The Indian government is reportedly planning to provide a 100 percent credit guarantee to lenders for credit to small and medium enterprises (SMEs). The government is effectively telling banks and financial institutions to relax their credit norms so that more businesses can get loans.
This will solve cash-crunch problems for SMEs that currently run the risk of going under. I have already written about how three out of four Indian SMEs can survive this lockdown and that one key pre-requisite for business survival is liquidity, often in terms of loan availability.
Rather than just look at this incentive from the government to continue business as usual, lenders should use this as an opportunity to make key and potentially long-lasting shifts in their lending models to SMEs. Here are three things I believe that this credit guarantee program should end up achieving.
With credit for SMEs guaranteed, lenders can now look to ease some of their loan conditions, especially their rigid CIBIL norms. It has been gospel for most lenders to regard promoter CIBIL as an indicator of business creditworthiness. A credit guarantee scheme allows lenders to experiment with this hypothesis that a business owner’s track record on personal debt necessarily reflects the business’ ability to repay its debt.
For instance, loans can now go to SMEs with their promoter’s CIBIL score of 700 or even 650 instead of the usual minimum threshold of 750. With this, and other credit model experiments that lenders choose to implement, a true risk assessment of project viability can be done rather than using CIBIL score as a crutch.
And this brings us to the second point.
How do banks or bigger financial institutions check if an SME is viable or not before they lend to it? "Metro-oriented" banks — those who understand larger corporates — may not have such an understanding. This is where large lenders can partner with local or micro-lenders. These are institutions that have the experience of lending to local businesses and, more importantly, of recovering their loans.
The idea of community banking, with its deep understanding of local and often remote markets, and their involvement in lending to SMEs is not without precedent! The United Kingdom has already roped in crowd-sourcing platforms and purely digital alternate banks to reach SMEs.
Our cooperative banks are not very different. Banks can easily tap them for their knowledge and scope of local products and services to ascertain the viability of projects. This also means that the Central government will not have to actually open new financial institutions to help SMEs get their hand on capital to keep going!
This is related to my earlier point on experimenting with credit norms but deserves a place of its own because of how important it is to the survival and revival of SMEs.
The current norms on trade lending are that banks and financial institutions lend on the basis of invoices, usually confirmed by buyers. So, an SME will have had to first source money to manufacture their products, dispatch them, and then generate an invoice before it can approach a lender for financing. In this way, invoice financing continues to only solve a part of an SME’s financing puzzle.
Trade finance should ideally be available before manufacturing begins. In other words, an SME should be able to secure a loan when they receive a confirmed purchase order (PO).
Of course, there is always the possibility that a company can commit loan fraud with a bogus PO. This is where local presence and knowledge though grassroots partnerships with community banking organisations can help assess the viability and creditworthiness of an SME from its local reputation.
In short, the proposed SME credit guarantee scheme is not just a lifeline for stressed SMEs, it is also a strategic opportunity for lenders to evaluate and implement new credit models, reach new markets and build expertise in new products.