Following the thunderous announcement of Rs 20 lakh crore (10% of GDP) by the Prime Minister — the highest by any government post-pandemic, the Finance Minister came up with a six-point package sounding big relief for the micro, small and medium enterprises (MSMEs). When the final figures came for counting, the five-day pack whittled down to bare 2% of the GDP.
The MSME sector is sore over the package as it did not provide virtually any relief for either payment of wages or immediate payment of bills pending with the government itself (approximately Rs 5 lakh crore – both GoI, PSUs and State governments) and even forbearance of the loans for at least 180 days.
The initial moratorium on the term loan instalments and working capital, and the deferment of working capital were just a breather. Since the units were under lockdown, most of those availed, have no output to support the additional working capital. They are now offered relief in the margin.
This would mean that banks would give more working capital loan against deficient stocks, wages to the labour for the lockdown period etc, knowing it as an unsustainable debt because there is a National Credit Guarantee Trust (NCGT) and there is pressure to deliver by September 2020. For Rs 3 lakh crore as a relief package to the MSMEs, the Cabinet has provided Rs 41,600 crore under NCGT to be released over three years. Banks are unhappy with this type of guarantee dispensation since they still have to provide for likely capital erosion.
MSMEs that received the incremental credit during the Mar-June quarter, post-Covid, at 7.4% pa, are now told that they have to pay 9.25% for Emergency Credit Relief Package extending over four years with a moratorium of one year! The other measure, which is the sub-ordinated debt, is a follow-up of Budget 2020-21. The Cabinet is yet to clear it. The FM announced sub-ordinated debt (SOD) at the hands of the same banks that have all along been winking at the revival of these enterprises and on easy and timely credit access as part of the Covid relief package.
Banks that did not have an SOD on their balance sheets thus far should now look for providing it under investment category and that too upfront labelling it as NPA! They should develop standard operating procedures and help the clientele know of the nuances of availing it. To embrace innovation for a sector that is always viewed with suspicion, will they fall in line with the thinking of the FM?
SOD in simple terms is defined as a debt subject to subordination when there is creditor’s default. If ‘A’ bank has offered a subordinated debt to an MSME, and this enterprise goes bankrupt, it, therefore, becomes a defaulter. Bank cannot claim the money it has given as a loan from the enterprise.
After the senior debts are paid off in full, the leftover will accrue to the clearance of the subordinated debt. Singular advantage, however, is that in the case of companies (this category is just 2-2.5% of the total MSME borrowers), bank will receive its SOD claim ahead of preferred and equity shareholders. Banks will be able to recover their usual unsubordinated debt in the shape of term loans and working capital ahead of SOD.
This simply means that SOD is riskier than the normal term loan and working capital loan offered either as cash credit or overdraft. Banks that have been lurking to grant loans against the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) to the extent of Rs 2 crore cannot be expected to grant SOD again at the same guarantee window!
Sub-ordinate debt, by definition, stands higher in risk and lower than the principal loan in terms of claims by the bank. For Rs 20,000 crore infusion by the Centre, the CGTMSE is just Rs 4,000 crore based on the default rate of such client. It would have been fairer had Nirmala Sitharaman extended sovereign guarantee for this purpose instead of CGTMSE. While CGTMSE has conditional provisions, sovereign guarantee provides full guarantee for the capital. Offering this high-risk product to already declared NPAs could trigger a lot of problems in operationalising this product.
It will be now for banks to roll out the product. SOPs for releasing this SOD will be very tough if not tricky for them. On top, the CGTMSE with which the banks are already unhappy is supposed to provide guarantee. Quite likely, several of the 2-lakh MSMEs may have already been covered under the CGTMSE and the claims must be hanging at one end or the other for consideration so that the banks concerned will close the NPA accounts!
It is advisable instead to offer equity to MSMEs – proprietary or partnerships – up to 50% of their total financial requirements and the balance as debt. This equity should be left untouched by banks for five years. Such equity should be for buying a leasehold right/outright sale in the site where the manufacturing unit is set up and or purchase of machinery/technology or acquiring of intellectual property rights. Once it is given as equity, banks will be forced to become the development partners of the MSMEs.
Assessment of revenue stream and monitoring it is extremely important to culture the enterprise in apportioning some percentage towards the equity contributed by the bank. There are two ways of ensuring this: 1. Banks physically monitor the functioning of the enterprise as its partners; 2. Set up a consent-based ERP architecture to monitor their debtors, creditors, sales and cash flows on the system.
Such equity can flow across the enterprises but must be on sound credit risk assessment and effective follow-up and supervision. Banks with their limited manpower can hardly be expected to do the former. Ensuring that the enterprise makes a seamless transition from unorganised to organised, they may have to outsource these services. They should also be able to re-engineer their workspaces and train their executives to catch up with the task.
The relief package is at best a pack of intentions. It is an additional loan burden. MSMEs’ cost of production will go up at a time when they are uncertain about the demand. They also become uncompetitive compared with MSMEs across the globe that have received cash relief and interest-free loan to rebuild their manufacturing business.
Neither the Reserve Bank of India nor the GoI has issued operational guidelines for the treatment of existing NPAs. Without reviving the viable MSMEs and carving out a definitive future, banks taking part in equity of such firms through the SOD route will be a wild goose chase.
But for the risky NPAs, sub-ordinate debt to roll out is a future, worthy to watch. Banks may innovate, who knows? In essence, the package is sweet on words and sour in delivery.
(The author is economist and risk management specialist, and has authored ‘The Story of Indian MSMEs’)
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