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The story of imitation jewellery retail chain Son Roopam should have been part of a narrative on entrepreneurship. But it has instead become one on loans — the lack of it, to be precise. Run by three young men, barely 30 years old, the retail chain is a pivot away from a decade-old wholesale business for imitation jewellery.Since starting off as retailers 18 months back, the entrepreneurs — three friends Vikas Singh, Praveen Singh and Ashish Mishra — have already invested Rs 5 crore of their own money from their earlier business. They have retail outlets in five cities in Maharashtra — glitzy showrooms, with an astrologer to boot — with the entire chain monitored via CCTVs from Dadar, Mumbai.Yet, in July, when they wanted to borrow Rs 15 lakh from a bank for the launch of a branch in Aurangabad, they hit a wall. Most Indian banks do not lend to businesses like these, they were told, which have less than adequate track record. Non-banking finance company (NBFC) Inditrade Capital gave them Rs 8 lakh on the basis of the daily usage of the credit card swipe machine (PoS machine) at the store.Barely 100 metres from Son Roopam’s Dadar outlet is a bar and restaurant called Gopal Krishna Boarding House. Owner Laxmidas Shetty wants to expand and open a women friendly section on the rooftop, with a separate entrance. He wants to cater to young executives working in nearby office complexes who are looking for an evening get-together before heading home.Shetty is constantly on the lookout to buy adjoining shops. He needs access to quick money to make a purchase when an opportunity presents itself. But getting a loan from a bank is a long process and does not help him. Shetty prefers borrowing smaller amounts from NBFC lenders and paying off the loans within a year through weekly instalments.Son Roopam and Gopal Krishna are today case studies of viable businesses that are hungry for growth and can create jobs but do not get bank funding. They are part of the middle and lower end of the spectrum of the micro, small and medium enterprises ( MSME ) segment. Such operations may not have books of accounts in order or a track record of paying income tax — disqualifying them from the strict norms followed by banks. This is where NBFCs come in.The non-banking entities have been addressing the debt needs of the lower rungs of the MSME segment by using innovative methods to assess their creditworthiness. The system was working fine till August when IL&FS, one of India’s largest NBFCs, defaulted on its repayment commitments. Suddenly, panic gripped the market. Credit availability for all NBFCs shrunk, creating a cascading effect on MSME enterprises.This squeeze has the potential to derail growth — after all, the MSME segment accounts for a third of India’s gross domestic product and employ 120 million people, according to the Confederation of Indian Industry. It has a huge funding need of Rs 45 lakh crore in 2018, which could be debt or equity, according to a recent report called “Credit Disrupted” by BCG and Omidyar Network.Numbers released by the Reserve Bank of India in mid-November showed a 1.4% drop in bank credit to small and micro industrial units in September over last year (the first drop since February 2017), and a 2.5% drop in 2018-19 till date. GDP numbers released at the end of November showed July-September growth at 7.1%, lower than 8.2% recorded in April-June 2018.Nirmal Jain, founder and chairman of one of India’s largest NBFCs, India Infoline Group (IIFL), says there is no reason to panic. “The major issue is a crisis of confidence. As you know, no NBFC has defaulted and no NBFC has been downgraded. But panic was created and liquidity also became tight because most corporate investors and mutual funds became wary of NBFCs.”There are 60-65 million MSME units in the country, according to the BCG report, and these have unmet credit needs of around Rs 30 lakh crore in 2018. Of this, around Rs 10 lakh crore is met by the promoters themselves — by borrowing in their personal capacity through formal channels against personal property. This leaves a huge gap of Rs 20 lakh crore.This gap obviously presents a huge opportunity, as public sector banks, which account for almost 50% of MSME lending till date (with their share reducing every year), do not want to touch smaller MSMEs. The share of NBFC funding for MSMEs, meanwhile, has been growing fast. This opportunity is spawning entrepreneurial ventures.Take, for instance, Sachindra Nath, the former CEO of Religare Enterprises, who quit his job to become an entrepreneur in late 2017. Ugro Capital, Nath’s venture, will start lending in January 2019. He has already raised equity of around Rs 1,000 crore and will start lending from the equity capital itself.In the current environment, Nath has decided not to borrow to lend. Instead, Nath says, he will have to build up a book of assets (loans) before he is able to take on debt for his business. But the fact that Ugro Capital, with a business model targetting MSMEs, was able to raise capital from multiple investors is a testimony to the potential.Nath says: “The demand-supply gap for MSME loans is huge. It cannot be met it in the foreseeable future.”The money that finds its way to MSMEs flows through to the sector through a storied structure — banks lend to NBFCs; some larger NBFCs also lend to smaller ones; and this money goes to borrowers like Shetty of Gopal Krishna Boarding House. NBFCs have other sources of finance, too, such as global development financial institutions, government-owned refinance giant Small Industries Development Bank (Sidbi) and mutual funds.Sidbi’s portfolio alone saw a huge jump last year. Deputy Managing Director Manoj Mittal says the refinance portfolio (advances to lenders) grew 117% between September 2017 and September 2018 to touch Rs 1.23 lakh crore. Much of these funds would have gone into refinancing loans to the more formal sector of the MSME segments, the larger companies. However, there is angst in those formal segments, too, as they find it difficult to adjust to tougher credit norms being pushed through by the Reserve Bank of India.Raja Shanmugam, a textile exporter in Tirupur and the head of Tirupur Exporters Association, says the Indian banking sector is not geared towards the small and medium industries sector. He even blames the MSME funding woes on the adoption of Basel norms by Indian banks. Shanmugam’s company Warsaw International is a major exporter. He says the regime of recognising a loan as a non-performing asset on the 91st day of default, as mandated by the RBI, and even marking it as special mention account (SMA) when it is in default beyond 30 days, is creating undue pressure on small and medium enterprises.“Every year after Diwali, we have a two-month lull period when cash flows are low. If banks come to us at the end of every month and start marking us as SMA1 in the first month and SMA2 in the second, how are we going to focus on our business?” Shanmugam asks.V Lakshmi Narasimhan, executive director of Shriram City Union Finance, uses an example to explain the situation. If a buffalo falls ill, a trader will have to nurse it back to health before he can sell it, he says. “The cash flows in this sector are often erratic. The 90-day NPA rule cannot work, and banks do not have the systems to absorb such situations,” Narasimhan adds.Shanmugam’s reluctance to access credit due to the new NPA norms is precisely the kind of approach that has created greater nervousness among creditors across financial institutions, especially after the default of IL&FS. The subsequent rescue act at the behest of the government, whereby the management was replaced, did not help calm the wider market fears.The IL&FS fiasco created anomalies in the market. One symptom of the malaise is visible in the commercial papers (CPs) market — a means to raise short-term money. The issuance of CPs had fallen by 65% in October. In November, large NBFCs seemed to be able to raise as much as they wanted through CPs. But the smaller ones were struggling, said NBFC industry veterans.Sudip Bandyopadhyay, chairman of Inditrade Capital (a lender to Son Roopam and Gopal Krishna Boarding House), says the CP option to raise funds for his NBFC has virtually disappeared. On the other hand, VA Ravi, CFO and executive director of Mahindra & Mahindra Financial Services, says he is able to raise as much as he wants using CPs, and also at lower rates.“It is a crisis of confidence,” Ravi says, adding that M&M Finance’s own lending to smaller NBFCs is also being stifled. M&M Financial Services is among the few institutions that are allowed to raise funds through fixed deposits. But beyond that, there is a shortage of long-term funds.“Long-term money is just not available,” Ravi adds. The liquid squeeze is tighter because 17 of 21 public sector banks are under the prompt corrective action framework of RBI, which limits their lending activity. Bandyopadhyay says: “None of us will default as we will pay our short-term dues with the funds we have. But I have become cautious with our lending and prefer to hold on to the money we have.”Everyone in the sector is hoping that the crunch will blow over in a couple of months. Jain of IIFL says: “The government and the RBI have done a lot to ease liquidity. So, it is too early to conclude that growth has slowed down. But if this liquidity crisis or fear of NBFCs remains for a longer term, it will impact the flow of credit to SME consumers and that can impact growth. At this point in time, we do not fear that.”With general elections due in the middle of 2019, the BJP-led government cannot afford to let a problem fester in the job-creating MSME segment. It has, therefore, prodded the RBI to ease credit flows. It has even held out the threat of using a rarely invoked section in the RBI Act, to direct the RBI.The central bank announced a slew of measures in two quick announcements last week. It allowed higher interest rate subsidy for MSME exporters and allowed more leeway to NBFCs on securitisation. In another move to hasten the process of loan approvals, the government announced an ambitious 59-minute approval for loans up to Rs 1 crore from PSU banks.Chandrakant Salunkhe, founder and president of the SME Chamber of Commerce, says many members of the association tried to use the facility but to no avail. There is no follow-up after an initial mail of approval. Instead of letting a separate company handle the front-end of the application process, he says, PSU banks themselves should jointly set up a company. This will give the process more credibility, he adds.Mittal of Sidbi, which is among the public sector shareholders of the company handling the loan applications, says the process has just started and will stabilise soon. Faster processing of applications, lower guarantees and collaterals, lower charges and quicker payments from public sector units will ease credit to the MSME sector, the apex industry body Confederation of Indian Industry has recently told the government in a set of 12 recommendations.“With small enterprises dominating the economy and providing livelihoods, infusing liquidity into the sector and addressing their credit challenges will relieve their stress, foster demand and spur growth,” says Chandrajit Banerjee, director-general, CII. Sumit Gupta, who heads rural and SME lending at Yes Bank, says one way forward would be to allow lenders like itself greater access to GST records of loan applicants so that a more formal framework is created.This will help 90% of the MSME sector that is outside the lending framework, he says. It will also help a lot if MSMEs hire a chartered accountant or a clerk to ensure its papers are in order, he adds. This would be music to the ears of the entrepreneurs at Son Roopam. They are looking at approaching a bank for a loan, after filing their income tax returns in 2019. It will be the second completed year for their retail venture, and banks often seek two consecutive years of income tax returns.Clearly, there is much at stake in the next six months.