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level to channelize credit to SMEs. SIDBI is the national level principal financial

institution for promotion, financing and development of SMEs. It provides direct

assistance to the SSI sector through several schemes like direct discounting, project

finance, assistance for technological up gradation and modernisation, marketing,

finance, resource support to institutions engaged in developing SSIs, venture capital,

factoring services, etc. It also provides indirect assistance comprising refinance, bills re-

discounting (equipment) and against

Inland supply of bills through an organized network of 910 Primary Lending Institutions

(PLIs) including banks and SFCs with more than 65,000 outlets throughout the country.

In order to enhance the flow of credit to the sector, various initiatives have been taken

by the Government of India/Reserve Bank of India from time to time, viz. enhancement

of loan limit under Composite Loan Scheme, increase in project cost limit under

National Equity Fund (NEF) Scheme, launching of Credit Guarantee Fund Trust for

Small Industries, extension of concessional assistance under Technology Development

and Modernization Fund Scheme, introduction of special schemes for modernization of

units under Technology Up gradation Fund Scheme for textiles and jute industries,

Tannery Modernization Scheme and Credit Linked Capital Subsidy Scheme for

Technology Up gradation. Further, to give focused attention to the needs of SSIs, public

sector banks have so far opened 391 specialized SSI branches. Last year, the

Government of India has announced that the credit to SMEs would be doubled in the

next five years. Various policy directives and schemes have been announced from

time to time to help improve the credit flow to the sector. The credit rating system for

SMEs has recently been introduced to ensure availability of adequate and timely

credit at low cost.

Dedicated agencies for credit rating to SSI sector have been created with a provision of

subsidized credit rating charges. The concept and practice of cluster financing has been

brought into practice. Besides, the RBI has recently allowed banks to appoint business

correspondents for collecting deposits and delivering credits. This could concept and

practice of cluster financing has been brought into practice. Besides, the RBI has

recently allowed banks to appoint business correspondents for collecting deposits and

delivering credits. This could decline from 17.5 % in 1998 to 8.5 % in 2006. Lack of credit

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at reasonable rate has hindered the growth of SMEs in the past. According to the third

All India Census of Small Scale Industries, there are around 11.85 million small scale

units in India, out of which, only 1.63 million are registered and rest are unregistered.

Only 14.26 % of the units in registered sector and 3.09 % in unregistered sector have

access to institutional finance. The coverage of institutional finance, thus, is far from

satisfactory. It is no wonder that according to a survey conducted by SSI Ministry in

2003-04, 48 % of the respondents cited shortage of working capital as at the key

reason for sickness in the industry. Non-availability of acceptable collateral is the major

problem at the time of starting a venture. The problems get further compounded in

case of young and women entrepreneurs. Even though the Government along with

SIDBI has set up a Credit Guarantee Fund Trust for Small Industries (CGTSI), to

encourage banks to extend financial assistance to SMEs without collateral, the banks still

seem to be hesitant to extend credit to SMEs. Similarly, despite a scheme for technology

and quality up gradation with a subsidy component, the disbursement under the

scheme is certainly below expectations.

It is clear from the above, that despite the best intentions of the Government to expand

the credit to SMEs, the results are far from satisfactory. It calls for an urgent need to

have a relook on the policy measures for the promotion of SMEs and iron out the

problems hindering the growth of credit to this sector. Following points could be

considered:

y First, a very important issue to understand is the composition of IndianSMEs and their financing needs. As per third All India SSI Survey, out of 11.85

million SSI units in India, more than 99 % units falls in the category of tiny, i.e.

investments in plant and machinery of these units is less\ than Rs. 25 lakh. Even in

this tiny sector, majority of them would be very small and would include cottage

industries and artisans. Only a few lakhs would actually form what can be

termed here as modern SSI sector having investments in plant and machinery in

the range of Rs. 25 lakh to Rs. 1 crore. The financing needs of these modern SSIs

along with medium enterprises, say with an investment in plant and machinery

less than Rs. 10 crore, are, most of the time, quite different than that of tiny

enterprises. These big units among the SSI sector would often require funds

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mainly for diversification and expansion of the business and technology up

gradation that needs to be dealt with separately. The schemes like credit ratings

are most relevant to this sector. On the other hand, micro financing would be

a very effective tool for financing smallest of small enterprises providing

coverage to a large number of small units and also reducing the risk of

banks. Further, there is a need of reorientation of government functionaries to

this vast range of SMEs. It will be in the best interest of the sector if

government officials are properly designated to take care of certain set of SSIs

and the relevant schemes.

y Second, one will have to realistically assess the positions of banks and otherfinancial institutions in this regard. They have the concerns about the NPAs

and the growing incidences of sickness in SSIs. Obviously, financing of SMEs

should be a profitable venture for banks so that they can extend credit to SMEs.

As the large enterprises have access to alternative sources of financing, like

capital markets\ and often the rate of interest is very low in case of large

enterprises, banks have also started looking at SMEs as a potential thrust area.

However, this needs to be further strengthened by the right mix of

promotional policies reducing the risk of banks while financing the SMEs. Banks,

on their part, would do well by providing adequate publicity to various

promotional schemes so that a large number of units could get benefited.

y Third, it is often observed that there is a lack of understanding of the governmentpolicy directives and guidelines and schemes of the RBI and the SIDBI on the part

of field level functionaries of financial institutions. The officials need to be

sensitized regarding the needs of the SMEs through proper training.

y Fourth, a number of private banks are venturing in the field of SME financingwith innovative schemes. Besides, cluster financing and innovative financing

schemes like factoring are emerging as powerful tools for extending credit to

SMEs. Credit rating is also gaining prominence. However, again there is a lack

of understanding of these schemes on the part of banks and other financial

institutions as well as SME entrepreneurs. It, therefore, becomes extremely

important to engage SMEs and financial institutions and apex SME

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developmental agency in a constructive dialogue to ensure better

understanding of policies and schemes. SME associations should come forward

in this regard and organize programmes in which all the stakeholders could

be invited and the schemes could be popularized.

y Fifth, the SME associations and NGOs should come forward and accept morerespon- sibilities. Their role should not be limited to only lobbying for their

members. The associations and NGOs can play a crucial role in micro financing.

They could also provide specialized services to the SMEs in preparation of

project documents and help in procedural aspects and could also help banks

in assessing the risk for financing a venture.

y Sixth, a few changes and improvements in the policies could help infuse credit tothis sector. Equity participation ceiling of large companies in small scale sector

should be raised from 24 % to 49 %. It would certainly motivate large

enterprises to invest in small enterprises and thereby expansion of these units.

Similarly, technology up gradation fund of SIDBI needs to be strengthened. The

scope of credit linked capital subsidy scheme should be enhanced to cover a

wide spectrum of products, sub-sectors and technologies.

y Seventh, over the period, it has been observed that small units that are linked tolarge corporate as suppliers, service providers, etc. are usually successful. It isrelatively easier for the banks and financial institutions to finance various

requirements including working capital, technology up gradation, etc. of these

units. Promotions of clusters linked to large units, thus, could help expansion of

credits to small units. Finally, it has been observed that one of the major

reasons for delays in sanction and disbursal of loans is the lengthy

documentation and legal procedures involved in the process. While the large

industries can afford to hire specialists for the job, the small scale entrepreneurs

are often ill-equipped to handle this job on their own. It will greatly help SMEs if

facilitation services are provided by various promotional agencies like SISIs,

DICs, SIDCs, industry associations, banks, etc. The evaluation of various

applications should also take place in a time bound manner and a stand

should be taken within a stipulated time period. In case the application is

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rejected, the bank must apprise the applicant of the reasons for not granting the

loan. For the benefit of SMEs, which through improved efficiency have

managed to reduce the stock, the banks should give consideration to other

factors for computing the maximum permissible bank finance.

2. SME FINANCE

The exact information on how small f irms are financed in their early

stages is l imited because the majority of SMEs is financed outside the

public domain, through informal sources. It is clear, however, that small

businesses use different types of finance compared to large firms, mainly

because small businesses do not have access to capital markets and

owner-managers themselves are the single most important providers of

start-up finance. The sources SMEs really use depend upon different

factors:

- the stage of business development where init ial start-up capital issought from internal sources, from the entrepreneur's own pocket, and

later on sources of external funding become more important;

- the extent and source of funds depend upon the size of business, withlarger ventures seeking external sources

- the industrial sector in which a SME operates (some production firmsare based on tangible assets land, buildings, equipment

- SMEs, l ike female-owned face larger barriers in the access to capital, atleast in some countries.

3. DEVELOPMENT OF SME FINANCE IN INDIA

To cure the overall disease of lack of appropriate growth of Indian SMEs

Small and Medium Enterprises, India needs several small pil ls such as

adequate credit delivery to SMEs, better risk management, technological

up gradation of Banks esp. Public Sector Banks, attitudinal change inBankers and so on. Among them, the major problem of inadequate

financing to SMEs needs an urgent attention. Having said this, it is

pertinent to mention that Small Industrial Development Bank of India has

achieved landmark results in the domain of small and medium enterprise

financing and fulfi l l ing their credit requirements t ime to time in various

forms such as long term project finance, working capital f inance, bil l

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discounting etc. However considering the level of appetite for credit

facil it ies of Indian small and medium enterprises, private and public sector

banks in India need to work out an unique and innovative model of

financing to this vital sector (SME) of Indian Economy.

In todays changing world, retail trading, SME financing, rural credit and

overseas operations are the major growth drivers for Indian banking

industry. The scene has changed since the adoption of financial sector

restructuring programme in 1991. The reform in the financial sector in

India along with the overall second generation economic reforms in

Indian economy has transformed the landscape of banking industry and

financial institutions. GDP growth in the 10 years after reforms averaged

around 6 %.

With the introduction of the reforms especially in financial sector andsuccessful implementation of them resulted into the marked improvement

in the financial health of the commercial banks measured in terms of

capital adequacy, profitabil ity, asset quality and provisioning for the

doubtful losses. Now, the rules of the game have completely changed.

Consolidation has become the new mantra for survival. Due to the

growing influence of globalization on the Indian banking industry, the

author is of the opinion that the financial sector would be opened up for

greater international competit ion under WTO. Opening up of the financial

sector from 2005, under WTO, would see a number of global banks taking

large stakes and control over banking entit ies in the country. They areexpected to bring with them capital, technology, and management skil ls

which would increase the competit ive spirit in the system leading to

greater efficiency. Government policies to allow greater FDI in banking

industry and the move to amend Banking regulations Act to remove the

existing 10 per cent cap on voting rights of shareholders are pointer to

these developments.

The pressure on banks to gear up to meet stringent prudential capital

adequacy norms under Basel I I and the various Free Trade Agreements

(FTAs) that India is entering into with other countries, such as Singapore,

will also impact on globalization of Indian banking.

However, the flow need not be one way. Some of the Indian banks may

also emerge as global players. As globalization opens up opportunities for

Indian corporate entit ies to expand their overseas operations, banks in

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India wanting to increase their international presence could naturally be

expected to follow these corporate entit ies and other trade flows out of

India.

Alongside, the growing pressure on capital structure of banks is expected

to trigger a phase of consolidation in the banking industry. In the past

mergers were init iated by regulators to protect the interest of depositors

of weak banks. In recent years, there have been a number of market-led

mergers between private banks. This process is expected to gain

momentum in the coming years. A merger between two public sector

banks or between a public sector bank and a private bank could be the

next logical development. Consolidation could also take place through

strategic all iances or partnerships covering specific areas of business such

as credit cards, insurance, SMEs financing etc.

Secondly, risk management has become the key to success in which

adoption of the state-of-the-art technology and latest rating and

management skil ls turn out to be the significant aid for better risk

management. The abil ity to gauge the risks and take appropriate posit ion

will be the key to successful financing in the emerging Indian banking

scenario. Risk-takers will survive, effective risk mangers will prosper and

risk-averse are l ikely to perish.

In this context, Indian banks have to ensure:

1. Risk management has to trickle down from the corporate office to

branches. They should be made more accountable and responsible

towards their duties.

2. As audit and supervision shifts to a risk-based approach rather than

transaction oriented, the risk awareness levels of l ine functionaries

also will have to increase.

3. There is a growing need for banks to deal with issues relating to

`reputational risk' to maintain a high degree of public confidence

for raising capital and other resources.

In this process, the technological advancement of Indian banks would

create a soothing climate to manage their risk in a better way. In the y ears

to come, technological developments would render flow of information

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and data faster, leading to prompt appraisal and decision-making. This

would enable banks to make credit management more effective, besides

leading to an appreciable reduction in transaction cost.

In order to reduce investment costs in technology, banks are l ikely to

resort sharing of facil it ies such as ATM networks. Banks and financial

institutions will join together to share facil it ies in the areas of payment

and settlement, back-office processing, data warehousing, and so on

majorly for cost effectiveness and secondary motto would be to provide

everything under one head.

The advent of new technologies could see the emergence of new players

doing financial intermediation. For example, we could see util ity service

providers offering, say, bil l payment services or supermarkets or retailers

doing basic lending operations. So for better profit margin, with the helpof technological innovation, consolidation and innovation in corporate

lending, the conventional definit ion of banking might undergo changes.

Considering such developments in the banking industry of India, it seems

that the next decade will be an era of consolidation and integration. In

such a scenario, the expected integration of various intermediaries in the

financial system would require a strong regulatory framework. It would

also require a number of legislative changes to enable the banking system

to remain contemporary and competit ive. There would be an increased

need for self-regulation among Indian banks since development of bestinternational standard practices could evolve better through this rather

than based on mandatory regulatory prescriptions. For instance, to enlist

the confidence of the global investors and international market players,

the banks will have to init iate adopting the best global practices of

financial accounting and reporting. It is expected that banks should

migrate to global accounting standards smoothly rather than waiting for

the regulatory circulars and guidelines, although it would mean greater

disclosure and tighter norms.

Last and the most important development in the Indian banking industry

is its change of focus in corporate lending on account of above

mentioned changes and challenges. In the sheltered days of corporate

lending by banks, when customers could be freely charged, banks

concerned themselves with only `revenue' which was equal to cost plus

profit . Post-reforms- after 1991, when the cost of services became nearly

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equal across banks and cost-control was a key to higher profits, the focus

of financial institutions especially banks shifted to `profit ' , which was

equal to revenue minus cost. This was an alternative measure of revenue

stream which every bank thought of due to effects of external

environment on their workings. And in the future, as domestic and

international competit ion hots up, financial institutions including banks

may have to shift their focus to `cost' which will be determined by

revenue minus profit .

In other words, cost-control in tandem with efficient use of resources and

increase in productivity will determine the winners and laggards in the

future. The economic theory of survival of the fittest works everywhere it

seems through this example.

The ray of hope is Small and Medium Enterprises (SMEs) 1 which is an

emerging, inevitable and profitable target market for the financers i .e.financial institutions and banks. However, that need not mean banks and

financial institutions will back-up the social banking. Rather than being

seen as directed and philanthropic-l ike financing, such lending should

have been now more business driven.

On the contrary, the authors believe that all the sources or market of

revenues have not been vanished yet. The SMEs sector is considered to be

an untapped market for financial institutions in India. We just need to

combat certain obstacles. The hurdles which need to be removed are:-

1. Minimization of probabil it ies of skewed returns from SMEs by

better risk management

2. Eradicate inconsistency in the knowledge of SMEs business. For

example, entrepreneurs may possess more information about

the nature and characteristics of their products and processes

than potential f inanciers.

3. Absence of managerial and technical expertise of

intermediaries whose role is to evaluate and monitor

companies

4. Lack of international infrastructure and expertise in SME

financing.

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