CRISIL SME Tracker: There is more to creditworthiness than size of an MSE

Information asymmetry and absence of credit trails have long been stumbling blocks in efforts to foster inclusion of micro and small enterprises (MSEs) in the formal lending system. 

Compounding the problem is low adoption of credit assessment in the sector, due to lack of awareness or inhibitions of promoters. A major factor keeping the enterprises from getting assessed appears to be a belief that creditworthiness is determined by size, as reflected in income or net worth. 

A CRISIL study of 3,570 MSEs, however, indicates that creditworthiness is not a function of absolutes, but of relative size and performance. Nearly one in four of the top rated MSEs (MSE 1 to MSE 3) in the sample studied had a small scale of operations, with annual revenue below Rs 5 crore in FY16. What set them apart was superior financial and operating performance — with revenue growth and operating margins over 500 basis points higher than lower-rated peers. 

These MSEs also had better leverage profiles and working capital management — with average receivables days at 56, compared with 72 for lower-rated peers. On the operating front, too, a long track record, experienced promoter(s) with an ability to infuse funds, good local/regional market presence and established stakeholder relationships provided an edge. 

Clearly, it isn’t about size alone. In fact, it is almost a tautology that MSEs have limited financial flexibility, and thereby limited capacity to withstand shocks. However, those that have successfully overcome constraints associated with lack of size are viewed positively in rating. The case for credit assessment gets stronger with the advent of GST. 

As these entities mainstream into a more digitalised economy under the new regime, assessment of their relative performance through credit rating, coupled with digital transaction trails, can act as a surrogate on financial discipline. In turn, this can help identify small creditworthy players who can be extended collateral-free movable lending.