Small finance banks: A pivot for change?

Mukesh Gulati & Karan Butalia believe there is a huge opportunity to lend to micro and small enterprises

The Reserve Bank of India has decided to issue licenses for a new category of banks called small finance banks (SFBs) differentiated from existing banks to serve local areas to meet credit and remittance needs of small businesses, unorganised sector, low income households, farmers and migrant work force. These banks will be newly created or existing non-banking financial companies will fold up to become SFBs. It is intended that at least 50% of their loan portfolio should constitute loans and advances of up to Rs 25 lakh that serves the needs of micro and small enterprises (MSEs) with significant contribution to employment, value addition and exports in the Indian economy. Only about 5% of MSEs are able to access formal finance, while the rest go to their friends, relatives and informal money lenders. 

In absolute terms, banks in India have incrementally increased their lending but in terms of the scope, micro, small and medium enterprises (MSMEs) continue to be starved of financing by an estimated $418 billion as per a study by IFC in 2012. Clearly, the lack of finance has strangulated the spirit of entrepreneurship thanks to the perpetuation of a linear, conventional mode of collateral-based thinking among lenders. 

Does the recent announcement of SFBs augur an innovative shift in MSME financing? Does it connote a hope, a desire and perhaps a new direction that RBI wants to take? Attempts to break the traditional collateral based SME lending through schemes like CGTMSE based on non-collateral lending are yet to reach a significant level even after 20 years. SFBs could well be a turning point if the new lenders can make a clean break from the past to value chain based or cluster based collaborative-developmental models. 

‎There are many commercial and non-commercial actors like industry associations, development NGOs, local banking correspondents, skill development agencies, export promotion and other marketing councils. Many of them have a rich local knowledge about the financial and non-financial needs of the enterprises. The power of these actors needs to be fully harnessed. Can the SFBs, unlike the regular banks, harness the power of these local cluster actors when they go through the stages of identification of potential clients, techno-financial appraisal, documentation, seeking safety assurance of proposed credit, sanctioning, disbursement and finally monitoring the loans? The multiplier effect of such collaborations can only be imagined when we realise that two-thirds of all MSMEs are located in geographically concentrated clusters with similar techno-commercial needs that can be reached by these new banks. 

These cluster based enterprises have requirements of similar raw materials and input services. Joint purchase can help not only reduce the input costs but also ensure superior quality of inputs. Moreover, they can develop joint financing models for carrying zero inventories. Local institutions can play a significant role in identifying and analysing a range of many more such financing options through awareness creation and providing value added services in financial documentation, value-added information about technology, equipment and marketing. Let us call it the ‘financing plus’ model for SFBs. 

These ideas are fundamentally radical from implementation perspective. It calls upon the SFBs to view the entire lending system through a systemic model rather than cherry picking and serving individual enterprises. What are the new elements that the SFBs can use to harness the new power? First of all, the cluster of micro and small enterprises need a coordinator who can ideate, analyse and facilitate implementation of new possibilities. An SFB can stimulate this by investing into such mutually win-win propositions. Second, the SFBs will need to leverage the value of their financial products by combining with unmet non-financial needs of enterprises for mutual benefit. Third, they will need to develop commercial models to involve trusted stakeholders who can help reduce cost of financial delivery and scale up the transaction for the banks. Fourth, they will need to analyse the financial needs of enterprises as a part of the cluster in the social, environmental and economic context. This will throw up new opportunities in financing such as energy efficiency, packaging and marketing that are locally replicable. Fifth, they will need to train their staff through sectoral and cluster level techno-commercial knowledge. Sixth, they will need to analyse new opportunities by exploring relevant government initiatives such as public procurement, infrastructure development, foreign direct investment, renewable energy promotion and social sector development. 

A somewhat similar line of thinking has been echoed by Prime Minister Narendra Modi at the launch of the Mudra Yojana. Will the proposed SFBs grab this opportunity and draw up new business models? 

Mukesh Gulati is director, Foundation for MSME Clusters and Karan Butalia is chief business relations officer, Axis Bank. Views expressed are personal.