Final Project (SME Loans n Credit Ratings)

8/2/2019 Final Project (SME Loans n Credit Ratings)

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SME loans :-

Introduction

Small and medium-sized enterprises (SMEs) are the backbone of all economies and are a key

source of economic growth, dynamism and flexibility in advanced industrialised countries, as well

as in emerging and developing economies. SMEs constitute the dominant form of business

organisation, accounting for over 95% and up to 99% of enterprises depending on the country.

They are responsible for between 60-70% net job creation in OECD countries. Small businesses

are particularly important for bringing innovative products or techniques to the market.

Microsoft may be a software giant today, but it started off in typical SME fashion, as a dream

developed by a young student with the help of family and friends. Only when Bill Gates and his

colleagues had a saleable product were they able to take it to the marketplace and look for

investment from more traditional sources.

While not every small business turns into a multinational, they all face the same issue in their earlydaysfinding the money to enable them to start and build up the business and test their product or

service.

Why is it harder for them to borrow money from banks or to find private investors than for larger

firms? And why is it easier for small businesses to raise money in some countries than in others?

These are important questions given the fact that small businesses, and particularly innovative

SMEs, become increasingly vital to economic development and job creation as the knowledge-

based economy develops.

This Policy Brief looks at the extent ofthe SME financing gap, and what governments can do to

make it easier for them to obtain the funding they need to start, grow and prosper, and thuscontribute to creating jobs and economic growth.

Why is financing SMEs so important?

SMEs are vital for economic growth and development in both industrialised and developing

countries, by playing a key role in creating new jobs.

Financing is necessary to help them set up and expand their operations, develop new products, and

invest in new staff or production facilities. Many small businesses start out as an idea from one or

two people, who invest their own money and probably turn to family and friends for financial help

in return for a share in the business. But if they are successful, there comes a time for alldeveloping SMEs when they need new investment to expand or innovate further. That is where

they often run into problems, because they find it much harder than larger businesses to obtain

financing from banks, capital markets or other suppliers of credit.

This financing gap is all the more important in a fast-changing knowledge-based economybecause of the speed of innovation. Innovative SMEs with high growth potential, many of them in

high-technology sectors, have played a pivotal role in raising productivity and maintaining

competitiveness in recent years. But innovative products and services, however great their

potential, need investment to flourish. If SMEs cannot find the financing they need, brilliant ideas

may fall by the wayside and this represents a loss in potential growth for the economy. Thebagless vacuum cleaner and the wind-up radio or flashlight which need no batteries are nowcommon household items, but nearly failed to see the light of day because their inventors could not

find financial backing to transform their ideas into production.


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Already, differences are emerging between countries in terms of how easy it is for innovative

SMEs to grow and develop. This sector has been very dynamic in the United States and a few

other countries, but has lagged in many continental European countries and Japan, to the detriment

of job creation and competitiveness.

IS THERE A FINANCING GAP? WHERE IS THE GAP? (GRAPH)

Figure 1.

How big is the SME financing gap?

While the SME financing gap is more pervasive in emerging markets, business financing overall is

not a problem in OECD countries (Figure 1), where banks are adopting strategies to cope with

reducing the risk of lending to SMEs and where there are well-established systems for raisingmoney through banks and capital markets.

Many countries that do not report an overall financing gap for SMEs say that they do have a

financing problem when it comes to innovative SMEs, precisely because they do not fit the mould

applied in traditional SME financing. Since innovative SMEs tend to be newcomers to the market,

or seeking financing for a new type of product or service, and usually have negative cash flows

and untried business models, they represent a higher risk to banks and cannot be assessed in the

same manner as traditional SMEs or large firms.

One fundamental problem in dealing with the SME financing gap is lack of basic information

about just how big such a gap may be. Often the only evidence is in the form of complaints fromSMEs themselves and this is difficult to use in analysis or for comparison. Moreover, the

definition of an SME varies between countries and financial institutions, some only compile

figures by size of loan, not by size of the company borrowing, and some do not keep regular

statistics of SME lending at all. And this is just in OECD countriesoutside the OECD area,

information is even scarcer.

What are the obstacles to SME access to financing?

The difficulties that SMEs encounter when trying to access financing can be due to an incomplete

range of financial products and services, regulatory rigidities or gaps in the legal framework, lack

of information on both the banks and the SMEs side. Banks may avoid providing financing to

certain types of SMEs, in particular, start ups and very young firms that typically lack sufficient

collateral, or firms whose activities offer the possibilities of high returns but at a substantial risk of

loss.

SMEs tend by their very nature to show a far more volatile pattern of growth and earnings, with

greater fluctuations, than larger companies. Their survival rate is lower than for larger companies

one analyst found that manufacturing firms with fewer than 20 employees were five times more

likely to fail in a given year than larger firms. Thus, SMEs are at a particularly severe disadvantagewhen trying to obtain financing relative to larger and more established firms.


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It can also be difficult for potential creditors or investors to distinguish the financial situation of

the company from that of its owners. The entrepreneur may have re-mortgaged his or her house to

acquire the start-up funds for the company, for example. If there are two cars in the driveway, can

one or both be considered part of the companys assets? If the owner dies, is there someone to take

over the business, or will it die with him or her?

The SME may have several stakeholders, but again unlike a large company, they are likely to be

the friends and family of the SME owner. What happens if one of them decides to take his or her

money elsewherewill the other stakeholders make good on the investment, will they look for a

new investor in their own circle, or will they ask the bank for more money?

This is a very different set of financial circumstances than that faced by banks when dealing with

large well-established firms, so the whole risk assessment is different. Banks and other traditional

sources of credit may decide that SMEs represent a greater risk than larger companies, and respond

by charging higher interest rates. This makes it more difficult for SMEs to borrow than for bigger

companies, and may make it effectively impossible for many SMEs to borrow money at allbecause the price of credit is too high.

If entrepreneurs cannot gain access to finance through the regular system, they may not start up a

business or simply go out of business, a potential loss to the economy. But the other danger is that

they will abandon the formal system altogether and operate in the informal economy, sidestepping

taxes and regulations, and thus not making a full contribution to economic growth and job creation.

How easy is it for SMEs to borrow from banks?

In most countries, commercial banks are the main source of finance for SMEs (Figure 2), so if theSME sector is to flourish it must have access to bank credit.

The overall SME financing gap is particularly pressing in non-OECD countries, since the bulk of

them report a widespread shortage of financing for all categories of SMEs. Even though SMEs

account for a large share of enterprises, and represent potential employment and economic growth

in emerging economies, they receive a very low share of credit. Indeed, most of them are denied

any access to formal financial markets.

The characteristics of the banking system in emerging markets frequently inhibit SME lending.

Many banks are state-owned, their credit may be allocated on the basis of government guarantees

or in line with government targeting to develop specific sectors. Often banks are subject to ceilings

onthe interest rates they can charge, which makes it difficult to price credit in a way that reflectsthe risk of lending to SMEs. Many banks may have ownership and other ties to industrial interests

and will tend to favour affiliated companies. In a market where banks can earn acceptable returns

on other lending, it will not develop the skills needed to deal with SMEs.

Market-based banking, where banks are accountable for achieving high returns to shareholders and

maintaining high prudential standards, is gaining acceptance on a global level. This model creates

a competitive market where there is more incentive for banks to lend to SMEs, but many emerging

markets have been comparatively slow in implementing this model.

As OECD countries have competitive financial markets, SMEs do not generally have a problem in

obtaining bank loans since banks perceive SME finance as an attractive line of business and aredeveloping, or have developed, effective techniques to deal with them. They are replacing their

traditional risk assessment models with new techniques to distinguish high- and low-risk SME

borrowers, and to identify those likely to expand and survive. Banks are also altering the nature of


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their products, with an increasing proportion of their revenue coming from fees for services rather

than interest on loans, which favours lending to entities such as SMEs.

Nonetheless, OECD governments are convinced that there are still enough instances of market

failure in SME finance to justify focused government intervention. Countries have launched a

number of programmes to use public funds to facilitate SME lending, and the available officialsurveys suggest that banks efforts to develop the SME market, supported in some cases by a

moderate amount of government guarantees, have resulted in a situation where a large share of

SMEs have access to bank financing.

SOURCES OF FINANCING FOR EU-BASED SMEs ( graph) Figure 2.

Where can innovative SMEs find funding?

Despite the importance of innovative SMEs, they face particular problems when attempting to

access financing in most OECD countries, as they represent a higher risk than traditional SMEs orlarge firms. They are thus not really candidates for traditional bank loans. Moreover, banks are

mindful of the fallout from the burst of the dot.com bubble after the steep rise of Internet-relatedstart-ups in the late 1990s.

Instead, innovative SMEs rely on investors who will provide risk capital, generally in return for a

share in the company. The risks for the investor are high, but so are the potential rewards if he or

she is backing a winner.

Financing for innovative SMEs is complicated by the fact that these firms are likely to require a

range of financing vehicles at different stages of their development (Figure 3). The seed money

to start up the company generally comes from friends, professional contacts and family. The SMEmay also be able to tap into government funds or university grants for developing prototypes or

carrying out feasibility studies. Increasingly, business angels are seen as a vital link in thefinancing chain at the early stage of business development, as they bring business experience to the

table as well as their own capital. As SMEs begin to grow, but have yet to establish the track

record or size and collateral that would give them access to bank financing, they tend to turn to

other types of risk capital offered by venture capitalists, who favour larger projects at later stages

of the business cycle. Funds are usually obtained from institutional investors, especially pension

funds, but financial intermediaries and the corporate sector are also major investors.

Although there are many countries (including some in the OECD) where the venture capital

industry is still under-developed, the global venture capital industry is now a relatively matureindustry that has succeeded in mobilising hundreds of billions of dollars from institutional

investors and deploying these funds to attractive business opportunities throughout the world.

In contrast to the formal venture capital sector, the role played by early stage risk capital, although

not well known, is more relevant for innovative SMEs, and thus represents an opportunity for

government policy intervention.

How to bridge the SME financing gap?

Governments can play an important role in supporting the SME sector,

particularly where there is market failure or where incomplete marketsinhibit the provision of adequate financing on terms suitable for the

SMEs stage of development

Figure 3.

.


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Government measures to promote SMEs should be carefully focused, aimed at making

markets work efficiently and at providing incentives for the private sector to assume an active

role in SME finance. Where necessary, banking systems should be reformed in line with

market-based principles.

Governments should also act to improve awareness among entrepreneurs of the range of

financing options available to them from officials, private investors and banks. Micro-credit

and micro-finance schemes play an important role in developing countries and efforts should

be made to boost their effectiveness and diffusion.

Any provision of official funding should respect the principle of risk sharing, so official

funds should only be committed in partnership with funds from entrepreneurs, banks,

businesses or universities. Governments should also look at whether government technical

support can be used generate the emergence of business angels and to make the existing

business angel systems operate more efficiently.

Policy makers need to ensure that the tax system does not inadvertently place SMEs at a

disadvantage. They should also review the legal, tax and regulatory framework to ensure that

it encourages the development of venture capital.

At the same time, national policies should encourage diverse forms of institutional savings

and institutional investors should be regulated flexibly.

The market for corporate control should be allowed to function efficiently for both domestic

and foreign entities.

In order to assess the success of such actions, governments need to be able to measure the

size of the SME financing gap and evaluate the impact of government actions. OECD and

non-OECD governments have asked the OECD to take the lead in establishing international

benchmarks to facilitate comparisons of the relative performance of markets in providingfinancing to SMEs and entrepreneurs and to shed light on outstanding financing gaps and

issues.

Bank Finance to the SME Sector

Issues And Perspectives

There are a number of issues in lending to the SME sector, whichbanks generally face. The

keyissues among them are outlinedbelow:

(a) Information Asymmetry:Accurate information about the borrower is a critical input for decision-making by banksin

the lending process. Where information asymmetry (a situation where business owners or

managers know more about the prospects for, and risks facing their business than their

lenders) exists, lendersmay respond by increasing lending margins to levels in excess of that

which the inherent risks would require.However, the sheer ticket size of SME lending makes

it inviable for banks to invest in development of information systems about SME borrowers.

In such situations, banks may also curtail the extent of lending even when SMEs are willing

to pay a fair riskadjustedcost of capital.

The Implication of raising interest rates and/or curtailing lending is that banks will not be

able to fi nance as many projects as otherwise would have been the case.

(b) Granularity: This refers to a situation where the risk grading system at banks does not

have the requisite capability to discriminate between good and bad risks. The consequence istightening of credit terms, or an increase inprices, or both. From the borrowers perspective,


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this leads to an outcome where the bank is over-pricing good risks and under-pricing bad

risks. The fact that most banks in India have not developed adequate expertise in SME

lending risk assessment exercises leads to the problem of granularity when it comes to SME

lending.

(c) Pecking Order Theory:

Pecking order theory fl ows from the above two issues, which makes SME lending highlydiffi cult for banks. Under this hypothesis, SMEs, which face a cost of lending that is above

the true risk-adjusted cost, will have incentives to seek out alternative sourcesof funding.

Evidence suggests that in such situations SMEs prefer to utilise retained earnings instead of

raising loans from banks.

(d) Moral Hazard: Even when loans are made to SMEs, it may so happen that the owners of

these SMEs take higher risks than they otherwise would without lending support from the

banks. One reason for this

situation is that the owner of the fi rm benefi ts fully fromany additional returns but does not

suffer disproportionately if the fi rm is liquidated. This is referred to as the moral hazard

problem, which can be

viewed as creating a situation of over-investment. The moral hazard problem may, thus,result in SME lending turning bad in a short period of time, a situation that all banks would

like to avoid.

(e) Switching Costs: SMEs may fi nd it harder to switch banks,when countered with any

issue.It is a known fact that the smaller the business, the more signifi cant the switching costs

are likely to be and, therefore, it is less likely that the benefi ts of switching outweigh the

costs involved. This situation results in SME lending becoming a sellers market,which may

not be attractive toSME borrowers.

Steps for Smooth SME Lending

In order to ensure that the above issues do not stand between SMEs and Bank Finance, the

following steps could be taken as remedial measures:

Collateral: Existence of collateral that can be offered to banks by SMEs could be one

effective way of mitigating risk. Banks could, therefore, look at collateral when pursuing thequestion of SME lending. It can also be stated that a borrowers willingness to accept a

collateralised loan contract offering lower interest (relative to unsecured loans) will be

inversely related to its default risk. However, not all SMEs would be able to offer collateral to

banks. Hence, Reserve Bank of India (RBI) allows banks, with a good track record and

financial position on SSI units, to dispense with collateral requirements for loans up to Rs. 25

lakhs.

(a) Relationships: The length of the relationship between a bank and its SME customers is

also an important factor in reducing information asymmetry, as an established relationshiphelps to create economies of scale in information production. A relationship between a SME

and a bank of considerable duration allows the bank to build up a good picture of the SME,

the industry within which it operates

and the calibre of the people running the business. The closer the relationship, the better are

the signals received by the bank regarding managerial attributes and business prospects

(b) Quality of Information:SMEs are required to provide accurate and qualitative

information to the banks for them to undertake a reliable risk assessment. Accurate risk

assessments obviously rely upon

good information regarding the SME and its prospects. Hence, it is suggested that banks

should make efforts to encourage SMEs to improve the quality of information provided.

(c) Customer Consideration: The SME market is somewhatdifferent to the corporatemarketin that corporate customersgenerally have a widerange of financing options tochoose from


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and are not as dependenton bank financing asis the case with SMEs. Theextent to which

SMEs can take necessary steps, with the aid of public initiatives, to easily switch to another

bank is another factor that can infl uence the level of competitive pressure on banks in the

case of SME lending.

Role of Government and Banking Regulator in SME LendingAs is apparent, the above factors are only idealistic solutions and may not be practical for

SMEs to follow because they are faced with several problems such as weak fi - nancial

strength, inability to provide adequate collateral and other factors. Hence, the Government

and banking supervisors should take a holistic view of the SME Sector while considering

SME fi nancing, taking into account the risks faced by banks and the problems faced by

SMEs. In this regard, the initiatives taken up by the Government and Banking Regulators

across various countries and in India are as follows:

(a) Cross-country perspectives: Increased competition in financial markets in developed

countries has led several Governmentsand Banking Regulatorsto encourage banks andother

fi nancial institutions to

launch a number of initiatives to serve the fi nancing needs of SMEs effectively. Some ofthese initiatives (along with necessary government and regulatory support) include the

promotion of venture capital; receivables financing; leasing finance; soft loans, grants, and

guarantees for entry into public tenders; setting up of special financing companies with state

participation; micro-finance programmes, etc.

For instance, New Zealand has introduced a scheme called BIZ Investment Ready, which

targets innovative businesses and entrepreneurs seeking funds to expand, diversify or

commercialise a new

concept. The European Union has devised a scheme to facilitate contacts between SMEs and

banks and other fi nancial institutions, by developing a code of good practice for SME

lending. The Philippines

has instituted a fi nancing programme called SME Force (SME Financing for

Organisationally Competent

and Excellent Franchise Businesses), which is a franchise development fi nancing facility that

will be implemented with the participation of franchiser organisations.

(b) Indian scenarioGovernment initiatives: Even inIndia, the fi nancing of theSME

sector has received someattention since independence.Some of the initiatives takenby the

Government in this regardare as follows:

Setting up of the Small Industries Development Bank of India (SIDBI), as the apex refinance

institution in India for the purpose of channelling of fi nance to Small Scale Industries (SSIs)

and SMEs in an organised

manner. In line with the announcement made in the Interim Budget for 2004-2005, SIDBIhas proposed two fundbased initiatives for improving credit fl ow to the SME sector as

follows:

A contribution of Rs. 100 crore to the Rs. 500 crore corpus of the SME Growth Fund (SGF),

which shall make primarily equity/equity related capital investments in accordance

with SEBI guidelines, in SMEs operating in various growth sectors such as the life

sciences, biotechnology, etc. The SME Fund of Rs. 10,000 crore to give an impetus to the fl

ow of funds

to the SME sector. This fund has begun operations with effect from April 2004. Under the

Fund, assistance is provided to SMEs at affordable rates of interest, and direct fi nance is

extended to SMEs through SIDBIs networkof branches. Further, refi nance to State

Financial Corporations (SFCs) has also been made attractive in terms of low rates of interest.The Government of India has launched the Credit Linked Capital Subsidy Scheme (CLCSS),


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which aims at facilitating technology upgradation of SMEs in specifi ed products/sub-sectors.

SIDBI has recentlynegotiated a line of credit with the World Bank for financing and

development of SMEs in India, with a view to upscale the credit fl ow to the sector and

raising resources for the SME Fund.

(c) Indian scenarioRBI initiatives: The RBI, from timeto time, has formed several

committees and workinggroups to study the flow ofcredit to the SME sector inacomprehensive manner, andhas issued detailed guidelinesin this regard. Recently it has

constituted an Internal Groupunder the Chairmanship of

Shri C. S. Murthy to, interalia, consider the relaxationand liberalisation of creditlending

norms that are applicableto the SME sector. TheGroup has submitted its reporton June 6,

2005.The Internal Group, with reference to financing of SMEs,has recommended:

Constitution of empowered committees at the regional offi ces of the Reserve Bank to

periodically review

the progress in SME fi nancing and also to coordinate with other banks/fi nancial institutions

and the state governments in removing bottlenecks, if any, to ensure smooth flow of credit to

the sector. Opening of specialised SME branches in identifi ed clusters/centres with

preponderance of SME units to enable entrepreneurs to have easy access to bank credit and toequip bank personnel to develop the requisite

expertise. Empowerment of the boards of banks to formulate policies relating to restructuring

of accounts of SME units subject to certain guidelines. Restructuring of accounts of

corporate SME borrowers having credit limits aggregating Rs. 10 crore or more under

multiple banking arrangements to be covered under the revised CDR mechanism Appropriate

authorities are currently examining the above recommendations of the Internal Group.


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Good things in life begin small

Case on successful SME financingSIDBIWorldwide, the wind has been changing in the finance sector in general and banking-

investment sector in particular. Such a panorama teaches us that now, is the time of

cooperation rather than a competition, now its a time of convergence rather than cuttin g each

others neck over customers and markets, now its a time of consolidation rather thanantagonism. Curing the fatal disease requires the doses of small pills; impressive thoughts

come out from the small brain, similarly, India requires prominence of small and medium

enterprises for curing its problem of low economic growth vis--vis developed nations.

To cure the overall disease of lack of appropriate growth of Indian SMEsSmall and

Medium Enterprises, India needs several small pills such as adequate credit delivery to

SMEs, better risk management, technological upgradation of Banks esp. Public Sector Banks,

attitudinal change in Bankers 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 fulfilling their credit requirements time to time in

various forms such as long term project finance, working capital finance, bill discounting etc.However considering the level of appetite for credit facilities 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 and successful

implementation of them resulted into the marked improvement in the financial health of the

commercial banks measured in terms of capital adequacy, profitability, asset quality and

provisioning for the doubtful losses.


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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 competition 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

entities in the country. They are expected to bring with them capital, technology, and

management skills which would increase the competitive 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 votingrights of shareholders are pointer to these developments.

The pressure on banks to gear up to meet stringent prudential capital adequacy norms under

Basel II 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 entities to expand their

overseas operations, banks in India wanting to increase their international presence couldnaturally be expected to follow these corporate entities and other trade flows out of India.

Alongside, the growing pressure on capital structure of banks is expected to trigger a phase ofconsolidation in the banking industry. In the past mergers were initiated 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 alliances 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 thestate-of-the-art technology and latest rating and management skills turn out to be thesignificant aid for better risk management. The ability to gauge the risks and takeappropriate position 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

likely to perish.

In this context, Indian banks have to ensure:


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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 line 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 soothingclimate to manage their risk in a better way. In the years to come, technological

developments would render flow of information 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 likely to resort sharing of

facilities such as ATM networks. Banks and financial institutions will join together to share

facilities 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 utility service providers offering, say, bill payment

services or supermarkets or retailers doing basic lending operations. So for better profit

margin, with the help of technological innovation, consolidation and innovation in corporate

lending, the conventional definition 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 expectedintegration 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 competitive. There would be an increased need for self-

regulation among Indian banks since development of best international 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 initiate 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


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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 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 internationalcompetition 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-like 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 probabilities 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 financiers.

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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The Importance of Small and Medium Enterprises (SMEs) in any economy cannot be

overlooked as they form a major chunk in the economic activity of nations. They play a key

role in industrialization of a developing country like India.

They have unique advantages due to:-

their size

their comparatively high labor-capital ratio need a shorter gestation period

focus on relatively smaller markets

need lower investments

ensure a more equitable distribution of national income

facilitate an effective mobilization of resources of capital and skills which might

otherwise remain unutilized and

Stimulate the growth of industrial entrepreneurship.

According to a UNIDO report,4

supports for SMEs are generally based on three assumptions. it sustains a broad and diversified private sector and creates employment and thus

benefits the country as a whole

second, a strong SME sector will not emerge without support from the state, but they

suffer disadvantages in the markets because of their size

the programs aimed at smallest enterprises, have been justified more in terms of their

welfare impact than their economic efficiency.

Indian SME at a GlanceIn India, SME sector accounts for around 95% of the industrial units, 40% of the value added

in the manufacturing sector output, 34% of exports and provides direct employment to 20

million persons in around 3.6 million registered SME units. The SME sector in India

contributes to about 7% of Indias GDP during 2002-03. Now, the question is, Can itovertake the invasion of foreign companies through their innovative, quality,

affordable/reasonable and readily available products?

In developing countries like India, making the SMEs more competitive is particularly

pressing as trade liberalization and deregulation increase the competitive pressures and

reduce the direct subsidies and protection that Governments offer to SMEs. If our SMEs are

to be competitive enough to withstand and fight back the foreign


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MNC products, they have to be nurtured. According to Porter, the only meaningful concept

of competitiveness at the national level is Productivity, which is the value of outputproduced by a unit of labor or capital. Productivity in turn depends on both the quality and

features of products (which determines the prices that they can command) and the efficiency

with which they can be produced. Productivity is the prime determinant of a nations long-

run standard of living; it is the root cause of national per capita income. Further, to findanswers, we must focus not on the economy as a whole but on specific industries and

industry segments. We must understand how and why commercially viable skills and

technology are created, which can only be fully understood at the level of particular

industry.

International trade and foreign investment can both improve a nations productivity as well as

threaten it. They expose the nations industries to the test of international standards of

productivity. An industry will lose out if its productivity is not sufficiently higher than its

rivals to offset any advantage in the local wage rates. As wage rates in India are sufficiently

less to attract multi-nationals, the only way is to increase the productivity of local small

industries. This means, the increase in the productivity of labor i.e. human resources, the

productivity ofcapital and that of the process, which in turn relates to the use of technologythat yields quality and innovative products.

According to Ex-Commerce and Industry Minister and President of the National Productivity

Council, Mr. Arun Jaitley at the 47th meeting of NPC, It has become so competitive these

days that bulk of the labor, for reasons of higher productivity, has now shifted to female

labor. If we look at other Asian economies, Bangladesh or Srilanka, Cambodia or Myanmar,

we find that in manufacturing, it is female labor, which is being encouraged because theyhave been found more disciplined and hence with higher Productivity.

As every coin has two sides, similarly, even SME financing has a share in the overall

financing. The following are the issues of SME financing:

They are unable to capture market opportunities, which require large production

facilities and thus could not achieve economies of scale, homogenous standards and

regular supply.

They are experiencing difficulties in purchase of inputs such as raw materials,

machinery and equipments, finance, consulting services, new technology, highly

skilled labor etc. Small size hinders the internalization of functions such as market research, market

intelligence, supply chain, technology innovation, training, and division of labor that

impedes productivity.


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Emphasis to preserve narrow profit margins makes the SMEs myopic about the

innovative improvements to their product and processes and to capture new markets.

They are unable to compete with big players in terms of product quality, range of

products, marketing abilities and cost.

And most importantly, absence of a wide range of Financing and other services thoseare available to raise money and sustain the business.

Absence of Infrastructure, quality labor, Business acumen and limited options /

opportunities to widen the business.

Poor IT and Knowledge infrastructure.

To overcome all these difficulties, Indian SMEs and rural artisans deserves all the policy

support the Government can offer. What they need is, not protection but institutional support

to fund modernization and technology up gradation, infrastructure support and adequate

working capital finance. Also they have to have professional inputs and knowledge about

various happenings in their own industries in and around the country. This brings in the

concept of SME networks and clusters that stimulate innovative and competitive SMEs.These concepts (are not something new, but can be traced back to Alfred Marshalls analysis

of industrial districts in Britain in 1890s) essentially bring together various stakeholders like

technology providers, labor force, financing arms, consultants, marketing arms, and others,

for a common good that will help in enhancing the strength of SMEs.

THE Indian SME (small and medium enterprise) market seems to be emerging a promising

hunting ground for banks and financial institutions because it poised for tremendous growth.

As the access of SMEs to capital markets is very limited, they largely depend on borrowed

funds from banks and financial institutions. In majority of the economies, while the

investment credit to SMEs was being provided by financial institutions, commercial banks

extended working capital. In the recent past, with growing demand for universal bankingservices, the term loan and working capital are becoming available from the same source.

Besides the traditional needs of finance for asset creation and working capital, the changing

global environment has generated demand for introduction of new financial and support

services by SMEs.

Here, Figure-1 reveals the lackluster approach in industrial credit disbursement especially

Small and Medium Enterprises sector in India. The segment of medium and large Industries

where major chunk of credit has been absorbed by the big industrial houses, the growth rate

is only 5. 12 % in Financial Year (FY) 2003-04 as compared to previous FY 2002-03. Thegrowth rate is 9.04 % in FY 2003-04 in the Small Scale Industry segment whereas


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housing loan segment register the landmark 42.07 % growth in the same year. It clearly

reveals the lack of adequate credit facility to small and medium enterprises despite its

lucrative growth prospects in Indian economy.

Figure: 1 Industrial Credit Disbursement Scenario

However, some leading financial institutions such as Small Industrial Bank of India (SIDBI)has been started with the aim of contributing to industries that have the ability to grow and

contribute towards GDP, till now SIDBI has satisfactorily contributed in credit disbursement

to small and medium enterprises in India. In fact, it owns the major chunk of pie in the graph

of overall SME financing in India.


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SIDBI

SIDBI (small industrial development bank of India) was started with the motto of

refinancing as the sole business. RBI considers SIDBI and NABARD as two refinancing

institutions. As the main focus always has been this rather than direct financing, the brand

image of SIDBI has not changed in so many years. In the banking sector as a whole, there aretoo many middle level banks that come in direct contact with the customer and this has been

the main reason SIDBI is considered as the last resort for financing. SIDBI almost had a

monopoly in refinancing the small scale units but now there have been competition form

other commercial banks as well that have started initializing the SME finance like ICICI and

SBI. SIDBI has also started tying up with other nationalized and commercial banks in this

regard that can help it gain some more visibility and selling the products that need aggressive

marketing.

SIDBI has a special corporate status because it has got an expertise since 1964 and has been

an agent in government schemes and finance is provided considering all expenses related to

the project from conceptualization of the project to the successful execution of the project.

They target the SME as they are serving the niche market. It is also synonym todevelopmental banking as they have soft corner for the SMEs and for this section of industry

they have liberal policies, promote and develop small scale industries. Helping entrepreneur

is also one of the functions and duties of SIDBI. Thus its broad functions are promotion,

financing and development of Industries in the small scale sector and Co-ordinating the

functions of other institutions engaged in similar activities. SIDBI was established on April 2,1990. The Charter establishing it, The Small Industries Development Bank of India Act, 1989

envisaged SIDBI to be "the principal financial institution for the promotion, financing and

development of industry in the small scale sector and to co-ordinate the functions of the

institutions engaged in the promotion and financing or developing industry in the small scale

sector and for matters connected therewith or incidental thereto.

The business domain of SIDBI consists of small scale industrial units, which contribute

significantly to the national economy in terms of production, employment and exports. Small

scale industries are the industrial units in which the investment in plant and machinery does

not exceed Rs.10 million. About 3.1 million such units, employing 17.2 million persons

account for a share of 36 per cent of India's exports and 40 per cent of industrial manufacture.

In addition, SIDBI's assistance flows to the transport, health care and tourism sectors and also

to the professional and self-employed persons setting up small-sized professional ventures.


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SIDBI retained its position in the top 30 Development Banks of the World in the latest

ranking of The Banker, London. As quoted in the May 2001 issue of The Banker, London,

SIDBI ranked 25th both in terms of Capital and Assets.

State-owned SIDBI provides financial assistance to units in the small-scale sector. SIDBI

provides refinance against term loans granted by banks to SSIs, equity assistance, billsfinancing, project financing and resource support to institutions that are engaged in the

development of SSIs.

It provides assistance to wide-range of industrial sectors including transport, health care,

hotel and tourism and infrastructure.

It also provides funds to the professional and self-employed persons setting up small-sized

professional ventures.

Details about product & Services segment wise

SIDBI

As seen in the above chart, SIDBI has 6 product divisions, namely direct financing, bills

financing, Refinancing, international finance, micro finance and fixed deposit.

SIDBIs objective was to help the masses and the industry that is the base of all development,

i.e. small scale industries. Thus came up the idea of financing these industries directly and on

selective basis. So it was decided to introduce direct assistance schemes to supplement the

other available channels of credit flow to the small industries sector. Since then, SIDBI has

evolved itself into a supplier of a range of products and services to the Small & Medium

Enterprises [SME] sector.

Considering the level of competition in banking business due to globalized environment,SIDBI has now started spreading its wings either by way of diversifying its product portfolio

or entering into the strategic alliance with other leading private sector banks, public sector

banks and Non Banking Financial Institutions in order to achieve market development of its

existing portfolio of services. It aims to provide all the services a Small and Medium

Enterprise needs under one roof. Secondly, with the adoption of cluster development as the

key strategy to develop manufacturing sectors competitiveness, SIDBI has envisaged to

adopt the cluster financing method to assist SMEs. Finally, the bank is planning to get into

the business of commercial banking in a bid to serve the banking needs of the existing

customers since they have to approach commercial bank for daily routine transactions.

However, considering the quantum of competition in commercial banking business in India,

SIDBI is not aiming to enter into commercial banking business in haste.OperationsAny banks operational excellence is measured by aggregate sanctions, subsequent

disbursement of the sanctioned amount, the amount of revenue generated from the difference

in spread over the loan taken and advances granted, higher amount of fee based income andthe last and the most important timely recovery of dues. In addition, the banks assistance

towards promotional and developmental efforts in the form of loans and advances for project

financing as well as its overall utilization of available resources lying with the bank under

study is another significant indicator of operational effectiveness. However, an analyst has to

keep in mind that these are not the eventual pointers of the efficiency of any bank since it

varies from bank to bank depending upon the area of operations, profile and status of the

bank (Public, private, foreign, cooperative bank), geographical spread, its target groups andhistorical achievement.


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SIDBIs aggregate sanctions under all schemes during the FY 2004-05 were Rs. 9090.60

crore registering a growth of 10.24 % over the previous year. The disbursements during the

year were Rs. 6187.83 crore recording an impressive growth of 40.18 % over the

disbursement in previous year. (Figure 2)

Figure2 Overall Sanctions and Disbursements of SIDBI

Refinance AssistanceSIDBI has remained the premier refinancing institute for the promotion and development of

small and medium enterprises. The mechanism used by SIDBI is it lends to Primary Lending

Institutions (PLIs) and they deliver the credit facility to existing entrepreneurs and first

generation entrepreneurs. Figure -3 reveals the total sanctions and disbursement under

refinancing assistance.


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Figure: 3 Total Sanctions and DisbursementRefinance AssistanceTotal Sanctions and Disbursement under Refinance Assitance (Rs. in Crore)

The aggregate sanctions and disbursements under refinance schemes during 2004-05 were

Rs. 4419.19 crore and Rs. 2693.60 crore respectively. It shows the net growth of 3.98 %

increase in Sanctions and impressively 56.69 % increase in disbursement. This is the result of

the extra efforts in policy making and aggressive help provided by the bank for the overallwelfare of the small scale industries.

SIDBI has floated an excellent programme to meet gap in prescribed minimum promoters'

contribution and/or in equity considering the practical constraints faced by the promoters. For

instance, an entrepreneur visualizes an outstanding project on biotechnology which requires

Rs. 10 Lacs as an initial investment. Suppose, he approaches to a commercial bank for

financial assistance. The first question he faces is how much he (an entrepreneur) iscontributing towards the project. Now, assume that banks conventional practice is that a loan

applicant must contribute at least 25 % of the total project cost. He has to contribute at least

Rs 2.5 lacs as a promoters contribution in the above example. He may not able to initiate the

project unless he has the amount stated above (i.e. < 2.5 lacs) howsoever innovative,profitable and unique his proposition is. SIDBI has started National Equity Fund Scheme in a

bid to impart financial assistance for gap in promoters contribution.

The eligible borrowers for the NEF are:

Small entrepreneurs for setting up new projects in tiny / small scale

sector and rehabilitation of potentially viable sick SSI units

irrespective of the location.


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Existing tiny and small scale industrial units and service enterprises

[tiny enterprises would include all industrial units and service

industries (except Road Transport Operators) satisfying the investment

ceiling prescribed for tiny enterprises] undertaking expansion,

modernization, technology upgradation and diversification can also be

considered irrespective of the location.

It has been surprising to note that such unique scheme along with Mahila Udhyam Nidhi and

scheme of self employment for ex-servicemen have worked wonders since their inception.

The results of the aggregate sanctions and disbursements during the FY 2004-05, under these

schemes have been Rs. 43.97 Crore and Rs. 39.97 crore respectively.

A Global survey conducted in 18 countries by HSBC among SMEs to find out how this

business feels about current and future economic climate as well as their involvement in

international trade, threw up some interesting facts. The report said that working capitalrequirement, cash management and export finance are three important factors that hinder the

growth of the SMEs worldwide.

Given the potential of SMEs, several initiatives have been adopted by SIDBI to remove

working capital financing barriers. It has diversified its portfolio of financing considering the

current problems facing the development of SMEs and SSIs.

Bills financing have been another feather in the cap for SIDBIs portfolio of financing for

assistance of the SMEs. The objective of the scheme is to mitigate the problem of delayed

payments to SSI units. The schemes operating under Bills financing are Bills Re-discounting,

Bills direct discounting, receivables financing scheme. This is for short term purposes and

entrepreneurs in need of such short term requirements for working capital have favored thisscheme along with their financing options.


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Figure-4 Sanctions and Disbursement for Bills Financing

Total sanctions and disbursements for the FY 2003 and FY 2004 can be seen from figure- 4,

where the sanctions have increased by 37.19% in the year 2003 and disbursements have

increased by 40.69% in the year 2004 which shows that the sanctions and disbursements have

been at par with the target of SMEs being able to attain the credit available.Project financing being another area where SIDBI finances the whole project that is

innovative, economically and financially feasible and unique which would lead to a birth of

an industry in the near future. Under the direct financing of projects, though the sanctions

declined a bit during the last year, the disbursement showed an increase during the

corresponding year.


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Figure-5Project Financing Scenario of SIDBI

The above figure-5 shows that the overall sanctions for Project Financing by SIDBI has

shown the dramatic fall in FY 2005 from total sanctions amount of Rs. 1619.41 crore in the

financial year 2004 to Rs. 666.96 crore in the FY 2005 which is almost 59% lesser than the

previous year. The underlying reason for low sanctions is stringent risk managementpractices adopted by the bank. However, if one looks at the total disbursements under Project

Financing of SIDBI, he will find the increase in disbursements rate in FY 2005 as compared

to FY 2004 when total disbursements were Rs. 1521.44 crore.

Besides good track record in total sanctions and disbursements, SIDBI has performed pretty

well in rationalizing of all its existing schemes and programmes in a bid to simplify the

procedures, streamline the credit delivery mechanism and enhance the customer base. The

modus operandi adopted by SIDBI in streamlining its operations is either merging the

existing schemes with related schemes serving the same target market or extending the

different schemes to the target market of only one or two schemes. For instance, pursuant to

the announcement by the Ministry of Small Scale Industry, Government of India, units

assisted under National Equity Fund Scheme have also been made eligible for availingsubsidy under Credit Linked Capital Subsidy Scheme, provided other terms and conditions of

the same were satisfied.

Secondly, in an effort to simplify procedures, SIDBI has developed an electronic workflow

system which integrates and automates the main credit functions of sanctions, documentation

and disbursement. This process is known as


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Direct Credit Process. The system has generated spectacular results in standardizing the

processes and reducing the transaction time.

The real measure of operational excellence for a customer focused bank is the transaction

time taken from application of loan to the ultimate disbursement of the same. SIDBI has this

exceptional method of appraising the proposals interested in acquiring credit from the bank.-sanction department which is

similar to all the other banks as well. The process starts from initial screening where

feasibility of the project is checked with keeping in mind the profile of the

management. Emphasize is laid on the promoters capacity to manage.

-sanction department, the next step is physical

inspection where the 3 Cs that is Character, Capacity and Capital are judged on the

basis of on-site scrutinization of the promoters and their proposed activities.

appraisal by CART system which is a unique credit appraisal system set by the in-

house system in SIDBI. CART analyzes credit-worthiness of an applicant. The systemhas a two-level security a creator and a checker who can also be the same person.

CART allows for three basic forms-the appraisal, documentation of verification and

the disbursement note on approval. SIDBI has developed expertise in quick appraisal

of small credit proposals of existing well performing units (up to Rs 50 lakh) through

the Credit Appraisal & Rating Tool (CART) model. The same model shall be suitably

modified by SIDBI to cover i) green field projects, ii) working capital assessment and

iii) composite loan.

appraisal. SIDBI will also develop a simplified appraisal model for adoption by

banks. SIDBI has developed certain automated systems for loan documentationprocesses and the same may be offered to the banks. After studying the processes, if

the banks are interested they may effect the necessary modifications.

processing cell. This cell decides on the final feasibility of the projects and thus, the

loan/credit is granted for that project.

step of the credit grant process.

In order to pursue the stringent risk management in providing loan assistance, the SIDBI has

adopted risk management system in line with the Credit Risk Management (CRM) policy and

comprehensive Credit Risk Management Systems and Operational Risk ManagementSystems, developed by CRISIL Ltd. Its credit risk management system lays down the Banks

Risk Philosophy and covers inter alia, the credit risk organization, risk


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measurement, exposure limit framework, and pricing of the loan. In addition to CART, the

bank has developed some software tools known as Risk Assessment Models for credit risk

rating of various borrower segments. There is also a Risk Management Committee

comprising senior executives of the bank which guides the risk management functions of the

bank and also overseas and monitors the effective implementation of the CRM policy.

The mettle of efficient risk management system is measured thorough the efficient recovery

of dues and curbing of non-performing assets (NPAs) to the greatest possible extent. As far as

SIDBIs risk management system is concerned, it has an important tool of assets management

in which due emphasis is given on credit monitoring in the following ways:

to NPA category

are being restrained by identifying stressed assets periodically. In addition, SIDBI has

designed a system of identification of trigger points to help Regional Offices and

Branch offices to contain individual accounts from slippage into NPA category along

with an indicative list of early warning signals.

Branch level, Zonal level and at Head Office depending on loan size and monitoring.

efault review committees at branch and zonal offices to review all direct

finance cases at monthly intervals.

-cause analysis in respect of

fresh NPA cases for taking preventive measures.


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Financial Analysis of SIDBI

The standard way of financial analysis is ratio analysis of financial statements of any

corporate entity. Here, in this case, the author has analyzed almost last five years financial

statements.

Net Profit after Tax

Figure-6 Net Profit after Tax situation of last five financial years

.

Net profit after tax for SIDBI over the years have been pretty fluctuating as seen in the above

figure-6. If we look at the Net Profit position of the SIDBI of the last five years, we will find

that Net Profit has registered downfall in two years as compared to its previous year. For

example, the net profit declined in the FY 2003 by 26.44% from the previous years Net

profit. Again as seen in the figure, the net profit shows reduction in the FY 2005 by 6.6% as

compared to its previous FY 2004. The underlying reasons for such deviations are presence

of large number of entries of private sector banks and their thrust of industrial financing,

change in the banks portfolio i.e. introduction of new schemes for new target market like

women entrepreneurs, ex-servicemen etc. and shift in the consumers needs where by they

want everything under one head. However, in the financial year 2006, net profit has shown

northwards movement by 21.58 % due to its sound risk management system and judicious

use of available resources.


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Dividend Distributed

Figure-7 Dividend Distribution of SIDBI since Last four years

The total dividend distributed by SIDBI has been decreasing for two years consecutively

which results from the decline in the net profit of the bank. The dividend distributed for the

FY 2001 has been 67.5 Rs. that declined to 54 Rs in FY 2002 which was a 20% decrease andthis further came down to 45 Rs. in FY 2003 i.e. 16.67% decrease and this remained constant

even in FY 2004. The reasons for such a decrease have been the overall performance set back

due to low profits which resulted in low sales in services.


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Segment wise Revenue

Figure-8Revenue Segmentation of SIDBI

The segment wise revenue for SIDBI is divided in 4 sections namely, direct finance, indirect

finance, treasury investment and others nominal sources. The figure clearly reveals that it is

actively engaged in refinancing (indirect finance) business where the bank has employed Rs.8428 Crore in FY 2006 as compared to Rs. 6981 crore in FY 2005. Such huge capital

employed in indirect finance has contributed 40.25 %( Rs. 231 crore) of the total revenue

generated in the FY 2005-06. The next performing segment is the direct finance whereby

SIDBI directly assists small and medium enterprises. It contributes the 33.51 % of total

revenue. Like wise, treasury investment and other sources of revenue have share of 23.96 %

and 2.28 % respectively in the overall pie of SIDBIs revenue.

Earning Per Share

Earning per Share is the true measure of the net profitability of a company available to its

owners who are commonly known as Equity Shareholders. Theoretically speaking, higher

Earning per Share (EPS) reveals the better profit available to shareholders after distributingdividend to preference share holders.


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Figure-9 EPS position of last two Financial Years

As far as SIDBI is concerned, its overall shareholding belongs to financial institutions, ( 6.42

%), Insurance Companies (21.43 %), and PSU banks (72.15 %). Their return per share in FY

2005 is Rs. 5.04 registering 21.62 % growth in FY 2006 reflected from Rs. 6.13 EPS in the

same year.Capital To Risk Asset Ratio

Figure-10 CRAR of SIDBI since 2001 to 2004


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In banking business, the amount of capital maintained against the various types of risky

assets as per their risk weights is known as the Capital to Risk Asset Ratio (CRAR). SIDBI is

in the business of financing and refinancing small and medium enterprises where the amount

of risk involved can not be fully identified. The bank has been setting aside appropriate

amount as capital to risk weighted assets over the last four years. CRAR has increased from

28.1 % in the year 2001 to 51.6 % in the FY 2004, which shows that they have adequate risk

carrying capacity in comparison to the risky assets.

Non Performing Assets

Figure-11 SIDBIs Non Performing Assets Scenario from 2000 - 2004

Non performing asset, in common parlance means, any asset that is not effectively producing

income. The asset is non-performing if interest or installment are due but unpaid for more

than 180 days. In the case of SIDBI, the NPA is increasing every year since FY 2000, reason

being increase in amount of loans and disbursements. Usually, lower level of NPA is

considered as a proof of efficient working in the banks but considering the level of

competition in the market, the increasing level of NPA are satisfactory in comparison to therevenue generating accounts. The moment this revenue generating accounts also fail to

deliver and get into Non-paying assets is a time to evaluate the banks performance.


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Net worth

Figure-12 Net worth position of SIDBI from 2001-2004

For a company, Net worth means total assets minus total liabilities. Net worth is an important

determinant of the value of a company, considering it is composed primarily of all the money

that has been invested since its inception, as well as the retained earnings for the duration ofits operation. Net worth can be used to determine creditworthiness because it gives a snapshot

of the company's investment history. This is also called owner's equity, shareholders' equity,

or net assets. SIDBIs net worth is on an increasing trend since FY 2001 as seen in the above

Figure-12. The shareholding pattern for SIDBIs net worth shows PSU banks having

majority of the stake with 72.15% (Figure-13). Secondly insurance companies haveconsidered SIDBI as a viable option to invest because of its timely payment of dividend,

rising earning per share and stable operating profit. And lastly, even financial institutions

have started showing interest in the workings and returns from investment in SIDBI. This

shows that the banks performance has been impressive over the years and is continuing the

same trend.


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Figure13 Shareholding Pattern of SIDBI as on 31st March, 2004

The business landscape has been transformed worldwide. It is an age of cooperation rather

than competition. It is the age of synergy where two or more than two business houses

collaborate and use each others competitive advantages either to penetrate in the new market

or to expand the product portfolio. SIDBI has realized this fact on time. It has till today madestrategic alliance with leading public sector banks, private sector banks, venture capitalist and

Non-Banking Financial Companies. The purpose may vary from partner to partner but

ultimate goal remains to enhance the credit flow to small and medium enterprises of first

generation entrepreneurs as well as existing players.

SIDBI, which signed a MoU with UCO Bank and BANK of India (BoI) to increase the flow

of credit to SMEs, has started cooperation with newly established nine branches. The two

banks have set an incremental lending target of Rs 3,000 crore for this sector in 2005-06.

As per the MoU, either SIDBI or BoI would finance the term loans, while BoI would

exclusively meet the working capital requirements of SMEs. Financing of term loans will

carry an interest of 9.5 per cent (fixed) and working capital 10.75 per cent (floating). BoI andSIDBI will also jointly work to extend the reach of micro-credit through branches.

BoI hoped to see an increase of Rs 3,000 crore in its lending to the SME sector. Currently,

the bank's credit exposure to SME units is about Rs 12,600 crore, while for the small-scale

industry (SSI) , it is Rs 6,000 crore.


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This shows that banks are looking at the SME sector as a commercially viable sector.

This is part of RBI's initiative to further smoothen the flow of credit to SSIs, which primarily

depend on finance from banks and other financial institutions. Under the proposed scheme,

banks will be encouraged to establish mechanisms for better coordination between their

branches and those of SIDBI that are located in the 50 clusters identified by the Ministry ofSmall Scale Industries.

The existing branches of SIDBI (re-designated as Small Enterprises Financial Centres) would

take up co-financing of term loan requirements of SSI units, along with the bank branches.

The banks will meet the working capital requirements of these units.

Further, the branches of commercial banks will leverage the expertise of SIDBI in appraisal

of credit requirements of SSI units by payment of a nominal fee. SIDBI will help banks in

simplifying the application forms, documentation and disbursement procedures.

Under this tie-up, IDBI and SIDBI will offer anywhere banking facility for SMEs. SIDBI's

current account with IDBI will allow its assisted SMEs to avail themselves of banking

services through IDBI Bank branches in their vicinity, said an IDBI press release.

The alliance will also focus on joint initiatives in the areas of micro credit, cluster

development and other development initiatives.

SIDBI and IDBI will create a joint mechanism for appraisal of projects including merchant

banking.

One another leading public sector bank State Bank of India (SBI) signed a memorandum of

understanding (MoU) with Small Industries Development Bank of India (SIDBI) for co-

financing small and medium enterprises in Andhra Pradesh, Tamil Nadu, Uttar Pradesh,

Jammu & Kashmir, Jharkhand, Delhi and Bihar whose development is the need of the hour to

ensure the regional balanced growth and eliminate regional development disparity.

The agreement would help to bring in transparency in the working of SME units. which

would in turn reduce the risks associated with funding SMEs and make credit available to

them at better interest rates of interest in all the states mentioned above.

In addition to it, Punjab National Bank (PNB) also entered into a memorandum of

understanding with the Small Industries Development Bank of India (SIDBI) to strengthen

efforts to support small and medium industries. Both of the institutions would jointly explore

possibilities for extending credit to SMEs.


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SIDBI has not restricted itself to the public sector banks but also spread its wings and allied

with private sector banks such as Yes Bank and Non Banking Financial Institutions. In order

to promote infrastructure and financial support to develop textile parks it has made strategic

alliance with IL&FS. Under a MoU signed between the two institutions, it was agreed that

IL&FS will give infrastructure and marketing support and SIDBI will provide short-term and

long-term capital to textile parks.

In order to ensure effective implementation of MOU signed between SIDBI and IL&FS, they

have already identified seven textile parksfour in Tamil Nadu, two in Andhra Pradesh and

one in Karnataka for development. The entrepreneurs in the park will form a special

purpose vehicle to develop the park. Each of these parks will have land, infrastructure such as

road, water supply, power supply, telecommunication, factories, plant and machinery for

individual entrepreneurs. They will contribute 20 per cent of the entire cost of setting up and

maintaining the park. The Government grant forms 40 per cent and institutions will meet the

remaining 40 per cent. If required, SIDBI and IL&FS will also prepare to pick up equity in

the SPVs. The SPV will also provide other linkages such as marketing of the finished goods,

once the park is set up.It is important to note here that exports from the textile industry are likely to increase by Rs

15,000 crore once the textile parks are set up. Thus, SIDBI-IL&FS MoU will help not only

financing the gap between government grant on reimbursement basis and overall financing

requirement of the project but also overall competitiveness development of the textile sector

in India.

Non Banking Financial Companies have unique status in Indian Financial system especially

in terms of autonomy of operations, risk management and debt recovery. SIDBI began to give

loans to SMEs directly only three years ago. (Earlier, it was only refinancing banks.) Now its

direct-lending portfolio stands at Rs 4,660 crore, more than a third of its total loan portfolio

of Rs 13,890 crore. Today, one out of every two rupees lent by SIDBI is loaned directly toborrowers.

The bank intends to raise its direct lending portfolio to 70 per cent in three years. To do this,

it needs geographical reach. SIDBI today has 56 branches 12 of which were added last

year and it has committed to the government that it would put in place 100 branches by

2007-08. However, even 100 branches are not enough to disburse loans directly to borrowers.

Hence it started tie-up with NBFCs. SIDBI tied up with Sundaram Finance Ltd under which

the Chennai-based NBFC would originate loans for a fee.

In a bid to increasing loans given directly to small and medium enterprises, the Small

Industries Development Bank of India (SIDBI) intends pacts with more non-banking finance

companies (NBFCs) for loan origination.


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As an important development in the banks effort to seek strategic alliance , seven of the

country's leading public sector banks are set to propel the Small Industries Development

Bank of India (SIDBI) to its next orbit in funding the growth of the small and medium sector.

The seven banks that are likely to join hands with SIDBI are State Bank of India, Punjab

National Bank, Canara Bank, Bank of Baroda, Union Bank of India, Oriental Bank of

Commerce and Bank of India.

The tie-ups with the banks, which are in an advanced stage of negotiations, will help

formalize a comprehensive package to boost the credit flow to the SME sector. Once the

plans are set rolling, there would be enough comfort for lenders to fund units in the SME

sector. SIDBI is tying up with SBI, PNB, Canara Bank, BoB and Union Bank to participate in

the corpus of the proposed VCF - the SME Growth Fund. The CRA tie-ups are being

formalised with PNB, Canara Bank, OBC, BoB, BoI and Union Bank.

The VCF would provide support to start-ups that have good growth and export potential. It

would start with a corpus of Rs 100 crore which we plan to raise to Rs 500 crore in two to

three years. The fund, which will identify SME sector projects in areas such as agriculture,

biotechnology, food processing and auto ancillaries, is to be launched in September.

SMALL Industries Development Bank of India and Yes Bank has tied-up to provide credit

and other financial products to the small and medium enterprises sector, under a new co-brand called Yes SIDBI. This is the first tie-up between SIDBI and a private bank. This tie-up

is different from other tie-ups because Yes Bank has special skills in derivative products and

technology, which SIDBI lacks. Bundling of products is the global concept and they offer

that to the SME sector through the medium of SIDBI. On the other side, with this tie-up, YES

Bank will accelerate their focus on the SME sector. Whose exposure to the emerging

corporate entities and the SME sector is around Rs 350 crore.

Looking into the growth prospect of the SMEs in India and credit availability as a major

constraint, the Reserve Bank of India is drawing up a scheme to forge a strategic alliancebetween the branches of different commercial banks and those of SIDBI to enhance the flow

of credit to the small-scale industries (SSI).

Direct lending

In addition to aggressive indirect financing or refinancing, SIDBI since its inception 1990 has

launched a series of innovative products and schemes for directly catering to the credit

requirements of different segments of the SSI sector. During the year 2004-05, the bank

continued these initiatives with renewed efforts in the direction of simplifications of the

schemes, decentralization of powers, opening of new branches and other steps to expand


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banks direct reach to the customers. The bank has put in place its Credit Appraisal and

Rating Technique (CART) in direct lending that analyzes credit worthiness of the proposals.

With the high level of automation in the bank, the said model has facilitated SIDBI to take up

the appraisal, document verification and the disbursement on a fast track basis.

One of the reasons for SIDBI's penchant for direct lending is the loans' amenability to bettercontrol. For instance, only six accounts together involving an amount of Rs 1.97 crore, turned

non-performing in its direct-lending portfolio.

Secondly, with rating mechanism in place for small and medium enterprises popularly known

as SMERA5

, SIDBI feels more comfortable lending directly to borrowers.

Finally, if we take a look at the efficiency aspect in terms of return generated from the total

investment of each segment, some surprising facts come up to the surface. Table - 1,

Table: 1 Segment

Reporting with Return

on Investment (ROI) ofeach segment as well as

Total ROI (Rs. inCrore) Seg. No

Segment Year wiseSegment

Assets

Year

wise

SegmentRevenue

Return on

Investment

Return

on

Investment

2005 2006 2005 2006 2005 2006

1 Direct

Finance

3901 5463 220 323 5.63 % 5.91 %

2 Indirect

Finance

6981 8428 237 231 3.39 % 2.74 %

3 Treasury/

Investmen

t

5644 4738 465 388 8.23 % 8.18 %

4 Others 1638 1723 26 22 1.58 % 1.27 %

Total 18,164 20,352 948 964 - -

ROI - - - - 5.21 % 4.73 %

In spite of the SIDBIs primary role is to refinance for promotion of small and medium

enterprises by way of primary lending institutions, cooperative banks, commercial banks, and

public sector banks, it has aggressively started direct lending since three years back because

the return on investment is higher than the returns generated from indirect finance. For

instance, ROI in direct finance in FY 2005 and FY 2006 is 5.63 % and 5.91 %

- 31 -

respectively whereas ROI in indirect finance in the same years are 3.39 % and 2.74 %

respectively. Additionally, it is also found that the ROI is declining over the years in indirect

finance unlike the growing trend in revenue generation with the increased used of direct

finance segment. The most rewarding segment is SIDBIs treasury and investment segmentwhere annual ROI in FY 2005 and FY 2006 is 8.23 % and 8.18 % respectively. The


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investments were made mostly in government securities, debentures and bonds and

investment in subsidiaries/joint ventures. One may raise the point that if the return on

investment is relatively high in treasury/investment segment, SIDBI should invest more in

this segment. However, it should be noted that SIDBI is not the commercial banking entity

but development financial institution. Thus this is not its main activity so it cant pursue this

exercise. The last segment named as others contributes 1.58 % and 1.27 % ROI in FY 2005and FY 2006 respectively. Overall ROI a measure of revenue generated from the total

capital invested is 5.21 % in FY 2005 and 4.73% in FY 2006 which shows nearly 10 %

decline in the ROI as compared to previous years ROI. It can be easily concluded that the

bank has been generating lower revenue with higher investment from indirect financing and

more return from direct financing with relatively lesser capital employed in this segment. So,

it must start focusing on direct financing since it is more rewarding as well as socially viable

than refinancing where processing time is more due to intermediation of different types of

banking entities.

To a common reader, it seems as a contradictory phenomenon. On the one hand, SIDBI is

trying hard to stimulate credit growth through refinancing or indirect credit by way of forgingstrategic alliance with PSBs, Private sector Banks and NBFCs where Return on Investment is

unattractive and declining and on the other hand, it is not focusing adequately in direct

financing except few cosmetic measures where ROI is highly attractive and rising year on

year basis.

In this age of immense competition, survival is the key for any organization be it public or

private. Same goes in case of SIDBI and other banks that are in its competition now. Though

with a strong background, SIDBIs image hasnt shifted in the minds of the masses. The

awareness level is still low an

Final Project (SME Loans n Credit Ratings)

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