This article has been written by Nikunj Arora of Amity Law School, Noida. This article provides a practical and procedural aspect of SME Financing In India along with the schemes provided by the Government of India. The article also provides a short overview on SME lending and problems faced by SMEs to raise finance.
It has bee published by Rachit Garg.
The Indian economy has benefited from the growth of the Micro, Small & Medium Enterprises (MSME) sector and this sector has emerged as one of the most robust and dynamic sectors of the economy, according to the Ministry of Micro, Small & Medium Enterprises.
A small and medium-sized enterprise (SME) is no different than a large corporation, except that it is one that generates revenues, and assets, and employs fewer people. Small and medium-sized enterprises (SME) are defined in every country differently, and each has its own rules about what constitutes an SME. As part of the ranking process, certain criteria must be met, including the size of the company, as well as the industry in which the company operates. In business finance, financing small and medium-sized enterprises is an important function of the market. It is one of the major ways in which capital is provided, acquired, and cost for the different types of companies available on the market.
There is no definite method for identifying small/mid-sized businesses in the United States. The European Union (EU) offers clarity as to what constitutes a small and medium-sized enterprise, which are defined as companies with fewer than 50 employees and companies with fewer than 250 employees, respectively. There are also micro-companies, which are enterprises with up to ten employees. Similarly, the names and abbreviations of the categories vary based on the national standards. The European Union (EU), United Nations (UN), and World Trade Organisation (WTO) commonly refer to small and medium-sized enterprises as SMEs, whereas small-to-medium size businesses (SMBs) are frequently used in the United States. Other countries such as Kenya refer to them as MSME, or small, medium, and enterprise. While countries may have different names for their businesses, they share the same practice of segmenting them based on size or structure.
On March 21, 2022, to promote the economic inclusion of women through technology, the Bank of Baroda announced a partnership with the Reserve Bank Innovation Hub (RBIH), a wholly-owned subsidiary of the Reserve Bank of India. In its inaugural edition of Swanari TechSprint, the RBIH will be working with the Bank of Baroda as a ‘scale-up partner’ to deliver digital solutions to help women become financially independent and secure.
On March 22, 2022, the Parliamentary Standing Committee on Industry recommended increasing the repayment period under the Emergency Credit Line Guarantee Scheme (ECLGS) for micro, small and medium businesses. Under the scheme, MSMEs that are struggling to survive the second wave of the COVID-19 pandemic are currently restricted to a repayment term of three-four (03-04) years, including the moratorium period. Additionally, the panel requested that the principal amount be put on hold (moratorium period) for at least 2 years.
During the budget speech this year, Finance Minister Nirmala Sitharaman announced that the ECLGS scheme would be extended to March 2023 and the guarantee cover would be increased to Rs 5 lakh crore. As of May 2020, the scheme has extended credit to more than 130 lakh MSMEs.
Overview of SMEs : an Indian perspective
SME in India
Small and Medium Enterprises (SMEs) are common in India because the country possesses a highly valued demographic dividend. As per Section 7 of the Micro, Small and Medium Enterprises Development Act, 2006, small and medium enterprises are defined as :
Investments in these sectors are used to classify them. A minimum of Rs. 1 crore and a maximum of Rs. 10 crores are required to invest in the small enterprise sector, with a minimum of Rs. 5 crores and a maximum of Rs. 50 crores in revenue/turnover.
For medium-sized enterprises, investment criteria range from INR 10 crores to INR 50 crores, while turnover thresholds range from INR 50 crores to INR 100 crores.
Consequently, they are considered a significant component of both the manufacturing and service sectors of the economy and are therefore imperative components of secondary, tertiary, and quaternary sectors.
For a better understanding, the above-mentioned are summarised as below:
|Small/Medium Enterprises||Turnover criteria(INR)||Investment criteria(INR)|
|Small enterprises||1 crore to 10 crores.||5 crore to 50 crores.|
|Medium-sized enterprise||10 crores to 20 crores||50 crores to 100 crores.|
Also, those enterprises are unrestricted in their nature and type. As a result, there is a variety of SMEs such as proprietorships, corporations, cooperatives, Hindu Undivided Families (HUF), partnerships, etc. A key aspect of these provisions in India pertains to the fact that enterprises are not classified as SMEs based on factors like the number of employed individuals or the quantity of electricity they consume, as was done in the past and as is still done across the globe, including most of the countries in the European Union (EU).
The present scenario of SME sector in India
In India, SMEs contribute nearly half of the industrial output, 40% of exports, and generate one million jobs a year, and approximately 45% of the industrial output in India is produced by them. These enterprises produce over 8000 quality products that are exported to overseas markets. SME numbers have risen to over 48 million in recent years, with a 4.5% growth rate. The funds that target SMEs face several challenges, including a lack of resources to raise money. The truth is that the government continues to ignore the importance of this sector in boosting the GDP overall, even though it provides an impetus to it.
Despite facing stiff competition from the United States and China, India is poised to become the world’s second-largest economy by 2050, and the third-largest after the United States by 2032. Experts in the industry believe the SME sector would be essential to achieving this target. In India, out of the total exports, 43% are in the SME sector, according to Chandrakant Salunkhe, President of the SME Chamber of India.
An announcement, in October 2021, stated that the Government of India will offer small and medium businesses up to 1 crore in loans with interest rates beginning at 8% within 59 minutes. Increasing access to credit will be easier with this historic initiative that will develop the MSME sector.
A new website has been launched to facilitate this and an integrated digital platform has been created. Through this online portal, the MSME sector will be able to access loans in a fully automated manner; i.e. the process of applying for a loan will now be completely automated.
It used to take a month for the loans to be processed. With the new portal, the processing time will now be reduced to less than a minute, after submitting all required documents. Following this approval, the applicant will be disbursed with the loan within seven or eight business days.
Several measures are being taken by the Indian Government to boost the manufacturing sector. These measures are aimed at creating jobs and strengthening India’s economy. It is extremely important because, in addition to directly generating employment, it can also indirectly create employment.
Importance of SMEs
SMEs play an essential role in a nation’s economic development. According to some authors (Leutkenhorst, 2004), SMEs contribute significantly to jobs creation in developing countries because of the following reasons:
- Production via labour-intensive techniques: Producing goods and services in a more labour-intensive manner than much larger enterprises, thus generating more employment and distributing income more equitably.
- Providing more opportunities: SMEs provide more opportunities in an agricultural-based economy than any other enterprise, as they encompass simple and value-added processes in work.
- Promote entrepreneurship: SMEs contribute and support several entrepreneurial activities.
- Development of a strong economic system: By leveraging the strengths of small and large enterprises, SMEs improve the development of productive capacity and create strong economic systems.
Why SMEs often complain about finances
SMEs often complain that the lack of financing prevents them from capturing lucrative investment opportunities and growing. Moreover, it is considered to be an extremely difficult task to start even a small business from scratch, even if someone has a terrific idea or a product that is highly innovative. The majority of SMEs look for lenders who can help ease the cost of setting up their business. Yet, not every institution is helpful to new business owners. This is the reason why SMEs face the problem of insufficient credit availability in India.
Small businesses face a financing gap between what they can afford and what they can use for productive purposes. Understanding why this happens is therefore vital.
Firstly, it is important to realise that investors have a limited pool of funds. Investors rarely have much left to invest after satisfying their needs and desires to spend and pay their taxes. Secondly, investors’ funds are limited, thus, resulting in a competitive market. In addition, governments and large companies acquire a large number of allocated funds and, consequently, the SME sector suffers.
Thirdly, SME sectors suffer because they are perceived to have higher risk and uncertainty levels than many others, which makes investing in them less attractive. The following reasons can contribute to the above-mentioned:
- SMEs have an unproven track record in raising money and providing investors with satisfactory returns.
- They frequently lack adequate internal controls and the external controls are also usually minimal. Because of their size in the market and the economy, for example, they are unlikely to attract a lot of attention from the press.
- The owner of such a smaller business is often the only one who can question his or her decisions.
- Small businesses often have few tangible assets that can serve as collateral.
What is corporate finance and the associated ways of corporate finance
The function of corporate finance is to create capital for a company. Financing and management steps that increase the company’s value are part of corporate finance. This function serves as a conduit between the organisation and the capital markets.
Finance in corporations includes decisions made by companies that affect their finances, tools, and analyses aimed at prioritising and allocating resources. As a result, corporate loans aim to maximise a business’s value by implementing resources and planning to balance risk and profitability.
There are many convenient options available to businesses when they need financing. Some of the options include :
- Funds from internal sources: The majority of businesses prefer to fund their growth with their internal resources, which primarily include cash and savings. It is better this way since no money must be repaid or debts were taken on.
The downside to internal funding is that it drains your company’s cash flow. This can lead to cash flow problems. You may also be unable to take advantage of opportunities if your business is stifled.
- Debt financing: Debt financing involves borrowing money from a financial institution or a bank. Credit cards, overdrafts, and loans are the most common ways to obtain credit.
Since no other party will share ownership of your business in the future, you will be able to maintain control over your business and keep your profits. Tax-deductible interest is another advantage. A major reason why organizations choose to finance their operations through debt rather than equity is to safeguard the company’s value by preserving ownership. The investor retains an ownership stake in the company, such as selling common and preferred shares, as part of equity financing. Lenders provide debt capital, and in return, they are entitled to receive repayment plus interest. Consequently, business owners have the opportunity to keep full ownership of their company and end their obligations to their lender once the debt is repaid.
Equity financing: Thirdly, equity financing offers funding in exchange for ownership of the business. Investment professionals, such as venture capitalists and angel investors, are two common types of investors.
Since the investment is not a debt, this can be a better option than debt financing, but losing ownership and control of a part of your business is one downside.
The modern world approaches include strategies such as asset-based finance, alternative debt, crowdfunding, and hybrid instruments. You can learn about these strategies here.
Regulatory/government initiatives for the advancement of SMEs
With the introduction of the Micro, Small & Medium Enterprises Development (MSMED) Act in October 2006, India has taken numerous steps to promote the SME sector, such as enhancing the investment in plants and pieces of machinery from INR 1 crore to INR 2.5 crore and encompassing trading activities in MSMEs.
In addition, the act substitutes the word ‘Enterprises’ for ‘Industry’ to refer to services provided to MSMEs. The Nair Committee in its report dated 21st of February 2012 recommended that the threshold for investment in plant, machinery, and equipment for Micro and Small Enterprises (MSEs) be increased from INR 50 Lacs for manufacturing companies and INR 20 Lacs for services companies.
In 2000, the Indian Central Government launched a credit guarantee scheme that provides guarantees against default for loans to SMEs, even if no collateral is provided, up to 75 per cent of the lending bank’s credit loss. Unless the proposal meets the bank’s credit requirements, even new companies could avail of this facility. Yet, despite the lapse of considerable time, most banks are reluctant to offer free collateral-free loans to SMEs despite the availability of this product for a long time.
RBI’s take on MSME lending
Reserve Bank of India (RBI) has published FAQs regarding the MSME lending. You can check the detailed FAQs here. The following are the main highlights :
Priority sector lending
According to the RBI, there are only a few sectors included in priority sector lending, such as agriculture and micro and small businesses, which are employment-intensive and impact large sections of the population.
An initiative based on the cluster concept is intended to provide a full-service approach to cater to the high demand for financial services within the MSE sector. To this end, banks may wish to extend their services to recognized clusters of MSEs. It might be more advantageous to use the cluster approach if a well-defined and recognized group of entities is involved, there is adequate information to assess risk, the lending institutions are monitoring it and costs are reduced.
In view of this, banks have been advised by the RBI to view it as a thrust area and to increasingly employ it for small and medium businesses. Besides opening more MSE-focused branch offices that can also serve as counselling centres for MSEs, banks have also been advised to open more branches at different MSE clusters. One cluster should be adopted by each district leader bank. The detailed circular is available here.
Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) Scheme
With a view to facilitating credit flow to MSEs, the Ministry of MSME and Small Industries Development Bank of India (SIDBI) jointly established the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE). A primary objective of the scheme is to encourage lenders to place importance on the viability of projects when granting credit facilities and to secure credit facilities purely on the basis of the collateral for the assets being financed. Under the Credit Guarantee Scheme (CGS), lenders are assured that if an MSE unit fails to pay off its liabilities to the lender after availing of collateral-free credit facilities, the guarantee trust will make good the loss.
Under CGTMSE, lending institutions can extend credit facilities up to INR 200 lakh without collateral security and without the need for third-party guarantees. CGTMSE charges a membership fee for guarantee cover as well as a guarantee fee each year.
Guidelines for delayed payment of dues to the MSE borrowers
With the enactment of the Micro, Small and Medium Enterprises Development Act 2006, buyers have to pay the MSME units (for the goods and services supplied by the MSME units) according to the following schedule :
- Unless otherwise agreed upon between the buyer and the provider in writing, the buyer must make payment by the agreed-upon date. A maximum of 45 days of the agreement shall be allowed between the buyer and seller.
- On non-payment, the buyer shall pay the supplier compound interest with monthly rests at three times the Bank rate (determined by the RBI) on the amount from the appointed day or, at the agreed time, at three times the bank rate.
- The buyer is responsible for the interest as described above if the supplier supplies goods or renders services.
The Micro and Small Enterprises Facilitation Council shall resolve disputes with regard to any amount due. The banks have been advised that, in order to comply with the payment obligations of large corporate borrowers to MSEs, while sanctioning/renewing credit limits to their large corporate borrowers (i.e. those with working capital limits of at least 10 crores from the banking system), they should set aside separate sub-limits, within their overall limits, for meeting payments in respect of purchases from MSEs either on a cash basis or on a billing basis.
It was also recommended for banks to closely monitor the operation of the sub-limits, particularly with reference to their corporate borrowings to MSE units by periodically inquiring from their corporate clients about the number of their dues to MSE suppliers, and ensuring that the corporates pay off such dues before the ‘appointed day’/agreed date by using the balance available in the sub-limit.
Equitech platform for SME equity financing
Arun Joshi, founder of Apohan Corporate Consultants Pvt. Ltd., in his article “Necessity of an Equitytech Platform for SME Equity Funding” explains the reasons for the need for the development of EquityTech platform against the bank funding for SMEs.
The following are some of the reasons stated in his article:
- The gap: SMEs find it difficult to access credit from banks, non-banking finance companies, and many other types of lending institutions because they are not lending at all or not lending enough or lending at higher rates or with difficult (unfair/undesirable) terms & conditions. Business loan applications are rejected 40% of the time. Securing a loan can be unpredictable. Due to the repayment cycles, SMEs have trouble managing cash flow and default early.
- Unmet SME funding demand: Statistics from 2018 show that 0.6 trillion dollars were rejected by public sector banks in India alone. The total need for business funding considering applications that are not made in a hopeless state as well as those that are turned down by private banks and by other types of FIs is much higher.
- Recovery from banks: From an SME perspective (and not from the perspective of the stability of the banking system), banks are ruthless in their recovery mechanism from SMEs. SME lenders sanction a small percentage of the loan request by an SME, endangering its viability and creating NPAs.
In the current economic recovery environment, small and medium businesses are rebounding after being affected by the pandemic and intermittent restrictions. SME borrowers are poised to gain ground following the emergence of digital lending models for consumers. Fintech companies have changed their assessment of SMEs for loan eligibility over the past two years.
Similarly to the rest of the ecosystem, startups that are involved in neobanking and lending to small businesses have attracted investors’ attention as investors remain enthusiastic about how these startups are helping digitise credit and banking for India’s vast number of small businesses. Moreover, the way in which small to medium businesses are defined is rapidly changing.
Talking about SME lending, the working capital may be raised in the following three ways by small businesses :
The loans that banks and other lending institutions offer to small and medium-sized enterprises are known as SME loans. There are various loan schemes designed by banks and financial institutions specifically for SMEs, each with a different set of terms and conditions. Female entrepreneurs may have a special scheme. Furthermore, many of these loans do not require collateral. The following banks offer different types of schemes :
- State Bank of India (SBI) : SME loan schemes offered by the SBI are Cotton Ginning Plus, Doctor Plus Scheme, Export Packing Credit, E Dealer/Vendor Finance Scheme, etc.
- HDFC Bank : SME loan schemes offered by the HDFC are Working Capital Finance, Working Capital for Contractors, Working Capital for Transporters, Term Loans, business loans, etc.
- Axis Bank : SME loan schemes offered by Axis Bank are MSE Power, Services Power, SME Power, Business MPower Overdraft, Business MPower Term Loan, Power Rent, etc.
- ICICI Bank : SME loan schemes offered by ICICI Bank are cash credit/overdraft, export credit, and term loans.
There are some schemes and programmes initiated by the Government of India for supporting and encouraging SMEs besides bank loans. The Government has established guidelines and processes with respect to who can avail of the scheme’s benefits, as well as the purpose of each scheme. Some of these schemes, amongst others, include :
- Pradhan Mantri Mudra Yojana (PMMY),
- Credit-Linked Capital Subsidy Scheme,
- MSME Business Loan for Startups in 59 Minutes.
In addition to raising capital for purchases of raw materials and finished goods, SMEs can use various other sources of financing. Some of these include merchant cash, invoice finance, business credit score, and business credit card.
Top government SME loan schemes in India
The following are the government’s best SME loan schemes:
Pradhan Mantri Mudra Yojana (PMMY)
On April 8, 2015, the Hon’ble Prime Minister announced that the PMMY would provide loans up to 10 lakh to non-corporate, non-farm small and micro-enterprises.
PMMY classifies these loans as ‘MUDRA’. A commercial bank, a regional rural bank, a small finance bank, a co-op bank, and an NBFC can provide the above-mentioned loan.
The following are the key highlights :
Any Indian citizen can apply for the loan if they are engaged in a non-farming sector, along with income-generating enterprises like manufacturing, service sector, or any other similar field, whose credit demand is below INR 10 lakhs. A repayment period of three to five years is involved, with an interest rate of 7.3% per annum.
How to apply
If you wish to apply online you can do so via this portal or you can reach out to any of the lending institutions listed above.
SIDBI Make in India Soft Loan Fund for MSMEs (SMILE)
To promote MSMEs to take part in the ‘Make in India’ program, the Government of India has established the SIDBI Make in India Soft Loan Fund for Micro Small and Medium Enterprises (SMILE).
MSME lenders are primarily focused on providing financing to small businesses. Soft Loans serve as loans with a soft loan-to-equity ratio to help MSMEs establish themselves. The following are the key highlights:
This loan is available to MSME companies that have been in operation for at least three years and have a satisfactory financial standing.
In the manufacturing and service sectors, SIDBI may prioritise newly established SMEs. Borrowers can opt for a 36-month moratorium, but 10 years is the maximum repayment period. Depending on the loan amount and the borrower’s profile, the interest rate is set.
How to apply
Applying for this loan can be done either in person or online via this portal.
Stand-Up India was launched in 2016 to provide loans to SME businesses run by women and individuals in the SC/ST categories.
In addition to manufacturing, services, agri-allied products or trading activities, the company should engage in marketing. Furthermore, the company must be a sole proprietorship, and the SC/ST or female entrepreneur must hold 51% of the controlling interest.
The following are the key highlights :
Applicants can receive a loan between INR 10 lakhs and INR 1 crore under this program.
At least one SC/ST or woman entrepreneur must receive this loan from every bank. A fund of this kind would cover 75% of the total cost of the project. A guarantee or collateral is not necessary.
The loan is open to any individual above 18 years of age or any firm or business owned 51% by SC/ST or women entrepreneurs who hold 51% of the shareholdings. A maximum moratorium of 18 months is allowed during the repayment period of seven years.
How to apply
An individual or a business can apply for this scheme through this website.
MSME business loans in 59 minutes
There is a new initiative from the Indian Government for micro, small and medium enterprises (MSME). This scheme allows MSME owners to obtain business and MSME loans within 59 minutes. A loan can range from a 1 lakh to a 10 crore, and an in-principle approval from the company is usually given within 59 minutes of applying.
With five other public sector banks, including the State Bank of India, Bank of Baroda, Punjab National Bank, Vijaya Bank, and Indian Bank, SIDBI has set up a fintech platform named Public Sector Bank (PSB) Loans in 59 Minutes.
Following are the steps to apply for a 59-minute MSME loan:
- Visit the official website here.
- Enter a one-time password (OTP) and your full name when you register to become a member.
- Complete the registration questions after you register.
- The next step is to input your GST number.
- You may either upload your income tax returns in XML format on the next screen, or you may login with your PAN and date of incorporation.
- As a result, you now have to upload your bank account statement from the past six months, in the form of a PDF file, to the website. Log in to your netbanking account or contact your bank to access this statement.
- Provide the details of the director, the owner and the business address on the next screen.
- The next step is to enter the purpose of your loan, as well as the purpose of any past or present loans that you may have taken for your business.
- If the above information is entered correctly, you will be asked which bank you would like to use. You must remember that the interest rates for each bank may differ slightly.
- To complete the process, you are required to pay a convenience fee of INR 1000 plus taxes.
- Within 59 minutes of making the payment, you will be notified of the in-principle approval.
Other important schemes
- RMA Against Bank Guarantee,
- Credit Guarantee Trust Fund for Micro & Small Enterprises (CGT SME),
- Growth Capital and Equity Assistance Scheme,
- Prime Minister Employment Generation Programme (PMEGP).
For analysing the credit availability issues of SMEs, Berger and Udell (2006) in the article titled ‘A more complete conceptual framework for SME finance’, developed a conceptual framework.
As regards loans to SMEs, they assert that loan availability and credit facility characteristics are a function of two factors. First, we have lending technology, which consists of the primary information sources, screening and underwriting policies and procedures, loan contracts, and monitoring mechanisms that lend firms use.
Secondly, the lending infrastructure comprises legal, judicial, and bankruptcy frameworks, as well as the social, tax, and regulatory frameworks within which financial institutions operate in a particular country. Through financing infrastructure, government policies influence the loans that are offered in different countries.
SMEs play a major role in most economies, especially in developing nations. Globally, SMEs account for almost all businesses and contribute greatly to economic growth and job creation.
Several governments around the world consider SME development to be a high priority because according to the World Bank’s estimates there will be 600 million jobs needed by 2030 just to absorb the growing global workforce.
A majority of formal jobs in emerging markets are generated by SMEs. However, in emerging markets and developing countries, access to finance poses one of the biggest challenges to SME growth.
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