Refinance 2.0

Risks and responsibilities of Mudra Bank

Prime Minister Narendra Modi inaugurated the Micro Units Development and Refinance Agency (Mudra) Bank this week, projecting the institution as the solution to persistent concerns about lack of finance for micro, small and medium enterprises. Seeded with capital from a budgetary provision of Rs 20,000 crore, the institution is expected to enhance the flow of resources to this categories of enterprises by refinancing primary lenders. So what's new? This was pretty much the model followed by the erstwhile IDBI and its spin-off aimed at this very sector, Small Industries Development Bank of India (Sidbi). In fact, Mudra Bank is housed within the Sidbi structure - which raises concerns that the same factors that limited the effectiveness of the first refinance model may conspire to derail this one as well. The prospects of success lie in whether the new bank is able to channel resources into the right kinds of primary lenders, independent of ownership and affiliation.

A major reason for the drying up of financial flows into smaller enterprises is the breakdown of the state financial corporation framework, which was the channel through which IDBI and Sidbi operated. The basic capabilities needed to assess viability and risks of small and medium enterprises withered. Commercial banks stepped in to some extent; but by fiat of the priority sector requirements rather than by commercial attractiveness. This has been the prevailing situation for perhaps a decade and a half. So how might the Mudra Bank strategy address this? Clearly, the old channels are defunct and there is no point in trying to reactivate them. However, a whole range of new primary lending models have emerged, best reflected in the rapid expansion of micro-finance institutions, or MFIs. These are doing exactly what small and medium enterprises need; by virtue of their ground-level operations, they are well placed to evaluate business models that are primarily servicing local markets, both in terms of viability and risk. In fact, the new model of the small finance bank, which is what MFIs are expected to morph into, is actually the ideal channel through which the refinance operations of Mudra Bank can provide resources to small and medium enterprises. In an ideal state, the setting up of the Mudra Bank as an entity distinct from Sidbi, which should happen as soon as possible, will become the financial backstop for the small finance bank segment as well as other primary lenders who are closely connected to the small and medium enterprises domain.

Properly done, refinancing is a very effective method of expanding resource flows to any activity. And tapping into the MFI channel, which has emerged organically, is the best way to do it in India's current context. But this comes with responsibilities and risks for the new institution as well. A large number of small primary lenders will require significant investments in monitoring and compliance. Internal mechanisms for risk assessment and mitigation will need to be built up very quickly, if the capital base is not to be eroded by non-performing assets. For the model to work, close engagement between the refinancer and the primary lenders is essential. That should be the focus.