank of Baroda (Botswana).

2002: BoB acquired Benares State Bank (BSB) at the Reserve

Bank of India’s request. BSB was established in 1946 but traced its

origins back to 1871 and its function as the treasury office of the

Benares state. In 1964, BSB had acquired Bareilly Bank (est.

1934), with seven branches; it also had taken over Lucknow Bank

in 1968. The acquisition of BSB brought BoB 105 new branches.

2002: Bank of Baroda (Uganda) was listed on the Uganda

Securities Exchange (USE).

2003: BoB opened an OBU in Mumbai.

2004: BoB acquired the failed Gujarat Local Area Bank, and

returned to Tanzania by establishing a subsidiary in Dar-es-

Salaam. BoB also opened a representative office each in Kuala

Lumpur, Malaysia, and Guangdong, China.

2005: BoB built a Global Data Centre (DC) in Mumbai for running

its centralised banking solution (CBS) and other applications in

more than 1,900 branches across India and 20 other counties where

the bank operates. BoB also opened a representative office in

Thailand.

2006: BoB established an Offshore Banking Unit (OBU) in

Singapore.

2007: In its centenary year, BoB’s total business crossed

2.09 trillion (short scale), its branches crossed 2000, and its global

customer base 29 million people.

2008: BoB opened a branch in Guangzhou, China (02/08/2008)

and in Kenton, Harrow United Kingdom. BoB opened a joint

venture life insurance company with Andhra Bank and Legal and

General (UK) called India First Life Insurance Company.

In 2010, Malaysia awarded a commercial banking licence to a locally

incorporated bank to be jointly owned by Bank of Baroda, Indian

Overseas Bank and Andhra Bank. That same year, BoB also opened a

branch in New Zealand.

In 2011, BoB opened an Electronic Banking Service Unit (EBSU)

was opened at Hamriya Free Zone, Sharjah (UAE). It also opened

four new branches in existing operations in Uganda, Kenya (2), and

Guyana. BoB closed its representative office in Malaysia in

anticipation of the opening of its consortium bank there. BoB received

'In Principle' approval for the upgrading of its representative office in

Australia to a branch.

The Malaysian consortium bank, India International Bank Malaysia

(IIBM), finally opened in Kuala Lumpur, which has a large

population of Indians. BOB owns 40%, Andhra Bank owns 25%, and

IOB the remaining 35% of the share capital. IIBM seeks to open five

branches within its first year of operations in Malaysia, and intends to

grow to 15 branches within the next three years.

SUBSIDIARIES

BOB Capital Markets (BOBCAPS) is a SEBI-registered investment

banking company based in Mumbai, Maharashtra. It is a wholly

owned subsidiary of Bank of Baroda. Its financial services portfolio

includes initial public offerings, private placement of debts,

corporate restructuring, business valuation, mergers and

acquisition, project appraisal, loan syndication, institutional equity

research, and brokerage.

AFFILATES

India First Life Insurance Company is a joint venture between Bank

of Baroda (44%) and fellow Indian state-owned bank Andhra

Bank (30%), and UK’s financial and investment company Legal &

General (26%). It was incorporated in November, 2009 and has its

headquarters in Mumbai. The company started strongly, achieving a

turnover in excess of 2 billion in its first four and half months.

INTERNATIONAL PRESENCE

In its international expansion, the Bank of Baroda followed the Indian

diaspora, especially that of Gujaratis. The Bank has 101

branches/offices in 24 countries including 61 branches/offices of the

bank, 38 branches of its 8 subsidiaries and 1 representative office in

Thailand. The Bank of Baroda has a joint venture in Zambia with 16

branches.

Among the Bank of Baroda’s overseas branches are ones in the

world’s major financial centres (e.g., New York, London, Dubai,

Hong Kong, Brussels and Singapore), as well as a number in other

countries. The bank is engaged in retail banking via the branches of

subsidiaries in Botswana, Guyana, Kenya, Tanzania, and Uganda. The

bank plans has recently upgraded its representative office in Australia

to a branch and set up a joint venture commercial bank in Malaysia. It

has a large presence in Mauritius with about nine branches spread out

in the country.

The Bank of Baroda has received permission or in-principle approval

from host country regulators to open new offices in Trinidad and

Tobago and Ghana, where it seeks to establish joint ventures or

subsidiaries. The bank has received Reserve Bank of India approval to

open offices in the Maldives, and New Zealand. It is seeking approval

for operations in Bahrain, South Africa, Kuwait, Mozambique, and

Qatar, and is establishing offices in Canada, New Zealand, Sri Lanka,

Bahrain, Saudi Arabia, and Russia. It also has plans to extend its

existing operations in the United Kingdom, the United Arab Emirates,

and Botswana.

The tagline of Bank of Baroda is "India's International Bank".

CODE OF BANK’S COMMITMENT TO MICRO AND

SMALL ENTERPRISES

This is a Code, which sets minimum standards of banking practices

for banks to follow when they are dealing with Micro and Small

Enterprises (MSEs) as defined in the Micro, Small and Medium

Enterprises Development (MSMED) Act, 2006. It provides protection

to you and explains how banks are expected to deal with you for your

day to- day operations and in times of financial difficulty.

The Code does not replace or supersede regulatory or

supervisory instructions issued by the Reserve Bank of India (RBI)

and we will comply with such instructions /directions issued by the

RBI from time to time. The provisions of the Code may set higher

standards than what is indicated in the regulatory or supervisory

instructions and such higher standards will prevail, as the Code

represents best practices agreed by us as our commitment to you.

THE OBJECTIVES OF THE CODE ARE -

To give a positive thrust to the MSE sector by providing easy

access to efficient banking services.

To promote good and fair banking practices by setting minimum

standards in dealing with MSE.

To increase transparency so that MSE can have a better

understanding of what MSE can reasonably expect of the

services.

To improve our understanding of your business through

effective communication.

To encourage market forces, through competition, to achieve

higher operating standards.

To promote a fair and cordial relationship between MSE and

bank and also ensure timely and quick response to MSE banking

needs.

To foster confidence in the banking system.

APPLICATION OF THE CODE-

As defined in the MSMED Act, 2006, MSEs cover Micro and Small

Enterprises engaged in the manufacturing or production or processing

or preservation of goods and those engaged in providing or rendering

of services.

Unless it says otherwise, this Code will apply to all the products and

services listed below, under current regulatory instructions, whether

they are provided by branches, subsidiaries, joint ventures or agents,

across the counter, over the phone, by post, through interactive

electronic devices, on the internet or by any other mode. However, all

products discussed here may or may not be offered by us.

Current accounts, term deposits, recurring deposits, and all other

deposit accounts.

Payment services such as payment orders, remittances by way of

Demand Drafts and wire transfers, all electronic transactions

like Real Time Gross Settlement (RTGS), Electronic Funds

Transfer (EFT), National Electronic Funds Transfer (NEFT) or

any other mode.

Banking services related to Government transactions.

Demat accounts, equity, government bonds.

Indian currency notes exchange facility.

Collection of cheques / instruments, safe custody services.

Loans and other credit facilities which include fund based such

as cash credit, overdraft, cheque and bill purchase/discount

(both inland and foreign), negotiation under reserve of

documents tendered under Letter of Credit (both inland and

foreign) and non fund based such as establishment of inland and

/or foreign Letter of Credit (D/P or D/A), issuing of Guarantee

(both inland and foreign), Inland or foreign bill or cheque for

collection, Co- acceptance and avalisation of bills, buyer’s

credit, etc.

Foreign Exchange Services as permitted under Foreign

Exchange Management Act (FEMA) / Reserve Bank of India’s

guidelines including money changing.

Third party insurance and investment products marketed

through our branches and/ or our authorized representatives or

agents.

Card products like ATM/ Debit/Credit cards, smart cards and

services.

Factoring services.

Merchant Services.

BANK KEY COMMITMENTS TO MSE-

To act fairly and reasonably in all bank dealings with MSE by-

Providing minimum banking facilities of receipt and payment of

cash/ cheques at the bank’s counter.

Providing speedy and efficient credit and service delivery.

Meeting the commitments and standards in this Code, for the

products and services bank offer, and in the procedures and

practices bank staff follow.

Making sure bank products and services meet relevant laws and

regulations in letter and spirit.

Ensuring that bank dealings with MSEs rest on ethical principles

of integrity and transparency.

Operating secure and reliable banking and payment and

settlement systems.

WORKING OF FINANCIAL PRODUCTS AND

SERVICES-

Giving them information in any one or more of the following

languages: Hindi, English or the appropriate local language.

Ensuring that advertising and promotional literature of bank is

clear and not misleading.

Ensuring that they are given clear and full information about

bank products and services, the terms and conditions and the

interest rates/service charges, which apply to them.

Ensuring that there is no mis-selling of bank products.

Giving information on the facilities provided to MSE and how

MSE can avail of these and whom MSE can contact for

addressing queries.

TO HELP MSE IN USING ACCOUNT OR SERVICE

Providing them regular appropriate updates.

Keeping them informed about changes in the interest rates,

charges or terms and conditions.

TO DEAL QUICKLY AND SYMPATHETICALLY

WHEN THINGS GO WRONG BY -

Correcting mistakes promptly and cancelling any bank charges

that bank apply due to bank’s mistake.

Handling MSEs complaints promptly.

Telling MSEs how to take complaint forward if they are not

satisfied.

Providing suitable alternative avenues to alleviate problems

arising out of technological failures in the bank.

CREDIT INFORMATION COMPANIES-

The role of Credit Information Companies (CIC) and the effect the

information they provide to their members can have on MSEs ability

to get credit.

When MSEs open their account, we pass their account details to

CIC/s which includes business /personal debts MSEs owe to bank.

Updated information about credit availed from bank will be reported

by bank to the CIC/s on a monthly basis.

Information reported to CIC/s will also include personal debts you

owe to bank even when-

MSE have fallen behind with their payments

The amount owed is in dispute

MSE have made any proposals to repay which bank is not

satisfied with.

If MSEs loan account has been in default and thereafter

regularised, bank will take steps to update this information with

the CIC/s in the next monthly report.

Bank shall keep the CIC/s updated of MSEs account details, on

a monthly basis, especially when their account becomes

‘standard’ after a period of being ‘sub-standard’ and / or

immediately after the account is regularized / closed to our

satisfaction.

LENDING-

Bank loan policy will be reflective of the objectives and spirit of the

National Policy and the Regulatory Prescription. Bank will endeavour

to provide facilities through a Single Window Mechanism.

Bank has policies on-

Lending to the Micro and Small Enterprises

Rehabilitation for the Micro and Small Enterprises

Bank will inform MSEs about salient features including benefits

available and charges payable and terms of Credit Guarantee Scheme

of CREDIT GUARANTEE FUND TRUST FOR MICRO AND

SMALL ENTERPRISES which is extended by eligible banks and is

popularly known as CGTSME guarantee scheme for MSEs and which

is available at present to new as well as existing Micro and Small

Enterprises including Service Enterprises with a maximum credit cap

of Rs. 100 lakh ( Rupees One hundred lakh) per borrower, excluding

retail trade, educational institutions, training institutes and Self Help

Groups (SHGs) as per the said Scheme.

Where a loan is eligible to be covered under any subsidy scheme in

force, bank will explain to you the features of such scheme and any

requirement you will need to fulfil.

Bank will endeavour to conduct programmes to enhance knowledge

on financial management of prospective borrowers.

CREDIT ASSESSMENT-

Bank will-

Verify the details mentioned by MSEs in application by

contacting then through bank staff / agencies appointed by bank

for this purpose at their business address/ residence.

Before lending MSEs any money or increasing their overdraft or

borrowing limit/s, bank shall carry out proper assessment of

their loan application undertaking detailed due diligence and

appraisal.

Satisfy bank about the reasonableness of the projections made

by MSEs.

While assessing their credit requirement, take into account the

seasonality or cyclicality of their business and, where required,

fix separate peak and non-peak credit limits.

Bank may require MSEs to give them the following information

to enable them to make a fair assessment-

Purpose of borrowing.

MSEs Business plan.

MSEs Business’s cash flow, profitability and existing financial

commitments supplemented, if necessary, by account

statements.

MSEs Personal financial commitments.

How MSEs have handled their finances in the past.

Information bank gets from Credit Information Companies.

Ratings assigned by reputed credit rating agencies, if any.

Information from others, such as other lenders /creditors.

Market reports.

Any security provided or whether CGTSME guarantee cover is

available if the credit requirement is within Rupees One hundred

lakh. Any other relevant information.

Bank will –

Not insist on collateral for credit limits up to Rs.10 lakh or up to

limits specified by Reserve Bank of India, from time to time.

Consider providing collateral free credit limits up to Rs.25 lakh

if bank is satisfied about MSEs track record and financial

position being good and sound.

Seek MSEs consent to cover the credit facilities sanctioned to

MSEs within credit cap of Rs.100 lakh (Rupees One hundred

lakh) under Credit Guarantee Scheme of CREDIT

GUARANTEE FUND TRUST FOR MICRO AND SMALL

ENTERPRISES and accordingly will not insist on collateral

security and / or Third party Guarantee for facilities within a

maximum limit of Rs.100 lakh (Rupees One hundred lakh) if the

facility approved by us is an eligible facility and has been

covered under the CGTSME scheme and for which you have

agreed to.

Provide micro and small enterprises (manufacturing) working

capital limits computed on the basis of a minimum of 20 per

cent of your projected annual turnover.

Consider MSEs request for suitable enhancement in the working

capital limits in cases where the output exceeds the projections

or where the initial assessment of working capital is found

inadequate and you have provided necessary evidence therefor.

NON-FUND BASED FACILITIES-

Bank offers non-fund based facilities for purchase of capital

equipment or raw materials/consumables etc. through issuance,

advising, confirmation, negotiation, discounting of Letters of

Credit (LCs). Facilities such as Letter of Credit, Guarantees,

Collections are governed, besides national laws, by relevant

Rules and applicable Publications of International Chamber of

Commerce (ICC) published from time to time and you agree to

the same.

Bank may stand as a guarantor for MSEs financial obligations.

Bank may help MSEs in collection of export bills and domestic

outstation trade and service bills

NURSING SICK MSES AND DEBT RESTRUCTURING-

Bank will consider a nursing/ debt restructuring programme in case

your borrowal account remains substandard for over six months, or

your unit is considered to be sick as per the policies of our bank.

For examining MSEs request for rehabilitation /debt restructuring we

First see whether MSEs are viable/potentially viable.

If MSEs are found to be viable/potentially viable, initiate

corrective action for MSEs revival.

In case MSEs unit is potentially viable and is under consortium /

multiple banking arrangement, and if bank have maximum share

of outstanding, work out the restructuring package.

Work out a rehabilitation package which will also include MSEs

contribution in accordance with RBI stipulations and implement

the same within a maximum period of 60 days from the date of

receipt of your request.

If bank do not think that the rehabilitation plan will succeed,

bank will explain the reasons why and help MSEs and your

advisors consider other options.

POLICY ON COLLECTION OF DUES AND SECURITY

REPOSSESSION-

Bank collection policy is built on courtesy, fair treatment and

persuasion. Bank believes in fostering customer confidence and long-

term relationship. As part of policy –

Bank will provide MSEs with all the information regarding dues

and will endeavour to give sufficient notice for payment of dues.

Bank will write to MSEs when they initiate recovery

proceedings against MSEs.

Bank will post details of the recovery agency firms / companies

engaged by MSEs on bank website.

Bank will also make available, on request, details of the

recovery agency firms/companies at our branches.

Bank staff or any person authorized to represent us in collection

of dues or/and security repossession will identify himself/herself

and display the authority letter issued by bank and upon request

display to MSEs his/ her identity card issued by bank or under

bank authority.

Bank will check before passing on a default case to collection

agencies so that MSEs are not harassed on account of lapses on

bank part.

All the members of the staff or any person authorised to

represent our bank in collection or/and security repossession

would be subjected to due diligence and they would follow the

guidelines set out below:

MSEs would be contacted ordinarily at the place of

business/occupation and if unavailable at the place of your

business/ occupation at the place of your residence or in the

absence of any specified place at the place of your authorised

representative’s choice.

Identity and authority to represent would be made known to

MSEs at the first instance.

MSEs privacy and dignity would be respected.

Interaction with MSEs would be in a civil manner.

Normally bank representatives will contact you between 0700

hrs and 1900 hrs, unless the special circumstances of business or

occupation require otherwise.

MSEs requests to avoid calls at a particular time or at a

particular place would be honoured as far as possible.

Time and number of calls and contents of conversation would be

documented.

All assistance would be given to resolve disputes or differences

regarding dues in a mutually acceptable and in an orderly

manner.

During visits to MSEs for dues collection, decency and decorum

would be maintained.

Inappropriate occasions such as bereavement in the family or

such other calamitous occasions would be avoided for making

calls/visits to collect dues.

Bank will follow a Security Repossession Policy in consonance

with the law.

FINANCIALS OF BoB-

FINANCIAL RATIOS-

CHAPTER 1

INTRODUCTION

There are so many countries, where loan guarantee programs are the

elements of government policy with respect to small and medium-

sized enterprises (SMEs). If loan guarantee schemes are to be

effective, the number of firms obtaining financial assistance through

such type scheme ought not to be able to get financing from existing

sources: a property known as incrementality or additionality. This

project tried to deal a new approach to measuring incrementality. This

work generally having a two-stage process to estimate the

incrementality of loans provided under the Bank of Baroda program.

The Stage First is essentially a credit-scoring model which estimation

is based on a large representative sample of SMEs. The final model

was firm with prior expectations and shown high levels of goodness-

of-fit. This model applied to classify the firms that had received loans

under the terms of the loan guarantee scheme.

Incremental loans may be classified as ‘Turndowns’ by the model. So,

the ratio of loan guarantee recipients that the model classified as

‘Turndowns’ is a straight measurement of incrementality. For the

BOB loan guarantee program, incrementality estimated with 95%

confidence as 74.8+/-9.0%.

Through out globe, the financial institutions are playing a very

important role in the economic development of any country. The

commercial banks like BoB are emerged as the provider of credit

requirement of the small borrowers and also played a positive and

supporting role in institutionalizing the community savings. An

excessive focus has been laid on quantitative achievement and

social obligations. Apart from this, the reason of expansion of bank

branches may be attributed to develop a strong banking base to serve

the economy efficiently and meet the banking needs of various

segments of the economy by developing specialized banks. However,

with the development of alternative sources of funds, the

dependence of industry on commercial banks for meeting their credit

requirements has been declined although the share of credit to

industry in India was significantly highest among all countries

(Ahmed, 2010). The corporate sector of India is heavily dependent on

the banking sector in comparison with other countries (Chavan and

Lamba, 2007). The commercial banks have of late emerged as the

major supplier of industrial credit for SME in the national and state

levels as well as in the districts under study. A large variety of

financial institutions including banks have emerged basically after

independence to satisfy the financial requirements of both small and

large scale industries at national, regional and state levels. There have

been several confusing features of credit flow to the small sector in

recent years. The overall availability of credit to micro and small

enterprises (MSEs) as percentage of net bank credit (NBC) of the

scheduled commercial banks (SCBs) has declined from 13.9 per cent

in March, 1997 to 6.2 per cent in March, 2006 and thereafter it

experienced a swelling trend and reached to 10 per cent of bank credit

in March, 2009 (RBI, 2010). In the light of the above, an attempt has

been made in the present project to analyze the bank financing of

SME sector in India.

NEED FOR THE STUDY

Micro, Small and Medium Enterprises (MSME) contribute nearly 8

percent of the country’s GDP, 45 percent of the manufacturing output

and 40 percent of the exports. They provide the largest share of

employment after agriculture. They are the nurseries for

entrepreneurship and innovation. They are widely dispersed across the

country and produce a diverse range of products and services to meet

the needs of the local markets, the global market and the national and

international value chains.

BACKGROUND

Ministry of Micro, Small & Medium Enterprises

The Government of India has enacted the Micro, Small and Medium

Enterprises Development (MSMED) Act, 2006 in terms of which the

definition of micro, small and medium enterprises is as under:

(a) Enterprises engaged in the manufacture or production, processing

or preservation of goods as specified below:

(i) A micro enterprise is an enterprise where investment in plant and

machinery does not exceed Rs. 25 lakh;

(ii) A small enterprise is an enterprise where the investment in plant

and machinery is more than Rs. 25 lakh but does not exceed Rs. 5

crore; and

(iii) A medium enterprise is an enterprise where the investment in

plant and machinery is more than Rs.5 crore but does not exceed

Rs.10 crore.

(b) Enterprises engaged in providing or rendering of services and

whose investment in equipment (original cost excluding land and

building and furniture, fittings and other items not directly related to

the service rendered or as may be notified under the MSMED Act,

2006 are specified below.

(i) A micro enterprise is an enterprise where the investment in

equipment does not exceed Rs. 10 lakh;

(ii) A small enterprise is an enterprise where the investment in

equipment is more than Rs.10 lakh but does not exceed Rs. 2 crore;

(iii) A medium enterprise is an enterprise where the investment in

equipment is more than Rs. 2 crore but does not exceed Rs. 5 crore.

The Micro, Small and Medium Enterprises in Manufacturing and

service sector are defined as under in MSMED ACT, 2006

Particulars Investment in Plant &

Machineries in case of

Manufacturing Enterprises

Investment in

Equipment in case of

Service Sector

Enterprises

Up to Rs. 25/- lacs Up to Rs.10/- lacs

Enterprises

Above Rs. 25/- lacs and up to

Rs.500/- lacs

Above Rs.10/- lacs and

upto Rs.200/- lacs

Medium

Enterprises

Above Rs.500/- lacs and up

to Rs.1000/- lacs

Above Rs.200/- lacs and

up to Rs.500/- lacs

Manufacturing Enterprises i.e. enterprises engaged in the manufacture

or production, processing or preservations of goods with investment

in Plant & Machinery as stated above. Service Enterprises i.e.

Enterprises engaged in providing or rendering services and whose

investment in equipment as specified above. (Original cost excluding

Land & Building and furniture, fittings and other items not directly

related to the service rendered or as may be notified under the

MSMED Act, 2006).

Loans for food and agro processing will be classified under Micro and

Small Enterprises, provided the units satisfy investments criteria

prescribed for Micro and Small Enterprises, as provided in MSMED

Act, 2006. Bank has for internal purposes given focused attention to

finance all Commercial enterprises i.e. enterprises which may be

outside the purview of regulatory definition of SME but having

turnover up to Rs 150.00 crores and new infrastructure and real estate

projects where the project cost is up to Rs. 50/- crores by treating

them as part of SME segment.

The economic history of the developed nations shows that economic

growth and growth of financial infrastructure moves together. The

role of banks is a very crucial in the industrial development of any

country or region. A sound and progressive banking system is

prerequisite for industrial development. The loan/credit is the pillar to

industrial development in any region. In India, commercial banks are

granting short term and medium term loans to industries. Banks are

the major apparatus of rapid industrializations of an economy. The

commercial banks are a major source of financing SMEs. The

industrial houses require credit for short period for working capital

and for long periods for their fixed capital requirements. The

commercial banks continue to be the major institutions meeting

over 90 per cent of the institutional credit need of SME sector

(SIDBI, 2010). Gomez (2008) observed that the commercial banks

have maintained an attitude of superiority as regards the provision of

long-term capital to industry. Shekher and Shekhar (2005) opined that

even in the case of providing short term finance, banks granted loans

only on the security of easily realizable assets and not on fixed assets

and they insist a large margin even in the case of easily realizable

assets, thereby making the system expensive. Further, most of the

banks do not maintain adequate technical staff required for the

proper valuation of assets and naturally, to be on the safer side, they

undervalue the assets. The report of the Task Force chaired by (1974)

stated that about 80 per cent of the commercial banks credit are

available to the small industries is in the form of working capital and

the balance is as term loans. The study group (1969) headed by Prof.

D.R Gadgil recommended for the adoption of an “area approach” for

development of credit and banking in the country on the basis of local

conditions. All India Rural Credit Review Committee in 1969

endorsed the view that commercial banks should come forward to

finance activities in rural areas. The lead bank scheme (LBS)

underwent significant transformation in 1989 when “service area

approach” was merged into the scheme. The service area restrictive

provisions were removed in 2004, except for the government

sponsored programme. As in March, 2009, there were 26 numbers of

banks mostly in the public sector, which have been assigned lead

responsibility in 622 districts of the country (RBI, 2009). The State

Bank of India (SBI) is to act as consortium leader of the districts

under study. The lead bank prepares the District Credit Plan

(DCP) and Annual Action Plan (AAP) with the help of bank

officials, developmental agencies -DICs etc. The LBS was evolved

as a framework to be more responsive to the need of rural and semi-

urban economy.

The objectives of the scheme cannot be achieved unless rural

lending is properly tied to well design programmes of

development. This requires an effective co-ordinations and co-

operations not only between lead banks and other banks but also

between banks in one side and the concerned government machineries

and other development agencies on the other side

OBJECTIVE OF THE STUDY

Objective of this project is to analyze the problems of the

MSME sector and to discuss the strategies for removal of the

obstacles. One of the major problems faced by the MSMEs is

related to credit and finances. It has been observed that majority

of micro and small business organizations are in the

unorganized sector. The task of the policy makers is to bring

this large number of small enterprises into some formal

structure, which will enable the existing financial institutions to

extend credit to these enterprises. Establishment of dedicated

stock exchanges for the SMEs, factoring services and proper

monitoring implementation of various programmes announced by

the Government will go way long way in removing the problem

of finance and credit of the SME sector. It is generally recognized

that a substantial amount of job creation is attributable to the growth

of small- and medium-sized enterprises (SMEs). While debated, many

perceive this growth to be obstructed by imperfections in the credit

market such that smaller firms face disproportionate access to the debt

capital needed for start-up, growth, and survival. To address these

perceived imperfections, governments and trade associations have

often intervened in credit markets using loan guarantee programs.

Such schemes are used in most countries in South America, Europe,

Southeast Asia, as well as in North America.

PRIMARY OBJECTIVE

One of the key issues with respect to debates about these interventions

is the extent to which the loan guarantees provide for financing that,

otherwise, would not have been available. This property of the

programs is known as ‘‘additionality’’ in the UK and Europe and as

‘‘incrementality’’ in North America. The extent to which the

provision of capital that is not incremental to that already available

reflects ‘‘a waste of the scarce resources available to Government’’.

This project describes a new approach to the measurement of

incrementality, specifically in the context of the Small Business

Financing.

Loan guarantee schemes are ‘‘an integral part of SME policy in both

developed and developing countries’’ and ‘‘little has been done to

evaluate such programmes.’’ All loan guarantee programs involve at

least three parties: borrower, lender, and guarantor. The motives of

the three participants differ. The borrower is typically an SME

seeking debt capital that approaches a lender for a business loan. The

lender is most often a private financial institution seeking to profit

from the loan transactions. Faced with information asymmetry,

lenders look for signs of creditworthiness from borrowers. For new or

small businesses the high-fixed costs of evaluation may prompt the

lender to refuse a loan application. Alternatively, the parties may

resort to a third-party guarantee of the loan. The guarantor, usually

government or a trade association, is typically seeking to facilitate

access to debt capital in the economy by providing lenders with a

guarantee for some portion of the loan and (often) for accrued

interest.

SUB OBJECTIVES

Access to debt capital achieves economic goals such as:

1. Expansion of the volume of lending to SMEs

2. Increases in employment and in tax revenues from the business and

its employees.

3. Increases in exports of goods and services.

4. Banks potentially profit from the development of a relationship

with SMEs. Hence, guaranteed loans are sometimes used to generate

new customers who may develop strong relationships with the lender

and provide the lender with ancillary sources of profit from both

commercial and personal banking services.

This generic arrangement implies an agency relationship between the

guarantor and the lender, in addition to that between lender and

borrower. The lender acts as a delivery agent of the loan guarantee for

the guarantor. To accomplish its objectives the guarantor must design

the parameters scheme to align its objective with the motives of the

lenders (making profitable loans). In the context of this agency

relationship, the guarantors can typically manage the following

parameters:

1. The degree of discretion in credit decisions. In some jurisdictions

the lender decides which borrowers receive guaranteed loans. In

others the guarantor reviews – at least notionally – each application.

2. The level of the guarantee. This parameter also varies by

jurisdiction and within jurisdictions. For example, prior to 1982 the

guarantee level for US SBA loan guarantees was 90%. When the US

SBA introduced its ‘Preferred Lender’ program (for which SBA

approval of a given loan was automatic) in 1982, the guarantee was

reduced to 75% of the debt.

3. Typically, guarantors set fees in an attempt to recover costs of

honouring defaults or to preserve the integrity of the pool of capital

that, in some implementations, often lies behind the guarantees.

4. Eligibility criteria. In most implementations, guarantees may not be

permitted for certain purposes of borrowing. In Canada, for example,

guarantees are not available for loans used to support working capital.

These parameters vary across loan guarantee schemes according to

the setting and objectives of the participants. The objectives upon

which loan guarantee programs are based can differ substantially.

Countries establish loan guarantee programs for a variety of reasons

and the rationales impact directly the extent to which the guarantor is

concerned with loan incrementality. Some countries design loan

guarantee and risk sharing programs primarily to augment the

financing available to small business (e.g., Canada, France, and UK).

In other countries, loan guarantees are designed to act as lenders of

last resort, offering the loan guarantee only when SMEs fail to obtain

other sources of financing (e.g., US). Some of these programs actually

require that the applicant has officially been turned down for

financing by commercial lenders. Other countries (e.g., Japan) use

loan guarantees to provide funding to forestall the failure of small

firms that would otherwise go under. As a result of the diversity of

objectives, incrementality may be left undefined or defined in terms

of program impacts according to each jurisdiction’s objectives.

There are also wide differences in the way loan guarantee programs

are administered. In some countries lending institutions are fully

responsible for credit decisions and for approving and administering

the loans and the guarantees. In contrast, loan guarantee

administrators in other jurisdictions play an active role in evaluating

each and every loan guarantee application. Doing so affords the

program administrators the opportunity to ensure loan incrementality

at the time the loan is granted: because program administrators review

individual loan applications, it is argued that they can ensure

incrementality when approving applications.

LOAN GUARANTEE PROGRAM

The Small Business Loans Act (SBLA) of 1961 embodied the original

legislation related to the primary loan guarantee program extended to

small businesses by the Canadian federal government. The then-stated

(1961) goal (which has remained unchanged) was to ‘‘increase the

availability of loans for the establishment, expansion, modernization

and improvement of small business enterprises’’ (Industry Canada,

1998, 2002). The rationale for this intervention rested in the

perception that the lack of financing on reasonable terms and

conditions was a significant barrier to the growth of small business.

DEMAND IN THE MSME SECTOR

There is a total finance requirement of INR 32.5 trillion ($650 billion)

in the MSME sector, which comprises of INR 26 trillion ($ 520

Billion) of debt demand and INR 6.5 trillion ($130 Billion) of equity

demand. To estimate the debt demand that Financial Institutions

would consider financing in the near term, the study does not take into

account the demand from the enterprises that are either not considered

commercially viable by formal financial institutions, or those

enterprises that voluntarily exclude themselves from formal financial

services. Thus, after excluding-

(a) Sick enterprises,

(b) New enterprises (those with less than a year in operation),

(c) Enterprises rejected by financial institutions

(d) Micro enterprises that prefer finance from the informal sector, the

viable and addressable debt demand is estimated to be INR 9.9 trillion

($198 billion), which is 38 percent of the total debt demand. The

viable and addressable equity demand is estimated to be INR 0.67

trillion ($13.4 billion), after excluding:

(a) Entrepreneurs’ equity contribution to enterprises estimated at INR

4.6 trillion ($92 billion) and,

(b) Equity demand from micro and small enterprises that are

structured as proprietorship or partnership, and are unable to absorb

equity from external sources. The second is estimated to be worth

INR 1.23 trillion ($24.6 billion), MSME Sector has demand of INR

32.5 trillion ($650 billion), 78 percent, or INR 25.5 trillion ($510

billion) is either self-financed or from informal sources. Formal

sources cater to only 22 percent or INR 7 trillion ($140 billion) of the

total MSME debt financing. Within the formal financial sector, banks

account for nearly 85 percent of debt supply to the MSME sector,

with Scheduled Commercial Banks comprising INR 5.9 Trillion

(USD 118 Billion). Non-Banking Finance Companies and smaller

banks such as Regional Rural Banks (RRBs), Urban Cooperative

Banks (UCBs) and government financial institutions (including State

Financial Corporation and State Industrial Development

Corporations) constitute the rest of the formal MSME debt flow.

MSME FINANCE GAP IN THE SECTOR

Despite the increase in financing to MSMEs in recent years, there is

still a considerable institutional finance gap of INR 20.9 trillion ($418

billion). After exclusions in the debt demand (62 percent of the

overall demand) and the equity demand (from MSMEs that are

structured as proprietorship or partnership), there is still a demand-

supply gap of INR 3.57 trillion ($ 71.4 billion), which formal

financial institutions can viably finance in the near term. This is the

demand-supply gap for approximately 11.3 million enterprises. While

a large number of these already receive some form of formal finance,

they are significantly underserved with only 40-70 percent of their

demand currently being met. With appropriate policy interventions

and support to the MSME sector, a considerable part of the currently

excluded demand can be made financially viable for the formal

financial sector. Of the viable and addressable demand-supply gap,

the debt gap is INR 2.93 trillion ($58.6 billion) and the equity gap is

INR 0.64 trillion ($12.8 billion).

The micro, small, and medium enterprise segments respectively

account for INR 2.25 trillion ($45 billion), INR 0.5 trillion ($10

billion) and INR 0.18 trillion ($3.6 billion), of the debt gap that is

viable and can be addressed by financial institutions in the near term.

Micro and small enterprises together account for 97 percent of the

viable debt gap and can be addressed by financial institutions in the

near term. Available data and primary interviews indicate that

medium enterprises in India are relatively well financed. The equity

gap in the sector is a combined result of demand-side challenges such

as the legal structures of enterprises, as well as supply-side gaps, such

as a lack of investment funds focused on MSMEs. The equity

requirements for the MSME sector are concentrated in the growth-

stage enterprises (~70 percent).

Figure 1 Overall Finance Gap in MSME Sector

Source: MSME Census, RBI, SIDBI, Primary Research

CHAPTER 2

LITERATURE REVIEW

AND SYNTHESIS

THEORETICAL RATIONALE FOR LOAN

GUARANTEE PROGRAMS

Even though the introduction of many loan guarantee programs pre-

date the economic theory, the theoretical rationales for these

interventions are often vested in the concept of credit rationing. This

concept arises from the seminal works of Stiglitz and Weiss (1981,

1983). In their 1981 paper, Stiglitz and Weiss use a theoretical

framework to show conceptually that credit rationing could result

from adverse selection and moral hazard: that credit rationing is a

consequence of lenders’ response to adverse selection and lenders do

not set interest rates to their market clearing level. Besanko and

Thakor (1987), Bestor (1985), and many others have extended these

theoretical positions. While conceptually strong, these concepts have

proven difficult to test empirically. Parker (2002) and Cressy (2002),

in their respective reviews of the literature, do not support that credit

rationing is such that interventions are warranted. Bradshaw (2002)

suggests that loan guarantee programs actually may be of direct

financial benefit to society through job creation and additions to the

tax base. Similar findings were reported by Riding and Haines (2001).

However, Vogel and Adams (1997) maintain that the inability to

measure incrementality accurately renders inadequate all evaluations

of the effectiveness of credit guarantee schemes. They assert that no

guarantee program had adequately documented additionality and

argue that problems arise from two sources. First, Vogel and Adams

note the ‘‘counterfactual problem’’: it is impossible to know what the

lender would have done in the absence of the loan guarantee program

so it is difficult to attribute benefits to the guarantee scheme. Second,

Vogel and Adams note potential substitution problems stemming

from intra-portfolio substitution by lenders: lenders may make

multiple loans to individuals to fit them under a loan-size ceiling

specified in the loan guarantee program; or, lenders may redefine the

purpose of existing loans to qualify borrowers for the loan guarantee.

Moreover, it is conceivable that lenders might employ ‘‘column-

shifting’’, moving distressed loans into the guaranteed portfolio.

These problems affect the accuracy of measuring loan incrementality

because – if true – firms are already providing access to credit under

existing lending institutional parameters and lenders are merely taking

advantage of the guarantee program to reduce risk that they might

otherwise have been willing to take in the absence of the program.

The usual definition of incrementality is: loans facilitated through the

program ought not otherwise have been available to the borrowers.

However, Meyer and Nagarajan (1996) identify additional forms of

incrementality:

• providing for a loan on more favourable terms (maturity, interest

rate, etc.) than would otherwise have been granted;

• providing for credit on a more timely basis;

• facilitating or initiating the working relationship between a business

and a lender; or

• providing for a broader financing package than would otherwise

have been available.

Accordingly, measurement of incrementality is not straightforward

and different forms of incrementality have been identified.

MEASUREMENT OF INCREMENTALITY

Measurement of incrementality is particularly important for many

types of government interventions. In the case at hand, incrementality

must be defined in terms of the explicit objective namely ‘‘to increase

the availability of loans [to small firms].’’ Before proceeding to a

discussion of incrementality, it is worth commenting on the stated

objective. This objective is explicit in the implementation of a loan

guarantee scheme but it is also common to many other such

interventions in other countries. In France, guarantees are

administered by trade associations for the same purpose. Whether or

not this objective has merit is itself subject to debate. Two extreme

points of view are readily identifiable. On the one hand are those who

would argue that an intervention to augment lending from the

commercial sector is wrongheaded. Among these, Vogel and Adams

(1997) contend that interventions into a market can only be justified if

an imperfection is present and that the nature of the intervention

should directly address the imperfections. Vogel and Adams would

argue that no imperfections have been identified and that loan

guarantee schemes are therefore unjustifiable. Rhyne (1988)

illustrates further this perspective when she quotes Stockman (1987)

as follows: ‘‘these programs [SBA] may inflict unfair private

economic harm: the 99% of unsubsidized small businesses

undoubtedly face downward pressure on market shares, profits and

return on investment owing to the artificial presence of government

fostered and subsidized competitors’’.

On the other hand, loan guarantee programs have been justified by the

observation that fixed costs of due diligence militates against

commercial lenders even considering relatively small lending

balances. Others (Riding and Haines, 2001) document that loan

guarantee schemes generate societal benefits that exceed the costs.

Again, Rhyne (1988) resorts to the debate in the

US Congress to illustrate this perspective: ‘‘The [SBA] loan

guarantee program is a vital source of long term capital for this

country’s small business community. It is a program which generates

revenues in excess of its costs to the government and is an excellent

partnership between the public and private sectors’’. This debate

makes accurate measurement of incrementality all the more

important. Even if economic theory suggests that interventions are not

justified, the presence of demonstrable societal benefits from such

programs provides an argument for re-examination of the economic

theory. To measure the net costs and benefits, a defensible measure of

incrementality is essential.

Therefore, loan guarantee schemes are incremental if the majority of

firms obtaining assistance through the scheme have been unable to

obtain financing from alternative sources. That is, lending under the

terms of the loan guarantee program ought to be additional, or

incremental, to the lending already available in the credit market.

Measuring incrementality however, is fraught with methodological

challenges. Much of the most current understanding of incrementality

emerged from discussions at the Roundtable on Credit Guarantee

Systems held at the Inter-American Development Bank measuring

incrementality requires an assessment of what would have happened

if what did happen had not happened. Perhaps the most well-known

attempt to evaluate incrementality was that undertaken by KPMG

(Clark et al., 1998) in their evaluation of the Loan Guarantee Scheme

(LGS) administered by the Department of Trade and Industry (DTI)

in the UK, KPMG sought to measure incrementality using two

complementary approaches.

One approach entailed a series of ‘‘aligned interviews’’ in which

borrowers and their 51 Incrementality of SME Loan Guarantees

respective loan account managers were subjected to in-depth

interviews about the process of applying for, and obtaining, a loan

guaranteed by the LGS. This approach turned out to be a very useful

means of learning about the lender-borrower relationship on the basis

of rich qualitative data. As a means of assessing incrementality,

however, it was subject to two shortcomings. First, this approach

reflected recollected data with all of the well-known problems

inherent in the use of such information. Second, the cost of collecting

interview data of this type militated against obtaining a sample size

that would allow estimation with desired accuracy.

The second approach used by KPMG was based on a survey of

owners of the firms that had received LGS-guaranteed loans. While

allowing for greater accuracy, this approach also relied on recollected

data and was subject to the biases resulting from the optimism with

which entrepreneurs are associated. In spite of the criticisms, the

KPMG work appears to be unique in the sense that it represents the

first public-domain study to even attempt to measure incrementality.

In its recent review of current practices with respect to incrementality

assessment, the Conference Board of Canada (2003) observed that it

remains difficult to measure loan incrementality with precision

because current methodology relies on the beliefs of borrowers and

lenders and depends on their recollections. These problems affect the

accuracy of measuring loan incrementality because firms are already

providing access to credit under existing lending institutional

parameters. Lenders may take advantage of the guarantee program to

reduce risk that they might otherwise have been willing to take in the

absence of the program.

EQUITY DEMAND IN EARLY-STAGE AND

GROWTH-STAGE ENTERPRISES

Early-stage enterprises are defined as those that have an operational

history of one-year or less. Analysis suggests that these enterprises

account for 23 percent of the overall long-term equity demand. Figure

2 below shows that demand is estimated at INR 0.58 trillion ($11.6

billion). The balance equity demand, after excluding early-stage

equity, comprises an estimated INR 1.32 trillion ($26.4 billion) as

growth-stage equity.

Figure 2 Equity demand in early and growth stages in MSMEs Sector

(in INR trillion)

CHALLENGES FOR ENTERPRISES IN EQUITY

INFUSION

The ability of an enterprise to accept external equity depends on its

legal structure. Limited companies and limited liability partnerships

allow investors to infuse external equity into the enterprise to the

extent their liability is limited to their respective shareholding. Other

legal forms such as proprietorship and partnership transfer unlimited

liability to the equity investor, hence discouraging equity infusion in

such enterprises.

An overwhelming 95.7 percent of MSMEs in India are

proprietorships or partnerships and as a result, are unable to attract

external equity. While change in the legal form of an enterprise to

limited company or limited liability partnership is an option, it entails

taxation and compliance overheads for the enterprises, often rendering

the business model financially unviable. In addition, many

entrepreneurs have limited awareness of alternative sources of

finance; hence the benefits of changing their legal structures are not

always obvious. In the absence of external equity, entrepreneurs use

informal sources (usually debt) to meet the needs of their enterprise.

Equity investors require transparency in both financial record-keeping

and governance. As a result, it is mostly the medium enterprises and

mature small enterprises which are able to keep their financials

transparent, and tend to attract more equity investors. Also, the legal

structure of medium and mature small enterprises allows for infusion

of external equity.

NON-ADDRESSABLE FINANCE DEMAND IN THE

MSME SECTOR

While the viable and addressable debt and equity demand presents a

significant opportunity for formal financial institutions, the potential

size of the MSME finance market can be further increased by

gradually transforming some components of the currently non-

addressable demand into demand that financial institutions would

consider viable. The current non-addressable demand comprises-

(a) In the debt market – new enterprises, sick enterprises, voluntary

exclusions and enterprises with poor financial records, and

(b) In the equity market – micro and small enterprises that have legal

structures such as proprietorship and partnership. Considerable efforts

by way of policy and building market and business models are

required to gradually transform the above demand and make it

financially viable.

Some of the interventions that can help transition the MSMEs into

lucrative financing opportunities for the financial sector include:

(a) Increasing awareness among entrepreneurs about how access to

formal sources of finance can benefit the growth of their business,

(b) Incentivizing entrepreneurs to increase financial transparency and

plan their financial requirements better,

(c) Creating an effective policy environment to revive sick enterprises

and make them financially viable,

(d) Providing incubation support to early-stage enterprises and,

(e) Increasing the enterprise knowledge on various low-overhead

legal structures available to them. Expansion in the level of formal

finance to the MSME sector could unlock enormous potential for the

sector’s growth and corresponding contribution to GDP.

OVERALL FLOW OF FINANCE TO THE MSME

SECTOR

Working with the assumption that all finance demand by the MSME

sector is met by either formal or informal sources, the estimate for

overall supply of finance to the MSME sector is also INR 32.5 trillion

($650 billion). This comprises informal finance, self-finance and

finance from the formal financial sector. However, what is

characteristic of the finance flow is that informal sources and self-

finance together make up most of the finance channelled into the

sector. An estimated INR 25.5 trillion ($510 billion), or nearly 78

percent of the sector’s debt demand, is fed by these two sources,

while formal sources cater to just over 22 percent of the demand at

INR 7 trillion ($140 billion) (Figure 3).

Formal sources of finance, i.e. banks and non-banking

institutions, account for INR 6.97 trillion ($139.4 billion) of the

overall formal finance supply, and commercial banks are the

largest formal sources of finance, primarily providing debt

capital to the MSMEs.

The supply of formal equity to the sector is INR 0.03 trillion

($0.6 billion).

Informal sources account for an estimated INR 24.4 trillion

($488 billion) in finance to the sector. Informal sources include

both institutional sources such as moneylenders and chit funds,

and non-institutional sources such as family, friends, and family

business.

In addition, entrepreneurs also leverage personal resources and

contribute equity to the enterprise. Self-equity contributions are

estimated to account for INR 1.1 trillion ($22 billion) of finance

flow into the sector.

Figure 3 Supply of finances to MSME Sector (in INR trillion)

FLOW OF MSME DEBT FINANCE FROM THE

INFORMAL SECTOR

Informal finance dominates the sector and 95 percent of it comes from

non-institutional sources. Sources such as family, friends, and family

business (Figure 4) together account for INR 23.2 trillion ($464

billion) of the informal finance to the MSME sector.

Financial transactions with non-institutional informal sources

are typically in the form of debt; these transactions are not

bound by any contractual agreement, and the repayment terms

are mutually agreed. Typical repayment terms include bullet

payment of principal and regular interest payments. Due to the

non-contractual nature of transactions, many micro enterprises

prefer informal sources over formal sources despite the relative

higher rates of interest.

Non-institutional lenders typically do not insist on any

immovable collateral. Instead such sources tend rely on personal

reputation or social collateral to hedge repayment risk, making it

easier for enterprises to access informal finance.

Costs of funds from such sources tend to vary from 1 percent

per month to 5 percent per month.

Figure 4 Share of non institutional informal source of financing

Institutional informal sources such as registered trade credit, chit

funds and moneylenders channel an estimated INR 1.2 trillion ($24

billion) of finance into the MSME sector. Unlike in the case of non-

institutional informal sources, transactions with institutional informal

sources are bound by legal contracts.

Institutional informal sources also provide financing in the form

of debt on the basis of mutually agreed terms of repayment or

transactions that are documented in the contract. Repayment

cycles are typically in the form of bullet payments as well as

daily, weekly or monthly instalments of interest. Trade-credit

accounts for 30-40 percent of the working capital finance in the

MSME sector. While trade credit plays an important role in

working capital finance, longer debt cycles often offset any

advantage that such financing has to offer.

As with other informal sources of finance, institutional informal

sources typically do not insist on any immovable collateral.

Inclusion of individuals in such community-based finance

institutions is based on referrals, and personal reputation is used

in lieu of collateral.

Enterprises also avail finance from community institutions such

as chit funds. The size of the organized chit funds market in

India is estimated to be INR 0.3 trillion (USD 6 billion). Chit

funds offer flexible repayment options and on-demand finance

with limited or no collateral.

Although the cost of funds (Table II) from informal sources

tends to be high, timely disbursal and shorter turnaround times

make them more attractive sources of finance, particularly for

micro and small enterprises.

Table II Cost of funds in select Institutional Informal Sources

FLOW OF MSME DEBT FINANCE FROM THE

FORMAL FINANCIAL SECTOR

The MSME sector receives INR 6.97 trillion ($139.4 billion) debt

from banking and non-banking institutions. Banks and government

financing agencies constitute the largest share of formal debt to the

MSME sector, and are estimated to provide INR 6.4 trillion ($128

billion) to these enterprises. The balance INR 0.57 trillion ($11.4

billion) of formal debt is supplied by non-banking finance companies

(NBFCs). Unlike in many developing countries in Latin America

where large banks are down-scaling to serve the Small and Medium

Enterprise (SME) market, in India large banks have been the largest

formal source of finance to MSMEs for decades. Figure 5 exhibits the

structure of formal debt supply to the sector.

Figure 5 Structure of formal debt supply to the MSME sector (in INR

trillion)

Although banks have a higher risk perception of the MSME sector,

they continue to be the key players in formal financing. The higher

share of bank supply can be attributed primarily to Priority Sector

Lending (PSL) guidelines set by the Reserve Bank of India (RBI) that

require banks to supply debt to priority sectors such as agriculture,

micro and small enterprises. Some key focus areas of PSL, with

regard to the MSME sector are:

PSL guidelines require banks to allocate sizeable share of their

credit portfolio to micro and small enterprises. The existing PSL

guidelines have set targets (i.e. share of credit portfolio) for

micro and small enterprises financing. The Nair Committee

Report (February 2012) on Priority Sector Lending (February

2012 has recommended that all domestic and foreign banks

allocate 7 percent of their credit portfolio solely for financing

micro enterprises.

The Nair Committee has also recommended that foreign banks

should have priority sector commitment of 40 percent of Annual

Net Bank Credit (ANBC), with a sub-target for the micro and

small enterprise sector at 15 percent of ANBC. If implemented,

this policy is expected to have a significantly positive impact on

the participation of foreign banks in the MSME finance over the

medium term. With continuous policy focus on financing to

micro and small enterprises, the share of large banks in the

MSME finance landscape is also expected to grow in the future.

NBFCs, unlike banks, are not required to comply with the PSL

guidelines. However their participation in the MSME sector is

driven to a large extent by unmet finance demand of these

enterprises, and the ability of NBFCs to develop innovative

financial products and deliver finance in a cost – effective

manner, with greater flexibility and quicker turnaround times.

In order to encourage banks to increase their direct lending to the

MSME sector, an RBI regulation in April 2011 excluded loans

sanctioned by banks to NBFCs for on-lending to micro and small

enterprises from priority sector targets. However, the Nair Committee

Report has recommended that commercial bank loans to NBFCs for

on-lending to specified segments may be considered for classification

under priority sector, up to a maximum of 5 percent of ANBC, subject

to certain due diligence and documentation standards. Although the

new recommendations allow a small window for indirect lending,

there are other attractive priority sector segments (such as

microfinance) that are also vying for the same pool of funds. Hence, it

is not clear if these recommendations will specifically increase

indirect financing for the MSMEs via NBFCs.

BREAKDOWN OF DEBT FLOW BY TYPE OF FINANCIAL

INSTITUTES

As already highlighted, scheduled commercial banks account for 92

percent of formal debt flow to the MSME sector. Scheduled

commercial banks comprising public banks, private banks and foreign

banks supply INR 5.9 trillion ($118 billion) debt, while smaller banks

such as Regional Rural Banks (RRBs), Urban Cooperative Banks

(UCBs) and government financial institutions such as State Financial

Corporation (SFCs) and State Industrial Development Corporations

provide INR 0.5 trillion ($10 billion) as debt finance (Figure 6)

Figure 6 Structure of Banking Institution Supply to the MSME Sector

(in INR Trillion)*

Analysis of the MSME credit portfolios of banks suggests that all

bank groups do not contribute equally to the overall MSME sector.

Data from RBI suggests that public banks account for 70 percent

(INR 4.5 trillion; $90 billion) of the banking debt to the MSME

sector, while the private and foreign banks account for 22

percent (INR 1.4 trillion; $28 billion), and small banks such as

regional rural banks, urban co-operative banks account for 8

percent (INR 0.5 trillion; $10 billion) of banking finance.

Commercial banks serve an estimated 8.4 million – 8.5 million

MSMEs; financial institutions such as small banks, NBFCs,

MFIs and others, serve the balance MSMEs receiving formal

finance. The above estimates take into account the fact that

medium and small enterprises may have multiple banking

relationships. This estimate is considerably higher than that of

the MSME Census 2007 on the number of enterprises served,

however it builds on the RBI data available on the total number

of micro and small enterprise accounts currently served, and the

average credit disbursed per enterprise. Public banks serve the

largest section, an estimated 6.9 million MSMEs, while other

banking institutions serve an estimated 1.5 – 1.6 million units.

The reason for the variance in the banks’ share in MSME debt finance

is because of the inherent differences in:

(a) Knowledge of the MSME sector

(b) Size of the branch network

(c) Internal risk management policies and

(d) Operational efficiencies.

These characteristics also determine the type of enterprise banks

prefer to finance, the risk segment or pricing range for financial

products, targeting mechanism and outreach strategy.

NON BANKING FINANCE COMPANIES

NBFCs provide an estimated INR 0.57 trillion ($11.4 billion) of debt

finance to the MSME sector. The size of credit disbursed ranges from

INR 0.3 million ($6000) for micro enterprises to INR 50-100 million

($1 million – $2 million) for medium enterprises. A large share of the

finance is used for asset purchase. Analysis of the NBFCs’ MSME

portfolio and primary research suggests that enterprises in transport

business dominate the portfolio. Engineering, vendor supply chains

and retail trade are among the other key industries served by NBFCs.

NBFCs are companies registered under the Companies Act 1956 and

engaged in business of loans, leasing and hire-purchase. NBFCs

function akin to a bank, with few key differences such as:

(a) NBFCs are not part of the payment and settlement mechanism,

i.e., NBFCs cannot issue transaction instruments such as cheques

(b) NBFCs don’t have the facility of deposit insurance and credit

guarantee.

NBFCs are governed by a separate set of regulations with lower

compliance overheads, affording them several operational advantages

and the flexibility to adopt innovative business models.

Key traits are:

The operational structure of NBFCs tends to be more flexible,

nimble, and cost-effective (operational costs) compared to a

The branch outreach of NBFCs is comparable to that of the

combined network of RRBs and UCBs. Due to their reach,

NBFCs have a better knowledge of the local context and non-

financial information on entrepreneurs and enterprises.

Armed with greater knowledge on enterprises, NBFCs are better

placed to finance assets that are considered risky by

conventional banks.

Although NBFCs enjoy considerably lower regulatory overheads,

they experience challenges in raising debt, as all NBFCs cannot

accept public deposits. Hence:

NBFCs rely heavily on commercial banks and promoter’s equity

for growth.

Due to high reliance on bank financing, the cost of funds for

NBFCs tends to be higher. As a result, NBFCs loans carry

higher interest than those offered by banks.

NBFCs leverage their operational strengths to differentiate products

and offer personalized service. Also, these require relatively less

documentation, process loan applications faster and allow flexible

collateral options. Primary research suggests that niche NBFCs tend

to use immovable property and hypothecated assets as collaterals,

while some larger NBFCs also offer collateral-free finance, based on

the cash flows and financial performance of the beneficiary

enterprises.

SCHEDULED COMMERCIAL BANKS

Public Banks have a better access to MSMEs, and take the lead in

lending to the sector, as compared to private and foreign Banks.

Public banks have considerable empirical knowledge of the

MSME sector, and with the increased use of core banking

technology, they are able to analyze historical data on MSMEs

to develop targeted products and better risk management

techniques.

The extensive branch network of public banks provides

unparalleled outreach across the country – public banks account

for 64.1 percent of the total bank branches in the country,

providing them with a distinct advantage in terms of reach to the

MSME segment. Private and foreign banks on the other hand

have a limited branch network, and tend to target MSMEs in the

vicinity of existing branches, or deploy third party agencies to

increase outreach.

In order to manage cost of transactions, banks prefer to finance

mature small enterprises that have larger credit requirement as

compared to micro enterprises.

Financial institutions continue to consider the branch banking

model to be the best approach to relationship banking, hence,

the high emphasis on an extensive branch network.

Although RBI has relaxed the branch licensing requirement for

Tier II and below cities, not many banks are aggressively

planning on branch expansion due to concerns of feasibility

regarding newer branches and high costs involved in setting up

of these branches.

Traditionally, many private and foreign banks overcame the

challenge of limited outreach by indirect participation through

NBFCs. Banks either lent capital to NBFCs or purchased

securitized assets from NBFCs that meet priority sector lending

guidelines. However, under the current guidelines, indirect

lending to the MSME sector through intermediaries such as

NBFCs is excluded from the priority sector.

All public sector banks, private banks and foreign banks have an

internal framework to manage risk. Primary research suggests that

while loan policies, prudential limits and pricing limits of all banks

tend to be similar, processes such as sourcing and underwriting are

varied.

Public sector banks adopt a branch-based multi-tiered approach

to source, service and monitor credit proposals. In such a

system, the branch personnel are responsible for both sourcing

and underwriting and the risk is managed by setting limits on

the amounts approved.

On the other hand, most private and foreign banks typically

segregate their sales and underwriting teams to manage the risk.

Underwriting in such banks tends to be centralized.

While the comprehensive processes enable effective risk

management, these processes also tend to increase the

turnaround time of proposals, which is a key constraint for

MSMEs that require timely access to credit.

The focus of the private and public sector banks on efficiencies

and higher profitability limits the expansion of their branch

network, hindering them from reaching out to newer customer

segments such as the MSMEs.

SMALL BANKS

Small banks such as RRBs, UCBs and government financial

institutions such as SFCs, SIDCs have extensive potential for

outreach.

Analysis of the data on RRBs and UCBs suggests that these

have a combined network of approximately 21,900 branches

across India. RRBs cover around 525 districts across the country

– their branch outreach is second only to the infrastructure of

public, private and foreign banks.

Smaller banking institutions have better knowledge of the local

context and have first-hand access to information on enterprises

and entrepreneurs. This means that these banks have the

potential to serve a much larger MSME customer base than they

are currently serving. Despite the potential for reach, these

institutions account for only 8 percent of the formal debt supply

to the MSME sector. Assessments of reports by the RBI suggest

that these banks have certain strategic and operational

challenges. These are:

RRBs operate in smaller, resource-poor markets but tend to have

organization structures and operating costs similar to that of

full-service bank branches.

RRBs face the perception of being a poor man’s bank, resulting

in lower deposit mobilization and increased dependence on

sponsor banks.

With borrowers wielding considerable influence over the

management, resulting in a conflict of interest and weaker

decision making, UCBs suffer from challenges of poor

governance.

High non-performing assets, poor credit appraisal and

inadequate under-writing policies have stifled the growth of

State Finance Corporations. In fact, very few of these

corporations are active.

MICRO FINANCE INSTITUTIONS (MFI)

Microfinance institutions are often incorporated as NBFC-MFIs, and

are mostly active in the unregistered and unorganized microenterprise

segment. MFIs are gradually scaling up from providing individual

loans to providing business loans for micro enterprises. The average

size of credit disbursed by MFIs ranges from INR 0.015 million

($300) to INR 1 million ($20,000) per enterprise. Primary research

suggest that MFIs accept immovable property such as land, building

and/or hypothecated assets as collateral.

MFIs have extensive fleet-on-street structures for ground

operations that enable them to reach unserved regions.

MFIs have extensive fleet-on-street structures for ground

operations that enable them to reach unserved regions.

MFIs supply INR 0.02 trillion ($0.4 billion) of debt to the micro

enterprise segment. In line with broad sector financing trends, short-

term working capital accounts for a larger share of the portfolio.

Despite the huge market potential, the current activity of MFIs is

limited due to constraints in accessing capital and other stringent

regulatory requirements.

MFI activity in micro enterprise financing is limited to loan sizes of

INR 0.05 million ($1,000), or less, due to recent changes in the

regulation. The new regulations for MFIs require them to be

structured as MFI-NBFCs, which will not have more than 15 percent

of the loan portfolio in loan assets of INR 0.05 million ($1,000) and

above. In other words, 85 percent of the loan portfolio of MFIs must

comprise loan assets, specifically for income generating activities and

not exceeding the INR 0.05 million ($1,000) limit.

EQUITY FINANCE FLOWS TO THE MSME SECTOR

It is estimated that a total of INR 0.03 trillion($0.6 billion) is directed

to the MSME sector by way of equity financing. Most of the

enterprises in the sector are proprietorships and partnerships that do

not allow for infusion of equity. In addition, equity investors require a

high level of operational and financial transparency, which is lacking

in a significant number of MSMEs. In sum, there are several legal

challenges that constrain the small and micro enterprises from getting

equity capital. Consequently, it is primarily the mature small and

medium enterprises that are the beneficiaries of equity capital

financing.

SIDBI Venture Capital Limited, along with a few private equity

firms, is currently leading the supply of equity capital to the sector. In

the General Budget of 2012-13, the Government of India announced

the intention to set up an INR 50 billion ($1 billion) India

Opportunities Fund through the Small Industries Development Bank

of India (SIDBI). The proposed fund is expected to enhance the

availability of equity for MSMEs. The fund could also potentially

encourage private sector funds to participate and innovate in setting

up equity/debt funds specifically targeting the MSME sector.

FINANCE GAP IN THE MSME SECTOR

The overall finance gap in the MSME sector is estimated to be INR

20.9 trillion ($418 billion). The potential demand for external finance

is estimated to be INR 27.9 trillion ($558 billion), while the total

finance channelled by formal sources is estimated to be INR 7 trillion

($140 billion). The overall finance (debt and equity) gap of INR 20.9

trillion ($418 billion) is split into a debt gap of INR 19 trillion ($380

billion) (Figure 7).

Figure 7 Overall Finance Gap in MSME sector (in INR trillion)

The potential demand is estimated to be INR 27.9 trillion ($558

billion), after excluding entrepreneur’s own contribution towards

capital expenditure and working capital finance (INR 4.6 trillion; $92

billion). Entrepreneurs finance this need through internal accruals, or

by leveraging personal resources. Studies on the MSME sector

suggest that entrepreneurs contribute approximately 25 percent of

capital expenditure demand and 20 percent of the working capital

finance demand.

The finance gap in micro, small and medium enterprise segments is

estimated to be INR 16.2 trillion ($324 billion), INR 3.9 ($78 billion)

and INR 0.8 trillion ($16 billion), respectively (Figure 8).

Figure 8 Finance Gap in Micro, Small and Medium Enterprises

Segments (in INR trillion)

MICRO ENTERPRISE SEGMENT

The micro enterprise segment accounts for the largest share (80

percent) of the viable and addressable debt gap to the sector, with a

gap-to-demand ratio of 51 percent. Analysis suggests that the gap in

the segment is due to both unserved and underserved enterprises –

approximately 1 million addressable micro enterprises are unserved.

For the micro enterprises that are served, the formal finance provided

meets only 40-50 percent of their requirement. Some of the key

constraints that explain the debt gap are as follows:

Micro enterprises mostly operate in the service sector, and most

entrepreneurs do not have access to immovable collateral to

secure finance or get the sanctioned limits to be raised.

Entrepreneurs have limited internal resources to capitalize

(equity) the business and limited managerial experience, both of

which make accessing debt capital from formal sources

challenging. As a result, an enterprise is vulnerable to working

capital strain.

Although both financial institutions and government agencies

have several products and schemes for micro enterprises, there

is little awareness about these among entrepreneurs, making it

challenging for institutions to reach out to them.

For financial institutions, sourcing and acquiring micro

enterprises is extremely challenging and expensive. The branch

walk-ins are very limited, and staff actively source potential

customers themselves, which increases the cost of acquisition.

Further, the third-party agencies sourced enterprise accounts are

not only expensive, but also limit building of customer

relationships.

Financial institutions are constrained by the lack of readily

available financial information on these enterprises. These

enterprises mostly transact in cash and have little incentive to

maintain proper financial records as book keeping increases the

cost of operations. Since financial institutions consider financial

viability critical for risk assessment, poorly documented

financial information compels them to either reject the

enterprise or sanction lower than required credit limits.

Yet another reason why institutional finance has had a limited

reach is the use of traditional credit assessment tools to appraise

micro enterprises, leading to conservative decision-making.

Since the cost is similar for acquiring a micro and a small enterprise

account, financial institutions prefer to service more small enterprises

as their average debt demand tends to be ten times larger than that of

micro enterprises. A lower gap-to-demand ratio of 18 percent

suggests that the small enterprise segment is relatively better served

than micro enterprises. Financial institutions find small enterprises

more attractive also because entrepreneurs in the segment are more

financially aware.

SMALL ENTERPRISE SEGMENT

The viable and addressable debt gap in the small enterprise segment is

largely due to the fact that a large number of enterprises in the

segment are underserved. Analysis of the gap suggests that on an

average, INR 1.5 million – INR 3.5 million ($30,000 – $70,000 per

enterprise) gets directed to an enterprise, which meets 40 – 70 percent

of an average demand estimated at INR 4 million – 4.5 million

($80,000 – $90,000). Some of the key demand-side and supply-side

constraints that explain the debt gap are as follows:

The debt gap in the sector is attributed largely to a shortfall in

working capital finance. Enterprises in the segment tend to have

longer working capital cycles due to delayed realization of

payments from buyers – median debtor days in the segment are

estimated to be 90-100 days (Figure 9). The working capital

limits sanctioned by banks do not meet the demand of the

enterprises adequately, resulting in the gap.

Figure 9 Debtors day in small and medium enterprises segments

Information asymmetry and opaqueness in the reported financial

statements is one of the key reasons for financial institutions not

sanctioning higher working capital limits.

Financial institutions report that the opaqueness in the financial

statements stems from inconsistency between reported past

performance and projected future performance. A deeper

assessment suggests that financial statements are often prepared

for taxation purposes, and don’t accurately reflect the

performance of an enterprise.

MEDIUM ENTERPRISE SEGMENT

Medium enterprises are the best served segment in the MSME sector,

and account for only an INR 0.18 trillion ($3.6 billion) of the viable

and addressable debt gap. In addition to debt, the medium enterprises

are able to absorb equity and other hybrid instruments. The debt gap

in the segment is due to a shortfall in incremental working capital

financing for manufacturing enterprises, and under-financing of

service-oriented enterprises in the segment.

CHAPTER 3

RESEARCH

METHODOLOGY

INTRODUCTION

Research in common parlance refers to a search for knowledge. One

can also define research as a scientific and systematic search for

pertinent information on a specific topic. Research is an academic

activity as such the term should be used in a technical sense. Research

refers to

Defining and redefining problem

Formulating hypothesis or suggested solutions

Collecting, organizing and evaluating data

Making deductions and reaching conclusions

RESEARCH PROCESS

Research process consists of series of action or steps necessary to

effectively carry out research.

These steps are to be followed in the same sequence. These steps are

as follows:

Specifying research objective

Preparing a list of needed information

Designing the data collection project

Select a sample size

Organizing and carrying data and reporting the findings.

Methodology may be described as:

1. "The analysis of the principles of methods, rules, and postulates

employed by a discipline".

2. "The systematic study of methods that are, can be, or have been

applied within a discipline".

Methodology may be a description of process, or may be expanded to

include a philosophically coherent collection of theories, concepts or

ideas as they relate to a particular discipline or field of inquiry.

Methodology also refers to nothing more than a simple set of methods

or procedures, or it may refer to the rationale and the philosophical

assumptions that underlie a particular study relative to the scientific

method. For example, scholarly literature often includes a section on

the methodology of the researchers.

SOURCES OF DATA

There are mainly two sources of data.

PRIMARY DATA:

NOT USED

SECONDARY DATA:

Bank of Baroda SME Reports

Banks loan SME circulars

Ministry of Finance Circulars for SME

Banks Loan Proposals for SME

As, India is going to be an economic superpower in the coming

years. This view is based on consistently good performance of the

Indian economy in the last few years. When many developed nations

were experiencing slowdown of the economy, India is one of the

country who manage to register a high growth in its GDP.

However, slowing down in the growth rate of GDP in the last

two years has raised fear among economists and policy makers.

In 2011 - 12, the GDP growth rate of 5.1 % was the lowest in

last ten years. To realize its goal of an economic superpower, the

National Manufacturing Policy (NMP) has envisaged increasing

the share of manufacturing sector in GDP to 25% over the next

decade and generating additional 100 million jobs in

manufacturing sector. The Micro, Small Medium Enterprises

(MSME) sector, being the major base of manufacturing sector in

India, with its contribution of over 45% in the overall industrial

output, it is stated that the achievement of the NMP targeted

growth of the manufacturing sector would necessitate substantial

enhancement of growth rate of the MSME sector during the 12th

Plan period from its current growth rate of 12- 13%. This calls for

identification of the problems and bottlenecks faced by the

MSME sector and appropriate measures for their removal. This

project analyses the significance of the MSME sector in Indian

economy and attempts to highlight major problems faced by this

sector. Specifically, the paper discusses challenges of financing the

MSMEs and suggests measures for their removal.

SIGNIFICANCE OF MSMES IN INDIAN ECONOMY

The Micro, Small and Medium Enterprises sector contributes

significantly to manufacturing output, employment and exports of

the country. It is estimated that in terms of value, the sector

accounts for about 45 per cent of manufacturing output and 40%

of the total exports of the country. The sector is estimated to

employ about 595 lakh persons in over 261 lakh enterprises

throughout the country. (Report of the Working Group on Micro,

Small and Medium Enterprise Growth for 12th Five Year

Plan).This sector has consistently registered a higher growth rate

than the rest of the industrial sector.

The MSMEs provide good opportunities for both self- employment

and wage employment.

TABLE –III ANNUAL REAL GDP GROWTH RATE (in %)

YEAR GDP GROWTH RATE

(in %)

2004 8.1

2005 9.2

2006 9.7

2007 9.9

2008 6.2

2009 6.8

2010 10.4

PERFORMANCE OF MSMES:

The performance of the MSMEs has been quite satisfactory during the

year. 2001-02 to 2010-11. The total working units in 2001-02 were

105.21 lakh which increased to 311.52 lakh in 2010-11. The

employment generated by the MSMEs in 2001-02 was 249.33 lakh,

which increased to 732.17 lakh in 2010-11. Similarly, fixed

investment in plant and machinery by the MSMEs were Rs.

249.33 crore in 2001-02, which increased to Rs.7, 73487crore in

2010- 11. The value of production by the MSMEs increased to Rs.

10, 95,758crore in 2010 - 11 from Rs.2, 82,270 in 2001- 02.

TABLE IV-

Table - IV provides a comparison of the growth rate of MSMEs

with respect to the overall industrial sector growth rate. From

the Table No - IV it is clear that the MSMEs sector has been

significantly contributing to the manufacturing sector. The growth

rate of this sector has been consistently higher than the overall

industrial growth rate. For example, while the overall industrial

growth rate was 8.7% in 2007- 08 it was 13.0% for the MSME sector.

TABLE V-

CONTRIBUTION OF MSMES IN GDP

The MSMEs are also significantly contributing to the National

GDP and their share in GDP is gradually increasing. The

MSMEs contributed 8.72% of GDP and 44.86% of total industrial

production in 2008- 09.

TABLE VI-

PROFILE OF THE MSMES

As per the National Census for Small enterprises, the total

number of registered MSMEs in 2007 was 15.64 lakhs. Out of

these 94.94% belonged to Micro firms, 4.89% belonged to

Small firms and only 0.17 % belonged to medium scale

industries. Out of the total registered MSMEs, 67.10% were

manufacturing enterprises and 39.90% were in service sector.

About 91% of the enterprises are proprietary organisations,4% are

partnership firms,2.78% are private companies and less than 1%

are public limited companies.

CREDIT FLOWS TO MICRO AND SMALL

ENTERPRISES

One of the important hurdles in the process of development of

small scale sector is the availability of credit and finance. The

problems of credit faced by the small scale sector can be judged

from the following facts disclosed by the Report of the National

Commission for Enterprises in the Unorganized Sector (NCEUS).

The Challenge of Employment in India: An Informal Economy

Perspective, Vol.I, Main Report, NCEUS, 2009, shows that

between August 2007 and 2008, while credit made available to

other sector of the economy increased at a higher rate, the rate

of increase in credit available to small scale sector was only 9.7 per

TABLE VII-

It has been observed that the overall availability of credit of

Scheduled Commercial banks has declined from 15.5% in 1996-

97 to 6.6% in 2007- 08. When we analyze the banks’ credit to

micro enterprises (investment up to Rs.25 lakhs in plant and

machinery) declined from 4.2% in 2002 - 03 to 2.8% in 2007-

08. The lower segment of micro enterprises (with investment up

to Rs. 5lakh in plant and machinery), which constitutes about

90% of the total MSME sector, has experienced a decline from

2.2% to 1.6% in the same period (Table- VI)The proportion of net

bank credit flows to the small scale sector has been falling in

recent years. It was about 16% in early 1990s, which came

down to 8% in 2006 - 07.Banks and other financial institutions

show their reluctance to extend credit to small enterprises

because of the following reasons:

High administrative costs of small - scale lending

High risk perception

Lack of Collateral

It has been observed that about 94% enterprises of the MSME

sector are in the micro enterprises sector and most of them are

in the unorganized sector. Hence the enterprises which need

financial assistance are deprived of credit facilities from the

formal banking structure. Bringing this large number of

enterprises in the unorganized into the ambit of the formal

structure of credit is a big challenge for the government. Various

estimates on the availability of credit too MSME sector indicate

a huge credit gap. The Fourth Census on MSMEs for reference

year 2006- 07 points out that only 5.2% (13.5 lakh units) of

total enterprises (261 lakh units) availed credit from financial

institutions. According to the Report on Creation of a National

Fund for the Unorganized sector by National Commission on

Enterprises in the Unorganized Sector (NCES (November,2007),

the credit gap for the micro enterprises in the unorganized sector

was estimated at Rs.6.01 lakh crore (75%) as at March 2011. Thus,

the credit gap is huge is normally met through informal channels,

which are often at higher cost than the institutional finance

(Report of the Working Group on Micro, Small & Medium

Enterprises Growth for 12th Five Year Plan.) Access to equity

capital continues to be a challenge for this sector and yet is a

pre- cursor to its development. High costs of raising capital,

inadequate means of finance and excessive cost of compliance

are some of the major challenges which affect the financial health

of the MSME sector.

HYPOTHESES FRAMED

The following hypotheses have been framed to meet the objectives of

the proposed study-

1. Consequent upon change in structure of industrial finance, the

financial intermediaries have enlarged their assistance.

2. There exists a close relationship between institutional finance and

performance of SMEs in the area under study.

ADVANCES CHANNELIZED BY BANKS

The commercial banks have been playing an important responsibility

of channelizing the funds with most important sectors to fulfil the pre-

determined objectives. The banks were especially concerned with

financing the priority sector of agriculture, small scale enterprises and

small transport operators. In course of time, other priority sectors

were also added, such as retail trade, professional and self-employed

persons, education, housing, loans for weaker sections and

consumption loans (Ahmed, 2010). The commercial bank credit is

an important input variable in the production functions of

agriculture, industry, commerce and allied productive activities

for the socio-economic development of the country. Raj Committee

(1977) recommended 40 per cent of lending to the priority sector. The

bank had earlier adopted a purely traditional approach in lending

based on ‘self liquidating theory’. Under this approach, the banks

followed the ‘commercial loan theory’ i.e., the banks granted loans

only against negotiable and tangible securities offered as well as on

the basis of business reputation of borrowers. After nationalization,

banks have attempted to steer the direction of change and strive

towards achieving fundamental objectives of mitigation of regional

disparities, dispersal of industries and reduction of concentration of

economic wealth (Raul, 1997). As a result, implicit weight age was

given to the socially desirable sectors in the credit policy with sizable

increase in the sector wise advances. In order to review the efficacy of

existing framework of money lending, a technical group, was

constituted under the chairmanship of S.C. Gupta, who submitted its

report on July, 2007 and recommended alternative avenues of credit

dispensation such as micro finance institutions (RBI, 2007). During

the past four decades, some noticeable positive changes have

been taking place in the credit advances by the SCBs.

Table-VIII PRESENTS THE BANK ADVANCES CHANNELED

END MARCH SOUTH

(In Rs. Lakh)

(In Rs. Crore)

1997 2502 13735 278401

1998 2985 15996 324079

1999 3298 20774 368837

2000 3796 22862 454069

2001 3749 28084 529272

2002 4462 35817 609053

2003 5705 62177 746432

2004 6873 95304 865594

2005 16036 133712 1124300

2006 19084 156204 1507077

2007 22325 139037 1931189

2008 25089 149732 2361914

2009 24843 175331 2775549

2010 29327 195779 3244788

CAGR 20.85 22.68 20.79

The total advances (bank credit) by all SCBs stood at `2,502 lakhs as

on 31st March, 1997, increased to 2,93,27 lakhs as on March 31, 2010

which shows 11.72 times increase in advances over the period.

The rate of growth of advances is higher in North India

(CAGR=22.68) than that of the study area (CAGR=20.85). The

scenario of advances growth is better than the deposit growth in the

study area. This may be due to the reduction of priority sector lending

norms from 40 per cent to 10 per cent on the basis of recommendation

of the committee on financial system (GOI, 1991) as the repayment in

non-priority sector is better than priority sector.

In order to assess the extent of credit channelization by the banks in

the districts under study, we have calculated the correlation

coefficients among the bank advances during 1997-2010.

MATRIX OF CORRELATION COEFFICIENT OF BANK

ADVANCES

(12.378)**

INDIA 0.969

(13.587)**

(9.0702)**

Source: self-calculated on the basis of table -vii

t0.05 (12 df) = 2.179, t0.01 (12 df) = 3.055

** indicates significant both at 0.05 and 0.01 level of significance

The analysis manifests that correlation coefficients (r) in respect of

advances of the districts under study in the context of national

scenario is positive. The r values are however, statistically significant

at 1 per cent and 5 per cent level of significance at their

respective degree of freedom. This implies that the districts under

study are maintaining the national tempo of credit channelization.

In other words, banks are deploying credit for the economic growth of

the area from which they have mobilized funds.

CREDIT PLANS (DISTRICT CREDIT PLAN AND ANNUAL

ACTION PLAN)

District Credit Plans (DCP) are prepared under lead bank scheme

to increase production, productivity and job opportunity in

different sectors of the economy especially in rural and semi-

urban areas of the country, thereby removing the regional

disparities in the country. DCPs are simply aggregation of the

Block Credit Plans operating in the concerned district. To make

credit plan successful, block, district, state, regional and national

level forums are created. Annual Credit Plan (ACP)/Annual Action

Plan (AAP) are prepared annually during the month of December (1st

December and 3rd December) and come into force by 1st April of next

year. The following paragraphs highlighted the performance of DCP

and ACP.

BREAK UP OF CREDIT UNDER ACP

The diversification of a large fraction of bank credit from the

traditional sector to the priority sector is a remarkable feature of credit

deployment in the post nationalization era. In this respect, RBI and

government of India have stipulated guidelines which is, more

deployment of credit to backward regions, preparation and

implementation of district credit plan (DCP) etc (Narasimham,

1994). The banks, without maintaining adequate security, have

supplied advances to priority and other neglected sections of the

society at a concessional rate of interest. The banking statistics

revealed that, this designated priority sector as well as neglected

sections received about 15 per cent of the total bank credit at the

time of bank nationalization (weblink, 2010). The following table-

8 presents the district wise and sector wise performance of ACP as on

30-12-2010. It is evident from the table that under ACP, the total

amount committed and achieved is higher in priority sector than that

of non-priority sector. During the year 2010, in priority sector 67.54

per cent of commitment and in non-priority sector 209.03 per

cent of commitment was achieved in the area under study. The

overall achievement was 93.04 per cent in the study area. The

scenario is better while compared with the figure of the state (85.21

per cent) as a whole. The following table 9 shows the break up in

more details. The scenario of achievement is better in case of service

sector followed by agriculture and industry both in the study area as

well as in Meghalaya state as revealed from the table above.

TABLE IX- PERFORMANCE UNDER ANNUAL CREDIT PLAN

(Amount Rs. In Lakh)

REGIONS TOTAL PRIORITY

SECTOR

NON-PRIORITY

SECTOR

GRAND TOTAL

COMMIT ACHIEVE COMMIT ACHIEVE COMMIT ACHIEVE

EAST 3596.87 2802.08

(77.90)

1108.00 234.85

(21.20)

4704.87 3036.93

(64.55)

WEST 4627.00 3120.24

(67.44)

823.25 3773.43

(458.36)

5450.25 6893.67

(126.48)

NORTH 1098.24 373.65

(34.02)

118.50 276.32

(233.18)

1216.74 649.97

(53.42)

SOUTH 9322.11 6295.97

(67.54)

2049.75 4284.6

(209.03)

11371.86 10580.57

(93.04)

TOTAL 52930.65 27830.23

(52.58)

23395.75 37205.12

(159.03)

76326.40 65035.35

(85.21)

(Figures in parentheses indicates percentage to total commitment)

Source: www.slbcne.nic.in

TABLE X- SECTOR WISE BREAK UP UNDER ANNUAL

CREDIT PLAN

(Amount Rs. In Lakh)

REGIONS

AGRICULTURE INDUSTRIES SERVICES GRAND TOTAL

COMMIT ACHIEVE COMMIT ACHIEVE COMMIT ACHIEVE COMMIT ACHIEVE

EAST 1781.01 356.23

(20.74) 332.70

(14.41) 1546.16

2397.91

(155.09) 4704.87

3036.93

(64.55)

WEST 1903.50 1265.27

(66.47) 701.00

183.02

(26.11) 2022.50

1671.95

(82.67) 5450.25

6893.67

(126.48)

NORTH 426.48 134.46

(31.53) 308.89

(11.40) 362.87

203.97

(56.21) 1216.74

649.97

(53.42)

SOUTH 4047.99 1755.96

(43.38) 1342.59

266.18

(19.83) 3931.53

4273.83

(108.71) 11371.86

10580.57

(93.04)

TOTAL 15114.15 5758.40

(52.58) 12505.47

2875.59

(22.99) 25311.03

19196.24

(75.84) 76326.40

65035.35

(85.21)

(Figures in parentheses indicates percentage to total commitment)

Source: www.slbcne.nic.in

CREDIT DEPOSIT RATIO

The CD ratio indicates flow of credit to various segments in relation

to deposits generally expressed in terms of percentage. It is

considered as a dependable indicator of efficiency of bank

participation in the developmental process. A higher CD ratio implies

more credit to the economy and a lower CD ratio hinders

economic development through lesser deployment of funds. The

desirable CD ratio is 60 per cent as per RBI norm. The CD ratio is

determined by factors like the availability/non-availability of

finance adequate with the individuals, the absorbing capacity of

the economy to utilize the credit for various productive purposes,

the attitude of people in availing bank credit, recovery rate and

entered non-performing assets, financial climate in an economy

and quantum of funds mobilized by banks. Mehrotra (1992) stated

that the CD ratio of the SCBs of India varies substantially across the

country with the industrially advanced or traditionally well banked

states enjoying higher ratios as compared with the relatively

backward states having lower ratios. Raul (1997) opined that CD

ratio is not an unbiased indicator, since it depends on two variables,

viz., total deposit and total advances. It has been observed that the

banks may have to grant advances to the beneficiaries through several

government sponsored schemes. The table 10 delineates the CD ratios

in the area under study.

TABLE XI – CD RATIO IN NORTH INDIA VIS-A-VIS IN SOUTH

END MARCH

CREDIT DEPOSIT RATIO

NORTH INDIA SOUTH INDIA INDIA

1997 24.97 15.15 55.1

1998 27.81 15.38 53.5

1999 26.11 18.10 51.1

2000 25.88 16.30 53.3

2001 21.63 17.06 53.5

2002 22.08 18.35 53.8

2003 26.27 29.01 56.9

2004 28.73 34.56 56.1

2005 53.96 43.63 64.9

2006 56.58 48.12 71.5

2007 54.10 35.70 73.9

2008 58.27 33.19 73.9

2009 41.43 28.26 72.4

2010 39.89 25.62 72.2

Source: Basic Statistical Return of SCBs, RBI

It is observed that the CD ratio of all SCBs in India by the end of

March, 2010 was 72.2 per cent, which was 55.1 per cent in March,

1997. In South India, CD ratio was 15.15 per cent in the year 1997

which increased to 48.12 per cent in the year 2006. This has further

declined to 25.62 per cent in the year 2010. The CD ratio for North

India over the 13 years (1997-2010) is far behind than the national

average. A pictorial presentation of CD ratio of study area is given in

Figure 10.

North India

South India

RELATIONSHIP BETWEEN INSTITUTIONAL

FINANCE AND GROWTH OF SMALL ENTERPRISES

The table 12 reveals the number of registered SSI units, investment in

plant and machinery, employment and deployment of credit to SSI

sector. India has witnessed a phenomenal growth of registered SSI

units since 1998. In the year 1998, there were only 624 registered SSI

units in India. The number of registered SSI units increased to 1388 in

2008. The cumulative investment for registered SSI units was `228.59

lakhs in plant and machinery in the year 1998. It increased to `902.08

lakhs in 2008. Thus, there was almost 3.95 fold increase in investment

in plant and machinery in registered SSI units over the period. In the

year 1998, 3,255 persons were employed in registered SSI units in the

study area. The cumulative number of persons employed in such units

had gone up to 7,750 in 2008.

An attempt has been made to analyze the impact of institutional

finance on the growth of SSI units in the area under study. For this we

have calculated correlation coefficient between institutional finance to

SSI and the growth of number of units during 1998-2007. The result

obtained as under –

R T(cal) T (tab) at 8 df

0.608 2.166 2.306 at 5% level

3.355 at 1% level

TABLE XII- PERFORMANCE OF SMALL SCALE INDUSTRIES

IN INDIA

Source: Statistical Hand Book of Various Issues

The positive r value (0.608) is statically not significant at both 5

per cent and at 1 per cent levels of significance which indicates that

the hypothesis “there exist a close relationship between institutional

finance and growth of small enterprises” is not true. The growth of

institutional finance does not have much impact on the growth of

industries in the study area. Further, in order to examine whether the

growth of investment in plant and machinery of small sector resulted

in the growth of institutional finance, we have employed correlation

analysis between investment in plant and machinery of the units

operating in the study area and credit deployed to SSI sector during

1998-2007. The result of correlation and t value are as follows –

R T(cal) T (tab) at 8 df

0.608 2.166 2.306 at 5% level

3.355 at 1% level

The positive r value (0.557) is not statistically significant at 5 per cent

and 1 per cent level of significance. This indicates that with the

increase in investment in plant and machinery of SSI sector, the

institutional finance to SSI units are not increasing in the study area.

Hence, the hypothesis “With the change of investment structure of

small sector, financial intermediaries have enlarged their assistance”

found to be incorrect. This has again confirmed with the district-wise

analysis of correlations between bank finance available for

manufacturing industries and growth of SSI units during 1998-2009.

For this purpose, we have used the data presented in table-12.From

the correlations result presented above, it is observed that r values

between bank finance and growth of units in both North East India

and North West India are insignificant but correlation in South India

is significant at 5 per cent level but not at 1 per cent level. This

indicates an inter-region disparity in extending the financial assistance

by banks and thereby growth of SME units.

Chart showing calculated data in tabular form

DISTRICS

COREELATIONS

T VALUE AT 10 DF

CALCULATED TABULATED

0.038 0.12024 3.169 2.228

0.254 0.83045 3.169 2.228

SOUTH 0.682 2.94886 3.169 2.228

TABLE XIII- REGION WISE DATA RELATING TO SMALL

SCALE INDUSTRIES

BANK FINANCE TO

MANUFACTURING AND

PROCESSING INDUSTRIES

(Rs. In Thousands)

NO. OF SMALL SCALE

INDUSTRIES

1998 1,43,56 1,91,19 60,46 260 317 47

1999 1,40,04 2,90,87 84,77 292 350 61

2000 1,32,99 2,38,53 59,30 314 375 72

2001 1,32,13 2,06,91 34,05 320 382 74

2002 1,13,82 7,56,01 1,36,18 370 391 79

2003 1,18,98 7,08,25 3,53,73 405 414 99

2004 51,75,20 3,66,17 90,45 437 428 107

2005 2,46,94 271,87,53 79,16 501 456 115

2006 3,40,31 520,83,61 2,25,18 617 490 130

2007 2,64,46 17,44,47 4,30,39 645 525 146

2008 2,45,53 10,63,44 49,28,67 676 549 163

2009 2,64,51 12,80,81 24,24,77 683 563 164

Source: Statistical Handbook of Various Issues and Basic Statistical

Return of Scheduled Commercial Banks, Various Issues, RBI

The methodology used here is based on the analysis of data from a

large-scale survey of SMEs borrowing experiences. The first step of

the work derives a statistical model of lending outcomes based on

loan applications by firms that did not use the loan guarantee scheme.

This statistical approach is not unlike credit scoring models widely

used in SME banking. The second step of the work uses the resulting

credit scoring model to ‘‘score’’ a sub-sample of firms that had

received loan guarantees. Thus, the model provides a prediction of

what the lending decision outcome would have been in the absence of

a loan guarantee program for a sample of firms that had in fact

received guaranteed loans. The data employed here were drawn from

a large-scale survey conducted by Statistics Canada about the

financing experiences of a large stratified sample of Canadian small

firms: the Survey of Financing of SMEs. These data, and this

research, reflect the cooperation of several federal government

ministries (Industry Canada, Finance Canada, and Statistics Canada).

The survey was conducted in 2001 and polled the owners of more

than 19,000 SMEs with respect to their financing experiences during

the year 2000. It comprised two stages of data collection.

The first stage sought information about SME owners’ financing

experiences along with extensive ‘‘tombstone’’ data on firm and

owner demographics. Responses to this stage of data collection were

received from 10,983 business owners, a 62% response rate. The

second stage of the data collection sought to obtain financial

statement information from these same (10,983) owners: 7,123

responses were received in the second stage of data collection.

The survey was stratified so as to ensure a minimum number (among

other criteria) of responses from owners of KBI businesses. Among

the respondents were 3,225 respondents that reported that their firms

had sought debt financing during 2000, respondents who replied in

the affirmative to the following question: ‘‘during 2000, did the

business or its owners approach any type of credit supplier to request

new or additional credit for business purposes?’’Table 13 provides a

breakdown of the types of loans sought in the year 2000 by the

respondents to the survey who had sought some form of debt

financing. For each responding firm, the survey reports loan

application outcomes and a number of attributes of the borrower firm

and its owner(s).Table 13 presents a list of the attributes of borrower

firms and their primary owners that are available in the survey data.

Term loans are the focus of this work because term loans are the only

form of financing that qualifies for the SBF. Of the 809 term loan

applications, 101 loans were identified by the respondents as

guaranteed and met the eligibility requirements of the SBF (loans

were for less than $250,000 and from firms with annual sales

revenues of less than $5 million). In addition, 281 other applications

were not guaranteed but were from firms with annual sales volumes

of less than $5 million. This subset of loan applications was used as

the basis for development of the logistic regression (credit scoring)

model of loan decision outcomes. Note that the number of cases

reported in the various analysis steps vary from these totals because of

missing data from particular fields. In particular, recall that financial

statement data was received from only 70% of respondents. The

approach to measuring incrementality using these data was a two-

stage process. In the first stage, the parameters and statistical

properties of a logistic regression-based model of loan decision

outcomes of non-guaranteed loans were estimated. The second stage

of the analysis uses the resulting model to classify a sample of SBF

loan recipients as to whether or not the firms in the sample would

have been turned down in the absence of the SBF loan-loss sharing

program. At the extreme, if the guaranteed loans were incremental

and if the model were reliable, then the model would predict that all

of the SBF loans would have been turned down. The proportion of

such loans that the model predicts as being turned down is, under this

logic, a direct measure of incrementality. The logistic regression

model of loan outcomes employed a dichotomous dependent variable,

namely whether a particular loan application was turned down or not.

Independent variables were those thought to be potential determinants

of the loan turndown/acceptance decision and that were available

from the data. The general form of a logistic model is:

E {f/n} = ef(x) / (1+ef(x))

Where E {f/n} is the predicted proportion of turndowns {f} among

{n} loan applicants and f(x) = a+ ∑ biXi. The method estimates the

coefficients, {bi}, of a linear function of the set of i predictor

variables, {Xi}, that will, under the logistic model, best predict the

proportion of borrowers for combinations of values of the set of

independent variables, Xi, in the above equation. Potential

explanatory variables were selected according to previous research.

Among others, Haines et al. (1994), Wynant and Hatch (1991), and

many bank training materials have identified determinants of

commercial lender decisions and that are logically related to the credit

granting decision. The variables selected for potential inclusion in the

model are listed below Table 13.

Table 13-

DEFINITION AND RATIONALE

ANNUAL GROSS REVENUES & NUMBER OF EMPLOYEES -

The level of annual sales revenues and the number of employees are

measures of the size of the firm and proxy measures of the firm’s

amount of capital, one of the ‘‘5 Cs’’ of commercial lending. Implicit

in this reasoning is the assumption that larger firms employ higher

levels of capital. To better conform to the assumption of normality,

these variables are transformed by calculating the logarithm of their

values.

PRODUCTIVITY-

Productivity is estimated by taking the ratio of annual sales revenues

to the number of employees. This measure of capacity is also a

measure of the firms’ ability to generate income from its inputs. To

better conform to the assumption of normality, this variable is

transformed by calculating the logarithm of its values.

CAPACITY-

This second measure of capacity is estimated by calculating the ratio

of annual sales revenue to the size of the loan request. It measures the

firm’s ability to service the debt. To better conform to the assumption

of normality, this variable is transformed by calculating the logarithm

of its values.

LENGTH OF BANKING RELATIONSHIP-

The duration of the borrower firm’s relationship with the lender is a

direct measure of the degree of information asymmetry that might

exist between the lender and the borrower. As such, this variable

represents a measure of character and provides information about the

lender’s ability to assess the applicant firm.

NUMBER OF LOAN ACCOUNT MANAGERS-

This measure is, in a sense, the antithesis of the above measure of

character. In previous research, it has been contended that frequent

changes in loan account manager have been identified as a

contributory factor in loan turndowns.

YEARS OF OWNER EXPERIENCE-

Owner(s)’ experience is often cited as one of the dimensions that

comprises the character dimension of the so-called ‘‘5 C’s’’ of

commercial lending. According to this rationale, the greater the

amount of experience, the greater the likelihood of receiving credit.

This variable is measured in the number of years of experience

reported by the primary owner of the firm. To better conform to the

assumption of normality, the variable is transformed by calculating

the square root of the number of years of experience reported.

AGE OF MAJORITY OWNER-

It has been suggested in the popular media that very young owners

may have more difficulty securing credit than older owners.

Accordingly, this is another measure of the character dimension. For

this work, owner’s age is expressed by two dichotomous variables.

The first is set equal to 1 (and to zero otherwise) if the primary owner

is less than 35 years of age. The second variable is set equal to 1 (and

to zero otherwise) if the primary owner is more than 45 years of age.

By including both years of owner experience and these measures of

age, the potential confounding effects of age and experience might be

assessed separately.

LENDER IS ALSO OWNER’S PERSONAL BANKER-

This measure of character and information asymmetry is set equal to 1

(and to zero otherwise) if the lender also manages the primary

owner’s personal banking.

HOME-BASED BUSINESSES-

This measure of collateral is set equal to 1 (and to zero otherwise) if

the firm is a home-based business. The rationale is that home-based

firms generally lack the working capital and real assets that might

serve as security for a loan.

LEGAL STATUS-

The legal status of the firm (sole proprietorship, partnership,

incorporated business) is measured by two dichotomous variables.

The first is set equal to 1 (and to zero otherwise) if the firm is a sole

proprietorship. The second variable is set equal to 1 (and to zero

otherwise) if the firm is a partnership. Limited liability incorporated

businesses would be those where the values of the two variables

above are both equal to zero. Because of the limited liability

associated with incorporated businesses and the potential availability

of the assets of multiple partners, these variables measure both capital

and collateral.

PURPOSE OF LOAN-

Loans used to finance real assets and working capital would typically

be associated with this assets ‘ability to provide collateral for the loan.

The purpose of the loan financing is measured by two dichotomous

variables. The first is set equal to 1 (and to zero otherwise) if the firm

is financing real assets. The second variable is set equal to 1 (and to

zero otherwise) if the firm is financing working capital. The reference

category (financing R&D or export development) is defined when the

values of the two variables above are both equal to zero.

HIGH TECHNOLOGY, R&D EXPENDITURES-

This variable is set equal to 1 (and to zero otherwise) if the firm

spends more than 5% of sales revenues on either R&D or computer

technology. It is a means of measuring the extent to which the firm is

technology oriented and is an alternative means of identifying firms in

knowledge-intensive sectors. As such, this variable measures the

conditions dimension of commercial lending criteria. In addition, it

reflects the BDC’s assertion that such firms may be subject to ‘‘gaps’’

in the commercial lending market.

RURAL SETTING-

This variable also measures the conditions and the context for the

business of the firm. It is set equal to 1(and to zero otherwise) if the

second digit of the firm’s postal code is 0.

OWNER IS MEMBER OF A VISIBLE MINORITY

VARIABLES TO CONTROL FOR STRATA WEIGHTING-

This variable is set equal to 1 (and to zero otherwise) if the owner

self-identifies as such. As noted, the sample data were collected using

a stratified random sampling process where the strata are defined by

the size and sector of the firms.

CHAPTER 4

ANALYSIS

There are many problems that firms are facing in the contemporary

dynamic business environment. Some of the common financial

problems faced by MSMEs are:

Inability to obtain external financing;

Inability to obtain internal financing;

Insufficient capital, start-up costs;

Expensive raw materials;

High wholesale price;

Large losses due to scrap rate, sabotage, breakage and crime;

Decline in sales volume;

Bad debts and write offs;

Heavy equipment and maintenance costs;

Government tax, VAT and customs duty;

Payroll, rent and utilities;

Transportation and petrol costs;

High interest rates on loans;

Ability to meet financial obligation;

Insurance costs and delay in account receivables payment.

These financial problems can be categorised into various themes as:

Financing problems;

Operational and administrative problems;

Sales and debtors problems.

The financial problems faced by MSMEs are discussed under these

three important categories.

FINANCING PROBLEMS

Literature review revealed that one of the most significant problems

faced by small businesses is financing problems. Indian economy is

largely subsistence-oriented and small; hence the firms in the

manufacturing face more problems in securing loans. During the start-

up stage of a MSME, they have to depend on both formal and

informal channels of financing MSMEs are facing heavy start-up

costs because they need to secure enough finance for purchase of

assets and meeting daily operational expenses. The need for finance

by the MSME fluctuates due to the MSME's stage of maturity in the

pecuniary life cycle. MSME has to rely on internal and external

sources of funds to finance their businesses. In manufacturing sector

debt financing is necessary.

Internal sources of finance for MSMEs include personal savings and

loans from family and friends. When the internal financing is

insufficient then MSMEs will move to external sources of funds.

External sources of financing in manufacturing sector include banks,

business suppliers and asset-based lenders.

OPERATIONAL AND ADMINISTRATIVE PROBLEMS

Government financial regulation on MSMEs has significantly

disadvantaged the MSMEs as compared with their large counterparts.

Specifically, the financial regulations imposed on MSMEs such as

government tax, VAT and customs duty has various implications on

the success and survival of small business. More importantly,

government has provided enormous tax breaks to large employers

who operate in tax-free jurisdictions-tax-free zones. MSMEs in the

manufacturing sector usually have the political clout to enjoy such

tax-free advantages however, the idea of MSMEs tax-free zones have

not yet been implemented.

MSMEs in the manufacturing sector are handicapped with low

echelon of process automation and elevated cost of importing better

technology. The imported technologies and the software solutions are

not customised and further the cost of customisation is exorbitant.

More importantly, the maintenance is expensive and time consuming.

In particular, firms in manufacturing sector also facing large losses

due to scrap rate, sabotage, breakage and crime. Simultaneously,

MSMEs has to develop an insurance plan for their business. MSMEs

in the manufacturing sector often insure for property and liability

insurance. Of greater significance is the fact that having a property

and liability insurance cover for MSMEs helps in securing good

customers. MSMEs' primary goal is to survive in the contracting

economic environment of India.

SALES AND DEBTORS PROBLEMS

Managing sales and debtors in small businesses is one of the most

crucial problems faced by MSMEs in the manufacturing sector.

According to one of the owners of a MSME the sales over the past

few years have been going down and the debtors are also delaying in

making payments on time. Even after sending several reminders for

them to pay they ask more time. I do not know how my business is

going to survive if the debtors will delay in their payments. Statistical

evidence suggests that, Indian economy contracted by an estimated

2.5 percent. Apparently, this contraction in the economy has resulted

in declining sales volume, delays in accounts receivable payment and

high bad debts and write offs.

CHAPTER 5

CONCLUSION

This study analysed the importance of financial obstacles faced by

MSMEs. Financial obstacles in which MSMEs are mainly concerned

are as follows:

Inability to obtain external financing;

Inability to obtain internal financing;

Insufficient capital;

Start-up costs;

Expensive raw materials;

High wholesale

Price;

Large losses due to scrap rate, sabotage, breakage and crime;

Decline in sales volume;

Bad debts and write offs;

Heavy equipment and maintenance costs;

Government tax, VAT and customs duty;

Payroll, rent and utilities;

Transportation and petrol costs;

High interest rates on loans;

Ability to meet financial obligation;

Insurance costs and delay in account receivables payment.

Financial obstacles that are of less significance to MSMEs are heavy

advertising and promotional costs and training and development costs.

These financial problems have been categorised into various themes

such as:

Financing problems;

Operational and administrative problems; and

Sales and debtors problems and have been discussed

accordingly.

It is envisaged that this project will provide an explicit picture to both

the academic and policy community with regard to the financial

obstacles faced by MSMEs. It should assist the policy makers in

designing and implementing specific and well-targeted policies for

the overall benefit of MSMEs.

CHAPTER 6

RECOMMENDATIONS

MINIMUM GOVERNMENT REGULATION AND TAX

One of the serious complaints from MSME is the impact of regulation

on MSMEs and particularly the disproportionate impact of

government regulations on MSMEs. The disproportionate impact of

the government regulation and taxation system hinders the growth and

survival of MSMEs in India and might otherwise drive out some of

these MSMEs who make a substantial contribution to the economy.

Essentially, from the public policy perspective, both the direct cost of

regulation and the cost of compliance of the regulation should be

reduced.

For example, income tax incentive scheme was introduced by

the government to support the establishment of MSMEs in sectors

such as agriculture, fishing projects, supportive projects to tourism

industry, tourism projects and social services. This tax incentive

scheme required that the income derived from agriculture, fisheries or

tourism activities of the relevant SMEs that have gross sales not

exceeding Rs 3 crore per annum be exempt from tax.

BETTER ACCESS TO FINANCE

Commercial markets work extremely well in providing financial

services to the MSMEs. Apart from the obvious banking services,

more specialist services such as term loans, factoring, invoice

financing, leasing and venture capital are offered by firms which

rigorously compete with one another to maximise their profits. Also

part of this competition, MSMEs find it difficult to compete with their

large counterparts and access the services on offer.

This constrains their growth and survival. It is essential for policy

makers to recognise that there need to be a cohesive and precise

public policy targeted at MSMEs that will ensure that they are well

protected in this dynamic and competitive environment. This

recognises the need for an extensive range of diverse and well

targeted programmes such as:

Loan guarantee programmes;

Regulating the interest rate charged on MSME loans by the

commercial markets;

Establishment of a well-established venture capital market;

Establishment of markets for private placements and initial

public offerings of varying sizes;

Government-sponsored programs for delivering credit and

equity funds of small business units;

Creating good awareness of the financial programs available to

small businesses; and

Ensuring that MSMEs keep proper financial records.

Proper cash and credit management practices MSME need to realise

that the real success of a business is based on its ability to keep close

control over cash flows, avoiding holding excessive stocks and

collecting debts on time. Many MSMEs have failed because firms

focused more on technical matters and forgot about cash flow.

MSMEs still believe that delivering a quality service ensures timely

payment however; MSMEs need to recognise that they need to do

something positive to ensure timely payment from debtors. MSMEs

have to ensure that they send timely invoices to their customers.

Overdue credit accounts avert further sales to the slow paying

customer. This overdue account ties up seller's working capital and

can also lead to losses from bad debts. There are four key items that

the MSMEs need to tightly manage:

Annual profit growth percentage, to equal or exceed sales

growth percentage;

Cash flow effectiveness to minimise external debt;

Efficient use of assets that are as slim as possible to achieve

sales; and

Interest avoidance since the cost is a drain on profits.

PRIVATE EQUITY FUNDING

The Micro, Small and Medium enterprises (MSMEs) are the

backbone of economic development in any country. They are the

incubators for talent, innovation and entrepreneurial spirit which are

central to a country’s development. Efficiently organized and

innovative, MSMEs often exercise frugal management skills and use

local resources to create innovative products and services which cater

to any country’s growing needs.

There are about 30 million MSMEs in India accounting for 8% of

India’s GDP, 45% of the total manufacturing output, and 40% of

India’s exports. Employing over 60 million, they churn out over 6000

products annually. The contribution of Indian MSMEs to the GDP has

been steadily growing over the years from about 5% in 2003 to 8.5%

in 2011. However in order to continue scaling up, timely and adequate

access to financial services is an imperative, and this has been

traditionally one of the biggest hurdles.

Funding Gap in MSMEs

The total gap in MSME funding is estimated to be around USD 126

Billion. Out of this, the debt gap is approximately USD 84 Billion and

equity GAP is about USD 42 Billion. Out of this the total equity

supply is only about USD 526 million, a huge shortfall. The major

reasons for creation of this Gap are information asymmetry which

exists in Indian SMEs, the family owned nature of Indian businesses,

and lack of information regarding tapping the right kind and source of

finance. Though the first two reasons are systemic, lack of

information can be easily resolved with targeted efforts from financial

institutions and government agencies.

Funding Structure

Traditionally, private funds from friends and family form the single

largest source of finance to MSMEs in India. MSMEs in India also

rely heavily on private money lenders and the unorganized financial

sector for their requirements, where the terms of financing are unclear

and interest rates are high. This small pool of funding providers often

forces many potentially viable and growth focused MSMEs out of

operation.

Banks have been making steady strides in order to bridge this gap.

However the approach followed by banks to funding is very

restrictive as the bank has to create value by controlling & managing

risk. In any loan application for a business, a Bank has to necessarily

evaluate the risks involved, gauge collateral support and the methods

to mitigate those risks. Therefore it is not always possible for an

entrepreneur to satisfy all requirements and conditions which the

Bank might pose. The above methods of financing are majorly debt

financing, and sources of equity funding remain elusive in India.

Private Equity Funding

Private equity and Venture capital is provision of equity capital by

financial investors for medium to long terms to companies with

growth potential. Private equity in a broader sense encapsulates

funding requirements at all stages of development of any company

and not only at the initial stage. However, since well established

companies have far greater sources of financing, this term is generally

used for early stage funding. Private equity firms in search of high

return on their capital seek out firms with growth potential; invest in

these firms and exit after achieving their required return.

HOW PE HELPS IN GROWING BUSINESS

Most of the PE funds would not only provide medium to long term

capital but would also act as a partner and provide strategic and

operational support. A PE firm might be able to help a business widen

its geographic access, provide strategic multinational partnerships,

and also at times bring in customers using its vast network and

contacts. A PE firm might also be able to marshal better management

frameworks improving marketing efficiency or HR metrics. It could

also improve new product development and provide technology

support which is generally sorely missing in any SME due to

inaccessibility.

Private Equity Business Model

The overall business model of any private equity fund has four

distinct stages, from forming a fund to exiting from an investment.

1. Raising Funds from Investors

2. Investing Funds

3. Managing the Investments

4. Redistribution and Exit

After forming a fund, fund managers (referred to as General Partners

or GPs) collect capital from investors known as Limited Partners

(LPs). The GPs who are in some sense employees of the fund then

look out for high growth companies to invest in. Limited Partners are

generally sophisticated investors like pension funds, HNIs, insurance

companies, banks etc. because of their greater understanding of

sectors, trends and risks.

Once the amount of required funds is raised, GPs select companies

according to the funds mandate and invest in equities of those

companies, which is the second stage of the process. When they have

fully deployed the funds, they have generally created a portfolio of

companies. In the third stage, fund managers work closely with their

portfolio companies, managing operations, subsequent fund raising,

ensuring business development and trying to time an exit from the

investment. In fourth and the final stage, fund managers exit their

portfolio companies after having mostly made gains due to the change

in valuation of the company accrued due to growth.

Private Equity for Entrepreneurs

Though complex in structure to understand, cracking a PE deal can be

a simpler process if Promoters and PE fund managers understand each

other’s expectations. Impeccable preparation and intelligent

negotiation can help an entrepreneur raise the right amount of money

from the right kind of fund which can see their business grow

manifold. Almost all PE funds have a specific mandate as to the type

of companies they can fund which is generally based on parameters

like turnover, sector, stage, structure and the like. Thus, if a PE fund

rejects a business plan does not imply that the business is unviable or

unprofitable. It is important to understand that the PE fund cannot

finance all types of businesses. Only highly profitable or growth

oriented business often get PE funding and thus only about 1% of all

companies evaluated by PEs actually get the desired funds.

The fund raising activity can broadly be divided into three to four

stages which start with the entrepreneur readying a business plan.

Business Plan

A business plan not only forces the promoter and management to

think about opportunities and challenges facing their business but also

serves as an initial point of contact and discussion between potential

investors and the promoter. Essential points that need to covered in

the plan are the company history, business potential, key highlights of

the company, the management standing, products and services,

analysis of the industry, operational performance, commercialization

and scalability, financial and volume projections, capital requirements

and last but not the least: exit strategy for the PE and the investor.

Selection of the right kind of private equity firm is most important. It

is imperative to ascertain the credentials, prior investment patterns

and exits of the firm before the initial discussion.

The Negotiation

After the initial phase when the PE firm has accepted the potential of

the business in principle, the long drawn phase of negotiation

normally would start.

Initial stages

The PE firm would first share guidelines for future negotiations. A

deal would typically involve a lot of legal and financial analysis as

there might be different types of financing structures like quasi equity

instruments, mezzanine financing, preferred share agreement etc. The

method of financing is dependent on the life cycle of the business,

growth projection as well as the mandate of the PE firm.

Price negotiation for a stake in a company is the most crucial aspect

of a deal. A PE firm will use all kinds of metrics to ascertain the value

of the company which might include discounted cash flow valuation,

comparative methods or any other appropriate method.

Due Diligence

The Due diligence process would involve the PE firm thoroughly

auditing the company’s financial as well as operational performance.

If found satisfactory, the PE firm would draft an agreement after a

final round of negotiation. The final agreement could include certain

protocols, warrants or statutes and thus needs to be thoroughly

examined before proceeding. An entrepreneur should also in this

process independently analyze and understand the value of his

company, how earnings are to be divided, future relations and

involvement of the PE firm, PE firms’ exit strategy etc. All business

advisors from management, legal counsels, accountants, and auditors

should be involved form the entrepreneur’s side for this process to

extract the maximum value out of any deal.

It is important to understand that although short term goals of a PE

firm and a promoter might be contradictory, the long term objectives

of balanced growth and profitability are common. There are various

exit routes for the entrepreneur as well as the PE firm which includes

IPO, secondary sale, management buyout, merger, liquation etc. The

exit route will normally depend on the lifecycle, future economic

condition and the industry cycle.

Private Equity in India

The turn of the 21st century has brought with it greater globalization,

regional economic slowdowns and a change in geographic growth

patterns with emerging economies out performing developing ones by

a more-than-fair margin. This phenomenon, along with greater global

capital flows has helped India become one of the most preferred

destinations for Private Equity investments. India has seen rapid

growth in domestic consumption. This coupled with favorable

demographics has led to a lot of young entrepreneurs setting up shops

in important sunrise sectors which have attracted Private equity

investments.

Empirical evidence shows that PE deal values are highly correlated

with the Sensex, indicating that overall economic sentiment has been

a critical parameter for investors to take long term calls.

Government Initiatives in MSME Funding

Government has always been cognizant of the funding gap which

plagues Indian SMEs. In the 2012-13 budget, government announced

an India Opportunity Fund of USD 878 Million to support Indian

SMEs. This entire amount will be routed to SIDBI and is divided into

specific targeted sectors which include:

Domestic MSMEs

Internationalization of SMEs

Sector Specific Funds –ICE, Traditional Sectors, Defence,

Infrastructure

IPO on SME Exchanges

Such initiatives would go a long way in bridging the financing gap

and ensuring that India gets a steady flow of entrepreneurs in various

fields.

CONCLUSION

Globally, even though private Equity remains one of the most

important and powerful engines in driving innovation, Indian

Entrepreneurs have still not fully recognized the potential of PE. It is

therefore important to build knowledge and instil mechanisms to help

entrepreneurs recognize their potential. It is only when PE funds are

spoilt for choice will there be appropriate valuation and optimal

capital utilization. Secondly it is imperative that the process of

establishing and making a company be made more promoter-friendly.

The biggest hurdle in getting PE funds on board is the information

asymmetry and the question mark on the integrity of Indian

promoters, as many of them still carry the legacy of the License Raj

and are accustomed to bypassing laws and mandates. Finally, there is

a need to firm up laws and regulations which make PE entry and exits

easy. All of these factors coupled together are necessary to attract

more PE in India.

CHAPTER 7

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http://www.wikipedia.com

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Suggestions to Stimulate Financing under Micro and Small Enterprises

Economy & Finance