CGSSD Scheme: New lease of life for stressed MSMEs in India

The new scheme is a well-conceived framework to enable stressed potentially viable MSMEs to secure a new lease of life and a much needed bridge to facilitate constructive engagement with the bank.

Recently an entrepreneur sought our assistance to revive his business units, one in South and the other one in North. Both are in the same activity and are incorporated in the year 2016. Both together consumed the investment in excess of Rs 30 crores with little than 50% of the bank loan. The business was new to the family although they are in the higher reach of the value chain of the industry for more than four decades.

Both businesses faced quite the same problem.  They failed to gather a robust team. The capacity utilisation was lower than the minimum viable level. . The key risks were not in control. Since the family members were at the helm of affairs, there was lax internal control and governance. No one took the burden of running the business professionally. 

Despite the most modern production facility and promoted by the family of successful entrepreneurs, the business failed to reach the expected revenue targets and started incurring huge losses resulting in the account becoming NPA in the books of the bank. Having no option left with, Banks in both the places  initiated recovery action under SARFAESI Act.

The family repeatedly sought assistance from the banks to restructure the loan and revive the business by infusing additional capital. However, banks were very adamant insisting for the recovery of the loan.

Latest Development: Revival is underway

Thanks to the Govt’s initiative of helping the stressed MSMEs through a new scheme “Credit Guarantee for subordinated Debt (CGSSD)”, the businesses of both these units are seeing a revival.

Under the new scheme, the loan restructuring is underway at the individual bank level.  A new business strategy is put in place.  The operation is restarted in both the units. The capacity utilisation is steadily rising.

The new guidelines from the Govt of India made the difference:

Recently Govt brought out a new scheme to facilitate the revival of stressed but potential MSMEs.  The purpose is to provide guarantee coverage for the CGSSD and provide Sub-ordinated Debt support in respect of the restructuring of MSMEs. 90% guarantee coverage would come from scheme/ Trust and the remaining 10% from the concerned promoter(s). The objective of the scheme is to provide personal loan through banks to the promoters of stressed MSMEs for infusion as equity / quasi-equity in the business eligible for restructuring.

The salient features are:

• The borrower should be the promoter of MSME unit
• The Account should be SMA 2 or NPA as on  30.4.2020
• The accounts classified as NPA after 1.4.2018 are eligible
• The loan amount will be 15% of Promoters stake in the business to the maximum of Rs 75 lakhs
• The loan will be extended to promoters.
• The loan will have guarantee cover from CGTMSE

The scheme is a game-changer:

The scheme is a source of great relief in the above instance. The promoters were sincerely looking for a way out from the messy banking relationship to revive the business.  The scheme extended a framework to work with the bank and find a viable path to return to profit. Today the units are in a position to extend jobs to many unskilled and semi-skilled employees in the region. Precious public money will come back to the bank in a phased manner without going through stressful, expensive and value destructive recovery actions.

A mechanism for handholding during the stressful scenario is needed for MSMEs.

Entrepreneurship requires to be encouraged for India to become a global powerhouse and assisting entrepreneurs in the stressed scenario should be part of the policy support they need. We explain  here below some of the reasons:

• Dealing with an uncertain environment is endemic  to entrepreneurship: Despite the best planning, many firms may challenge to survival due to factors not in their control. Many time changes in the policy or local regulation do impact the business of the small businesses very badly. 
• Internal factors and learning curve: There are chances that many a time entrepreneurs fail to get the grip on certain vital functions that may be the key success factor for the business. Every venture has its own learning curve and they need to be supported if there is any delayed onset of the business for want of understanding if its nitty-gritty.
• Bad financial planning: Many a time the decision to launch new busies is more an emotional decision than followed up with a clear financial strategy. We have seen many entities struggling to put the financial maths in place despite the best of technology, manpower, and having huge opportunities to become successful.
• Absence of professional advisors and mentors: Many first-generation entrepreneurs go through a long-struggling learning curve in the absence of access to independent and credible advisors and mentors. As a result, the process of finding the right formula for success gets longer.

Entrepreneurs do make mistakes especially in the early stage of new business.  There should be an avenue for course correction. Such businesses deserve a chance to correct the course and redraw their path to success.

In the above cases the CGSSD scheme played a major role to bring in difference. In the similar instances elsewhere entrepreneurs need to be given chance for course correction.  An opportunity to review and strategize their business will be of great to protect the value of enterprise they have passionately built.

Also the CGSSD scheme can create a good platform to  make the engagement between the bank and entrepreneurs more constructive even when there is distress and facilitate them to find a viable path jointly to turn around the stressed business.  In any case It will not take away the discretion of the bank to enforce the recovery if the attempt does not help to revive. 

Further improvement required:

CGSSD scheme is a welcome step to help the stressed MSMEs.  The support mechanism for stressed MSMEs may be further improved to broaden its horizon. Some of them are:

a)      Make it available all across the banks and NBFCs: The borrowing of any MSME is wider than one source. This should be mandatory of all of them join in the process. Unfortunately, lenders other than Govt owned banks are not supporting the MSMEs in this regard.  It should be available on a non-discriminatory basis. Govt may bring in required legal and/or regulatory actions in this regard.

b)      Remove the age of NPA clause: As per the norms of the guidelines, accounts classified as NPA from April 1, 2018, onwards are eligible. This may be relaxed to cover any potentially viable unit irrespective of the date of becoming  NPA.

Conclusion:

CGSSD scheme is a welcome step to help the stressed MSMEs to find new lease of life. Also, it is a much better option for the banks instead of seeking recovery action immediately after becoming NPA.

Leverage & Uncertainty- Double Whammy for MSMEs

The MSMEs which are leveraged will find going will be very challenging in the present circumstances. This should enhance the appreciation for prudent financial management.

Recently I had a call from one entrepreneur who has been into a movie screening business. The unit is leased to an operator for a monthly fixed rental payment. The same is discounted with a bank to get into another business. Unfortunately, that new business suffered a huge loss as they were new into it and they did not make a proper financial strategy before entering.

Despite the loss in the new venture, the debt servicing remains intact due to regular rental income from the tenant. However, the global pandemic of COVID 19 has changed all the calculations. The movie screening is stopped and so is the cash inflow.

The industry is not sure how long the situation will persist. The entrepreneur and his family are very tensely watching the evolving scenario.

COVID 19- Not a risk rather an uncertain event

Many are cribbing that they are not prepared for intense liquidity stress due to the economic impact of COVID 19 and resultant difficulty in debt servicing. The fact is that COVID 19 is not a risk to anticipate. The risk is one which can appear and reappear on the horizon and a positive probability can be assigned to it. Such that we may take some preventive measures,  avoid its happening and /or at least we can mitigate its impact. In case of uncertainty based events, nothing can be predicted- neither its arrival nor its impact.

Today the whole world is experiencing an uncertain event and its longevity is unpredictable. So is its impact on the individual business.

Leverage is a prudent strategy in the period of high economic growth. But timing high growth is a challenge:

The leveraged business model is good so long as the economy keeps an upward trend in growth because the cost of debt is lower than equity. The challenge is to predict how long it will last. It is difficult to predict. Growth prediction is becoming a challenge due to the globalised trade regime and newer disruptions from evolving regulations, technological advancement and changing business process driven by the internet.

If the economy hits a downward spiral or industry in which you are operating is slowing down, the debt will be a serious challenge. Once trapped into a vicious debt trap, many entrepreneurs borrow more to meet the repayment obligations. As they borrow more and more, the cost of borrowing will go up and eventually the credit record will suffer. More borrowing coupled with slowing business is sure toxic combination for any business to survive.

In India, we have been witnessing a steady decline in the growth in the last two to three years. That has affected the business of many well-run entities. We have witnessed the collapse of many large companies and being sold under bankruptcy code in the last two years. The common denominator was a high debt load.

COVID 19 has aggravated this. Many long-standing businesses are facing a serious crisis of survival in the wake of pandemic and coupled with borrowing. The borrowing now appears excessive due to lowering sales and they are facing a double whammy situation.

Policy Response to COVID 19: Govt/RBI initiatives and their impact

Many debt-laden firms are staring at the imminent collapse. Govt & RBI came to their support by offering fresh loan under ECLGS, Moratorium and MSME Debt restructuring Scheme.

Fresh loan under ECLGS has helped many to postpone their immediate repayable to four-years spread. Moratorium gave temporary respite from cashflow burden for stalled businesses. Whereas the restructuring extended a window of opportunity to take a fresh look at the business scenario and revise the debt servicing.

The measures are lead to rearranging the payables with reference to timing; whereas interest burden pertaining to moratorium remains and business sentiment remains weak. Otherwise, a normal level of leverage in the orderly economic scenario is now crystallizing to distress due to lower than expected cash flow.  Burden from the period of the moratorium will have a compounding effect.   A realistic solution could be allowing reduction or sacrifice of the interest burden. In the absence of such a step, the viability of many businesses will remain doubtful.

MSMEs are more vulnerable and affect the personal life of an entrepreneur

The long term prediction of the prospects with excessive reliance on debt is becoming a risky proposition for businesses –big or small. The impact will be more severe for small businesses because they normally mortgage their assets like living home to secure credit for the business. Any impact on the business will directly affect their family life. This is not the case with large corporates.

Many of the entrepreneurs do not think about derisking their business model while seeking more growth. They continue to pursue the growth through loans from banks and NBFCs and thus retaining 100% risk for themselves. All their assets and cash flow(business as well as personal)  are intensely leveraged to meet the financing needs.

COVID should be an eye-opener. It is the high time for MSMEs to explore ways and means of de-risking the business model and take it as a precursor for pursing the growth ambition. At least explore ways of minimising the risks to the family through smart structuring.

Conclusion

A leveraged business model is a good option in a high growth period. However, it can be toxic if there is a decline in the business that may arise due to internal and external factors. Creating excessive leverage on the cash flow anticipating the same economic scenario into the future for years is quite a dangerous phenomenon. No business can be stable in the long term in the new trade regime.

The learning from the present crisis is- Restrain from unbridled borrowing to fund the business plans. Rather derisking oneself while pursuing the growth should be the preferred option.

Credit Guarantee- A reality check

In the post- COVID scenario, MSME financing is almost identified with Credit Guarantee schemes. We look at its effectiveness and appetite among the consumers (MLIs).

Credit guarantee was born with a promise to ensure the availability of bank credit without the hassles of collaterals / third party guarantees to the entrepreneurs and others, Initially, it was established for Micro and small enterprises since the year 2000 as CGTSME (Credit Guarantee Scheme for Micro & Small Enterprises). In 2014-15, the credit guarantee got a huge boost with establishing National Credit Guarantee Trust Company(NCGTC) and the scope of credit guarantee expanded to include educational loan, MUDRA loan, Skill Development Loans, and Standup India Loans. The scheme operates with a pre-condition that these loans are not covered with any collateral security/personal guarantee by  the MLI(Member Lending Institutions)

The main objective is that the lender should give importance to project viability and secure the credit facility purely on the primary security of the assets financed. The other objective is that the lender availing guarantee facility should endeavour to give composite credit to the borrowers so that the borrowers obtain both term loan and working capital facilities from a single agency.

The Credit Guarantee Scheme (CGS) seeks to reassure the lender that, in the event of a borrower, which availed collateral-free credit facilities fail to discharge its liabilities to the lender, the Guarantee Trust would make good the loss incurred by the lender up to 50/75/80/85 per cent of the credit facility.

The recent schemes:

The need to analyse these have cropped up because recently Govt made two new schemes to support MSMEs who are facing a huge challenge for survival in the wake of a global pandemic caused by COVID 19 and sharp lockdown imposed overnight without giving time to reduce the activities in an orderly manner.

ECLGS (Emergency Credit Limit Guarantee Scheme): It is a top-up loan for existing borrowers within a cap of Rs 3 lakh crores. The scheme envisages 100% guarantee support from NCGTC.

CGSSD (Credit Guarantee Scheme for Subordinate Debt): This is another scheme to support distressed entities to secure a subordinated debt to the extent of 15% of their contribution and seek a restructuring of the bank loan to revive the business. This scheme is piloted by CGTMSE and the maximum cap is at Rs 20000 crores.

The schemes generated a lot of hope as well as the hype.

Hope because many entrepreneurs who are already reeling under distress due to slowing economy over the last few quarters and sudden lockdown have got a window to stabilise the finances as the loan under the scheme is a cash loan with an extended repayment plan.

It is hype because policymakers have positioned it as the panacea for the entire MSME segment thought the relevance is not inclusive and just top-up for those who are having loans. Further its utility is unlikely to benefit to the fullest extent unless there is a revival of demand for their trade.

The concerns around credit guarantee schemes and its affinity to primary consumers:

There is a proverb. It says every journey should start with the end in mind. This is relevant here for lenders. Because the lenders are the primary consumers of the credit guarantee schemes. After all, they are responsible for the recovery of the money that is lent and they ought to return to the depositors with the promised return.

Hence it is obvious for them (lenders) being concerned about the efficacy of the Credit guarantee with reference to claim settlement to ensure that they get back their money rather depositors money safely.

Claim settlement: The guidelines for settlement of the claims are very much published on their website. What is relevant for how effective it is…….

There are two important issues. One is Guarantor’s insistence for proceedings of staff lapse if any in handling the loan account. The second one is the mandatory filing of the case before the court/DRT before making a claim under guarantee. Another important related issue is lack of access to Bankruptcy Avenue instead of court proceedings.

Many of the ex-bankers whom I have interacted are of the same opinion that CGTMSE seeks confirmation of non-existence of staff lapse within the bank. It is an obnoxious demand because the staff lapse may arise for many reasons not necessarily relating to the loan transaction. Secondly depending upon the banks’ internal proceedings reflects badly on the underwriting standards within the Credit Guarantor’s set up. 

Reliance on Banks’ internal process to deal with lapses is the source of uncertainty for the banks to seek a claim from the Credit Guarantor.  Thus their appetite for credit guarantee in lieu of collateral security is low. Probably that is the reason bankers are not very enthusiastic about the schemes floated by the Govt.

It is unfortunate that despite being in existence for 20 years CGTSME and NCGTC have not evolved their underwriting standards and rather relying on certain internal processes of lenders having different purposes and outcomes. This is probably hindering the growth of credit guarantee market thus depriving the opportunity for many entrepreneurs to go for orderly capital formation path.

Filing a case for recovery before preferring claims: It reflects the unwillingness of credit guarantor to accept the risk though the guarantee meant to do so. It suggests that the failure of a business is unacceptable. It is a fact that the reasons for failure are not necessarily with the borrower. The industry and economy-related factors will also decide on the performance of a loan account. Another significant issue is there is no enabling provision to deal with the issue under bankruptcy code. Probably that would help to give new lease of life and or quicker resolution than seeking court intervention.

Credit guarantor should have provided a broad range of solutions to deal with events of defaults and the option of fling case should be invoked very discretely.  

Conclusion:

The Credit guarantee option is very good for entrepreneurs who lack the collateral security to start the venture. However, the Credit Guarantors should do more to convince MLIs who are their primary consumers of the products through modifying their operating guidelines. Being set up exclusively to promote the entrepreneurship among the economically weaker section of the society, they must evolve a broad range of solutions to deal with failures that are endemic to entrepreneurship journey.

COVID 19: The key risk for MSMEs- Liquidity or Solvency?

Post lockdown there is confusion about MSMEs’ real challenge- Is it temporary liquidity mismatch or long term sustainability.

Recently RBI announced a relief of moratorium (to pay EMIs) to businesses for three months. There was indeed a sigh of relief for many MSMEs as the cash flow is completely dried up and the obligations are firmly staring due to sudden disruption under COVID 19 lockdown. In addition, RBI also extended the relief from NPA classification for three months for the accounts in arrears.

They are welcome steps but will they suffice?  Whether MSMEs will revert to normalcy even if the lockdown is removed now and economy return to normalcy immediately.

Unlikely …….

Because each industrial segment has its own timeline to return to normalcy assuming every other factor is constant, and COVID19 will be at a manageable level.

Recently, Mr Deepak Parekh, an outstanding public personality and thinker said that the recovery may not happen at least for the next nine months. He also urged RBI to extend debt recast to enable the businesses to cope with the challenge.

I believe that it may take three quarters or more before we can see the normalcy returning to pre-March 24 level(the date of announcing the lockdown) in view of the steep demand destruction and uncertainties in the general economy that may lead to restricted consumption and investment.

If the general the situation should persist for such a long time, then obviously the question is whether the challenge for MSMEs is of Liquidity(cash crunch)  or its solvency (survival).

It is indeed solvency. The measures announced by RBI will not be sufficient to save the MSMEs from distress.

The present measures ( Moratorium and Suspending NPA classification) will last till May 2020.  It requires one to think of the possible solutions in a longer-term horizon. We are of the view that the policymakers need to extend more measures and options to deal with the crisis and to take away the pressure points in the relationship between creditors and borrowers.

What are the other options?

a)      Debt Restructuring

b)      Resolution support

Debt Restructuring: Debt restructuring is beneficial in the long-run to save from the distress and create breathing space to mitigate the impact of sudden disruption. MSMEs must look at this option without any hesitation. However, they have to have a properly drafted debt recast plan to realise its value.

Present debt restructuring scheme is available to those whose accounts are classified as standard and not availed the scheme earlier. This will last up to December 2020. Govt may prevail upon RBI to allow those who had already taken before this CoVID-19 event to help them as well.

In any case, it is desirable to wait (to apply) until the clarity in the situation emerges, maybe till June /July or before the account turns NPA.

Resolution Support:  There are many firms which have been sustaining their business on informal sources and even the suppliers also extend credit to them.   Some of the MSMEs are used to funding the business through multiple business loans from different banks and NBFCs.  In the present circumstances, people with diverse borrowing practice will suffer the most. Their numbers are not few. Bank loan restructuring scheme won’t solve their problem.

Supporting these organisations is important because they are huge in number and secondly they play an important role to facilitate return to normalcy in the economy.

The revival of these debt-laden yet potential firms require a different approach. The normal debt restructuring is not effective to help them sail through. There is a need to create a new roadmap within the existing institutional and policy measures.

Govt may help them by leveraging two instruments: Reactivating MSME revival framework and using the service of Insolvency Professionals to create a resolution framework.

Govt of India in the year 2015 came out with a framework to assist stressed MSMEs to undertake a Corrective Action Plan(CAP) to give the second lease of life. It is titled as “Framework for Revival and Rehabilitation of Micro, Small and Medium Enterprises (MSMEs)” In consonance with this framework, RBI came out with new regulatory guidelines in 2016 ( ref: RBI/2015-16/338 FIDD.MSME & NFS.BC.No.21/06.02.31/2015-16 dated March 17, 2016   )

This framework is quite comprehensive. A little bit of clarity and more inclusivity of interested persons /stakeholder will definitely help to find a viable solution to through resolution.

Some of the rules can be simplified For example it asks for forming a committee at the bank level to consider the cases and classification of the loan restructured as NPA.  We suggest that in place of the committee, Certified Insolvency Professionals who are specially trained and certified to handle the cases of distress may be roped in. Insolvency and Bankruptcy Board of India (IBBI) has empanelled a large number of professionals countrywide.

This special pool of competent people may independently assess the viability and bring on board all the interested persons to create a solution that will work at the grass-root level.

Another point is keeping the asset classification standard will obviously incentivize Banks and NBFCs to opt for this route.

Lastly, any resolution requires all the stakeholders to accept the longer timeline to recover their dues. Also, this mechanism may require that Banks and others commit to a lower rate of interest for the past as well as future. Still, it is a better option than One-time settlement that calls for a deeper haircut and causes permanent damage to the credit history of the borrowers.  Whereas reviving potential business asset leads to the huge economic multiplier effect.                   

Conclusion:

The situation is alarmingly different. Explicit policy support is the need of the hour. Without active policy support, many of the  MSMEs may not sustain in the long run. Govt needs to bring a comprehensive broad range of options to support the distressed entities to overcome the challenge posed by COVID 19 crisis without any element of uncertainty. It is because what MSMEs are facing is not just immediate liquidity risk alone but also long term solvency.

Covid 19- Banks need to be more flexible to support the businesses

Evolving scenario due to Covid-19 endemic is creating a huge liquidity crunch for many businesses especially MSMEs. Banks should support by extending loan with very flexible terms.

Post lockdown announced by the Hon’ble Prime Minister, the economy suddenly came to grinding halt. There are hue and cry in the business community for a rescue package to help them to overcome the challenge they face in managing the cash flow. In response, RBI Governor on March 27, 2020, announced to extend the moratorium on loans.

Alongside few Banks have announced schemes to support the business to tide over the acute cash crunch.

Against this backdrop, we reviewed the CoVid-19 loan of few banks on how they support the struggling businesses.

COVID-19- is an  uncertainty based risk:

The present global crisis triggered by the Coronavirus outbreak is one of its kind never seen since the organized lending (under the regulatory oversight of central banks) is started in the global economy. The pandemic is not a routine risk confronting the businesses. No positive probability can be assigned to estimate the likelihood of recurrence. It is an uncertain risk and can be classified as an act of god. In other words, it can be described as a force majeure event.

 Since it is a special event and an extraordinary situation is developed and still evolving. Its longevity, spread and impact are still unclear.  The world economy is entering into uncharted water and does not have the capability to estimate the impact.

Hence the situation demands special attention to those who need help to stabilise the economy by supporting the economic enterprises to prevent  their collapse and or value destruction due to their inability to adjust to the new challenge.  It is more pertinent to the MSME  segment who are shouldering the social burden of engaging unorganized & semi-skilled labours and largely financially weak to navigate the challenge from Covid 19.  

Banks have an important role to bail out the business in the scenario

The circumstances we are discussing is extraordinary and the global community never experienced this in the past.  It needs special attention.  The consequences on the business as well as finance providers are needed to be handled with the utmost sensitivity to the people who are affected.  

RBI and Banks are responding well.  Many banks have shown an inclination to assist the businesses in many ways. We have been seeing the press publications of special loan products launched by the banks in India to help businesses to tide over the cash crunch. Their enthusiasm is amazing.

I had a chance to review the special COVID 19 loan products launched by three banks recently.  Though the narrative signifies the commitment and concern for the businesses affected, the finer reading of the products is highly disappointing.

Out of three banks, two are major nationally important banks and. The glaring aspect is- products seeks to limit the eligibility to those customers whose account/s is graded SMA0 only. (SMA0  grade indicates the account which is a standard asset in the books of the bank and not having any adverse features in the operation. Other two categories are SMA1 and SMA2. These two categories are also standard assets but suffer from some deficiency in meeting their commitment on a timely basis).

There are two important points which negate the relevance of the Covid-19 loan products of these banks:

a)      Narrow scope: Limiting the eligibility to SMA0 means exclusion of a very large section of the borrowers to get accommodation, especially MSMEs. They lack the financial flexibility to remain SMA0. It is quite likely that banks mightn’t have made an assessment of what proportion of their customers will be eligible. As a result, this product is just a narrative than a source of comfort in the trying circumstances for many.

b)      The product does not recognize the evolving scenario: In the global crisis like the one we are witnessing, the risk across the asset class converge as we had seen in the Global Financial Crisis in 2008. In other words, the riskiness of SMA0 and SMA2 will be the same in this scenario. The distance between these two asset classes is not significant enough to predict the better default probability. Because they are going to confront the challenge in almost equal level. If the business scenario deteriorates and the default chances will be almost the same.

In the nutshell, the products of two banks have narrow relevance and have ignored an important aspect- how default probability will behave in the face of evolving uncertain scenario. Unless it is made more inclusive and having flexible terms,  there are high chances that many of the standard loan accounts may not be able to navigate the challenges, especially in MSME space.

Conclusion:

Businesses are confronting a very unique challenge and scenario is going affect them in almost equal measure for a large section of the business community. Banks need to structure the Covid-19 loan products to make it relevant to bail themselves out.

Loan Restructuring support for MSMEs –Extension is positive

The extended restructuring window to assist the MSMEs in distress is a welcome step. However, its utility depends on how we draw the restructuring proposal.

Finance Minister Mrs Nirmala Seetharaman in her budget speech announced that the scheme of one-time restructuring of existing MSME loans that have defaulted but are not non-performing as on  January 1, 2020, will be extended for one more year. Consequently, RBI also took steps to issue the notification in this regard.

The key points as below:

1.      The aggregate exposure, including non-fund based facilities, of banks and NBFCs to the borrower does not exceed ₹25 crores as on January 1, 2020.

2.      The borrower’s account was in default but was a ‘standard asset’ as on January 1, 2020, and continues to be classified as a ‘standard asset’ till the date of implementation of the restructuring.

3.      The restructuring of the borrower account is implemented on or before December 31, 2020.  

4.      The borrowing entity is GST-registered on the date of implementation of the restructuring. However, this condition will not apply to MSMEs that are exempt from GST-registration. This shall be determined on the basis of exemption limit obtaining as on January 1, 2020.

5.      It is clarified that accounts which have already been restructured in terms of the RBI’s previous circular dated January 1, 2019 shall be ineligible for restructuring under this circular.

The impact:

Extending the support by another nine months is a good step to assist the MSMEs to restructure their business and work out a turnaround path for themselves.

In the ongoing economic slowdown and growing incidences of Covid-19 outbreak, many MSMEs may suffer liquidity stress and require some breathing space to realign the financial model. If any entity experiences symptoms of distress, it is better to approach the bank to restructure the loans than seeking short term high-cost borrowing to keep the account regular.

However, we observed that due attention is not given to draw the proposal to avail its benefit.

The key factor of failure of restructuring – Not synchronizing  with cash flow:

Recently I met an entrepreneur who has availed this facility in the month of September 2019. Despite restructuring, he is still grappling with the same level of distress as it was prevailing before. Upon reviewing the revised repayment schedule, I found that it was drawn arbitrarily and there was no linkage to the business characteristics and cash flow from the operations. I found that the restructuring is undertaken without drawing financial projections and solely with the focus of avoiding to classify it as NPA.

It is not the right approach. The scheme is a one-time opportunity for both borrower and banker to undertake a course correction so that precious public money will be returned in an orderly manner. It is an appropriate context to review the business holistically and draw a  realistic financial projection for the few years and draw the repayment schedule based on that.

Arbitrariness in fixing the revised schedule will not serve any purpose and likely to render the project unviable leading to perennial distress. A situation can be easily avoided provided we give little attention to make a detailed and realistic financial plan.

We suggest  a simple process to make restructuring successful:

1.      Review the business holistically and understand the challenges and opportunities  in a very unbiased manner

2.      Draw a realistic financial projection based  on step 1

3.      Identify the needs – Rescheduling the existing loan/s, carving the  deficit, seeking additional funding, stretching the repayment holiday etc

4.      Make a comprehensive formal proposal and don’t accept the changes if it does not support the planned turnaround.

5.      Highly desirable to seek expert support while drawing a revival and restructuring plan

Conclusion:

A sustainable and enduring turnaround from financial distress requires a very meticulous approach. Restructuring of bank loan is an important step in this regard. The exercise needs to be approached with the utmost care and due concern to cash flow. As emphasized by the RBI circular, it is a one-time benefit for stressed MSMEs to undertake course correction. Don’t ignore the basics.

SMEs in Distress- Beware of ‘Soldiers of Fortune’

When in distress, many SMEs chase new money and normally end in traps of mischievous elements who make tall promises and swindle money.

I recently met one entrepreneur after a gap of two years. Once he had a flourishing business in excess of Rs 50 crores. He had built the business by himself brick by brick. Having come from a middle-class family, despite the success, he stuck himself to the higher values-Extremely affable, god-fearing, and committed to meet promises.

The back to back the introduction of policy measures – Demonetisation and GST-pushed him to the slippery position. Before he could make the required changes in the business process and financial management, the situation went out of control. The liquidity stress started appearing and he started defaulting on the payments resulting in personal insinuations from the providers of loan and suppliers which he never experienced in his life. On the other hand, the trade cycle got disrupted and order flow dried up as his principals started realigning their business to adjust to the new reality.

While he was battling in multiple fronts he started getting offers for a comprehensive bailout. Obviously these offers attract him as he was already exhausted to deal with demand from various people.

They offered to arrange a very large sum and consolidate the borrowings into a single source along with a very attractive rate of interest much below the RoI applicable to well-rated borrowers despite being highly stressed.

The waiting is still on…

Unfortunately, he is still hoping for the new money ever after two years. In the meantime bank and NBFCs have initiated recovery action against his properties and have been establishing their rights.  The business is closed and the family is living with agonising pain and praying for better days.

It is commonly observed among the entrepreneurs in distress:

Most of the entrepreneurs in financial difficulty look for quick solution fearing that continued distress may affect the business and their reputation.  Having pledged every asset to lenders they fear the impact of distress much more than what it really is. That in turn, prompts them to seek an instant solution. They tend to react to any proposal with much more intensity and avoid confronting those mercenaries to understand their credentials.

Fortune soldiers- Mercenaries who boast  about exclusive access to money:

These agents claim that they have an exclusive arrangement to secure money at very soft terms. They show a lot of empathy and promise to work for clients with all the sincerity.  If we analyse the experience of interaction with these fortune soldiers there are commonalities in their approach. Some of them are :

• They present as if they enjoy a high degree of confidence of the financiers.
• They seek very small fraction as advisory fee and a still smaller fraction as advance
• Terms are so compelling to justify taking risk of giving advance
• The advance will be packaged as a commitment fee or insurance premium to bring the money from abroad etc
• They do not reveal much about the financier.
• They prop up the  names of people in higher offices
• They set the meeting in very premium places

Eventually, their target is to extract advance as much as possible, keep giving excuses to frustrate and eventually make one go away.

Entrepreneurs are more vulnerable in India for financial distress than in any other country:

The options for turnaround are limited in India. The general perception of the stressed enterprise is highly prejudiced. Many see them with suspicion of laundering money from the firm. Being in stressed and struggling lonely, entrepreneurs are obviously vulnerable.

Many take risk of giving the advance in the hope of getting a large sum. Unfortunately, many entrepreneurs have lost a huge sum of money in their hunt for fortune.

The greater damage will be when an entrepreneur diverts his attention to chase this route and keep away from immediate tasks.  Lack of credible proposal may prompt recovery action leading to the collapse of the business and destruction of enterprise value.

How to deal with this situation?

If anyone offers a deal which is cheaper than a bank loan, it is to be examined thoroughly before committing. We have not still come across a charity extending helping hand to distressed businesses.

Entrepreneurs should desist from the temptation to seek quick money and allow them to be drifted away from reality. It is nothing but a distraction to find a viable solution within their reach and exacerbating the distress.

Keep your attention to immediate tasks such as talking to creditors and suppliers.

Many a time we falsely blame the absence of money for our distress. However, the fact is that most of the reasons for distress lie elsewhere and pumping more money won’t solve the problem.

Review the business strategy with the support of professional advisors. With professional assistance, you can build a new roadmap and lower the risk to sustainability.  When an outsider is roped in, fresh scrutiny will open the mind to explore alternatives.

Distressed entities require better policy support:

MSMEs need better implementation of the law to assist entrepreneurs to undertake course correction.  Unfortunately, half-hearted implementation of regulations to support distressed entities in India is preventing entrepreneurs from taking an orderly path to turnaround. This will naturally make them fall prey to unscrupulous elements.

The Insolvency and Bankruptcy code needs to be made universal.  The option of restructuring of loans should be enforced upon all the banks(public/private) and NBFCs.

In the present era of globalization, the vulnerability for risks is unlikely to recede rather likely to go up. Thus a stable policy environment is needed to support the turnaround of distressed entities. Also tagging prejudice of criminality with distress situation must end.

Conclusion:

Entrepreneurs in distress should appreciate that there are no short cuts to come out of it. Recovery from distress is an orderly process and time consuming requiring one to review in entirety and draw a new strategy.

 By

Anil Kumar Shetty, Founder, SME Advisors

Bank merger: Re-entry to the pre-1969 era for small businesses?

There is an apprehension that merger among the PSBs may lead to deprivation of opportunities for small businesses and startups to obtain a bank loan.

Govt has been pursuing the policy of consolidation of public sector banks(PSBS) into  4 to 5. Already SBI subsidiaries are merged. Last year another round of merger was implemented under the Bank of Baroda. Now again we are witnessing one more round of mergers.

We are looking at how this plays out in supporting small businesses that were one of the reasons behind bank nationalization undertaken in 1969.

Contribution of PSBs in Lending to MSMEs

It is a fact that PSBs are shouldering the responsibility of delivering credit support to the needy section of the society- be it agriculture, MSME, etc.  PSBs are always very magnanimous in supporting the MSME ventures, patronized innovations and have extended the long & short term loans. They have been wholeheartedly participating in Govt Schemes like PMEGP.  The support for financially distressed entities is commendable and they are meticulously implementing guidelines from Govt and RBI.

How the scenario may change:

With the consolidation, it is likely that the business at the branch level will also be consolidated like it is done with other mergers in the past. This will lead to lesser attention span for the extra customer load the branch will have to deal with. The attention span is important for the reason that social sector banking activities require handholding of the customers that is the hallmark of public sector banking service since 1969.

With reduced branch presence of PSBs, the access points will dwindle and invariably small businesses will have to have banking business with private peers however what they likely to miss is credit support the way they get in PSBs.

Thirdly even for PSBs, more orientation will be towards profitability since capital efficiency was the reason for consolidation. That may drive them to reorient towards large value exposures.

Private Banks show no or less keen to lend in priority sector lending:

It is a fact that private sector banks show little or no interest in priority sector lending. They prefer other via media to engage with such clients resulting in higher cost of credit for end users. Also, they are happy to compensate for the gap through alternate options extended by RBI.

They are very particular about securing their loans by taking collateral of fixed assets. Even though Govt has implemented CGTMSE scheme to extend credit guarantee for small business loans and it has been here since nearly 20 years, private banks have not shown much inclination to extend loan under this window.

They are obsessed with securing their loan more than supporting the entrepreneurship.  As a result, many budding entrepreneurs will not have access to bank credit and will be forced to seek support from predatory lenders.

If one looks at the profile of the product of many private banks, they are more keen to finance immediate needs than supporting capital investment. Support in distress is a far cry.

Role of RBI needs special mention:

Presently priority sector lending is handled by RBI. Most of the compliance with its directions are coming from only PSBs. With the reduction of their share and the increasing presence of private banks, we may see social sector lending will be reduced to islands everywhere.

Further, the RBI itself has created avenues for private banks to avoid direct participation in the priority sector lending that will further add to the declining credit flow.

Sadly RBI does not measure the flow of credit at the grassroots level rather relies on secondary data from Banks.

One can conclude that RBI action on this front is more of administrative and not accountable for the flow of credit to these needy segments.

How a merger may impact different sectors?

Mergers and consolidation of PSBs may create a huge vacuum of space of social sector lending. We believe that Micro and small enterprise will suffer more than agriculture because agriculture may get support from Coop Banks and Societies.  Also, political activism may help agriculture, that privilege is not available to MSMEs.

The way forward:  “Bring in a new law for creating sustainable financial architecture”:

Since consolidation exercise is underway, it seems there will not be any rethinking. However, Govt has to act to alleviate the apprehensions of a lack of access to credit from this process to small businesses.

In these circumstances, it is necessary to bring in legislation to create a sustainable financial architecture that binds regulator (RBI) and the banks to undertake lending to priority sector irrespective of ownership. They may be incentivized, extended liberal guarantees scheme coupled with provision for punitive action for not adhering to stipulations.

The notable benefits are :
a) It will make lending norms a legal mandate and ownership neutral.
b) It will universalise the access to credit in any region or activity

Conclusion:

Bank merger without implementing an alternative model to support social sector lending will leave a huge vacuum and may affect the economically weaker section resulting in further widening of inequality. This may end up at creating a pre-1969 era of lack of access to credit for small businesses and others. Legislative action is necessary to preempt this scenario. 

By: Anil Kumar Shetty, Founder SME Advisors (email: [email protected])

Non-classifying stressed MSME Loan as NPA- It is not enough

Non-classifying stressed MSME Loan as  NPA-  It is not enough

Govt’s recent decision to direct banks not to classify stressed MSME loans as NPA is just a temporary relief and it is not enough to stabilize the segment reeling in distress.

Recently Union Finance Minister announced that banks will not classify stressed loans in MSME segment as NPA till March 31, 2020, thus restraining them from initiate recovery action anticipating that this will help the stressed entities to recover themselves.

Though her concern to assist MSMEs to come out of distress is appreciable, the measure in itself is not enough to stimulate the revival of the stressed entities.

MSME segment is reeling under massive slowdown beginning from 2018 due to steep decline in the demand for their products and services. Many of the MSMEs are part of the production and marketing value chain of the large companies in sectors like automobiles. The slowdown is witnessed in the sectors like the automobile has a cascading impact on the financial viability of many MSMEs countrywide.

The ongoing slowdown is unlikely to recede in the near future.  Though the experts are having divergent views on the course of likely time period the slowdown will persist, it appears that demand recovery will take a few more quarters to gain momentum and this is expected to cause disruptions to many MSMEs.

Secondly, the segment is also experiencing the negative impact of the structural changes happening in the many industries due to changes in the way the buyer-seller interact on account of technology-driven processes and solutions.

Thirdly the segment is still experiencing the challenges from the lingering impact of economic measures such as demonetization and other policy actions either industry-specific or broader economic.

MSME Segment requires more than the standstill from the recovery:

The promise of standstill in recovery action can be a good measure provided the economy is in recovery or growth mode. That would have created more breathing space for many temporarily stressed entities and would have helped them to set right their finances in the next two quarters. However, given the present circumstances of negative sentiment about the economy prevailing in the country, this measure is of no help either to banks or entrepreneurs.

What are the most feasible solution for reviving MSME segment?

There were few measures announced by the Govt in the last few years and more recently on January 1 2019. These measures coupled with few more amendments can become a strong anchor to promote the revival of MSMEs. We discuss them as below:

Enforce  rigorously the RBI guidelines issued on January 2019 to restructure  stressed entities:

RBI had issued guidelines to support the restructuring of stressed MSME loans on January 1, 2019, without classifying the restructured loans as NPA. The guideline incentivizes the banks by allowing them to not to treat such restructured accounts as NPA  The new guidelines will be available on up to March 2020.

Effective implementation of these provisions definitely of help to stressed MSMEs. They will get breathing space and can reset the growth strategy. However, the implementation so far is far from satisfactory.

Extend resolution support to revive the stressed entities to give rebirth to them that involves writeoff/waiver of a part of dues to banks:

Many of these MSMEs are victims of the inability to adjust to expected and unexpected changes in the external environment like Demonetisation and GST implementation.

These stressed MSMEs have the potential to turnaround and can contribute significantly to the national economy as well as local communities in terms of job and earnings. However, the accumulated debt burden during the last few years of distress makes them unviable to face the competition. The level of debt (from the bank and others put together) is beyond the sustainable level.

These units require broad-based resolution support. The resolution support must have enabling provision for reassessing the debt servicing capacity and identifying the level of sustainable debt.

Taking a cue from the performance of IBC (Insolvency & Bankruptcy Code), we feel that MSMEs may be extended support through write off/waiver of dues as a measure to revive the segment. The big loan accounts are resolved with substantial haircuts under IBC route. In some cases, it is more than 50%.  A similar provision for sacrifices needs to be extended the MSME to revive the potentially viable MSME units outside IBC purview. The lenders are aware that the market for the assets of stressed units is very poor. The recovery under the regulatory mechanism is unlikely to provide any substantial gain to the lenders. The contribution of revived MSME units to the economy is expected to be more than the amount of possible sacrifice made by the lenders.

MSMEs needs structured support to tide over financial support:

Many of the stressed MSMEs have the potential to turnaround. There are many regulatory and administrative guidelines from RBI and Govt to help these stressed MSMEs to overcome the challenge. However, these MSMEs require a very comprehensive framework that addresses their financial woes and helps to find a structured approach to cover the gamut of issues, something akin to Insolvency and Bankruptcy Code 2016 without the need to through the process of Insolvency.

“Framework for Revival and Rehabilitation of MSMEs” – A better alternative:

Govt of India & RBI had implemented the above framework in the year 2016 (RBI/2015-16/338 FIDD.MSME & NFS.BC.No.21/06.02.31/2015-16 Dated March 17, 2016). The framework addresses the financial issues holistically and is capable to assist stressed MSMEs to recover the lost ground.  The framework can help the stressed MSMEs to firmly anchor themselves to come out the challenges. The framework may be amended to make it versatile and become an anchorage to stressed MSMEs. Some of the amendment can be as below:

a)      Add the provision of waivers/write-offs:  If this framework is amended to discover the sustainable debt and thereafter setting a stage for resolution, this can be a quick and supportive avenue for stressed MSMEs to seek turnaround.  

b)      Extend a fresh round of finance especially working capital: Also these MSMEs are normally at the receiving end and unlikely to generate liquidity to support. Thus the working capital facility is paramount to make restructuring and turnaround support meaning full and constructive. To make it better it is desirable that the firms may be given another avenue of support in terms of extending an additional round of working capital finance to revive the business. Though the framework allows extending additional funding, it is not implemented and thus remains a bottleneck for revival.

c)       New debt may be supported by CGTMSE: There is always an element of hesitation to extend fresh support for stressed firms. This requires explicit policy support to extend additional finance that may involve CGTSME.

d)      Simplify its administration: Present guidelines seek to involve people from outside including  Govt dept in the process of approving restructuring. Involving others may delay the process and resolution of stressed debts require timely intervention. Further having comprehensive framework backed by regulation and laws itself can create a conducive environment for enabling the arrival of a mutually understanding solution. Hence the participation may be limited to engagement between lender and borrower and/or their advisors without inviting outsiders can improve the speed of the process.

e)      Allow the advisors to assist: Bank loan restructuring alone is not sufficient. The turnaround of stressed business requires more than delaying loan repayment.  The turnaround of stressed business requires support from experts from fiancé, legal, and /or the subject matter.  It is better to involve the experts to structure a resolution plan and enable speedy implementation.  

Conclusion:

Distress in MSMEs requires a more holistic approach to assist the stressed units to come out successfully.  Instructions for standstill will not help. The present guidelines need to be reviewed and amended to support a speedy revival of the potential units and bring the buoyancy in the segment. Framework for Revival and Rehabilitation of MSMEs impended by the Govt with few amendments can be a robust platform to achieve that goal.

Equitable Access to MUDRA Loans – a need of the hour

MUDRA loans can transform the lives of many micro-enterprises at the lower end of economic strata, however, the delivery process requires to be toned up.

I have been tracking a story of a woman entrepreneur who had been running a small grocery shop with a major focus on milk vending business in our area. We have been here in this locality for more than five years. Till recently we have been buying milk from her. Unfortunately, she closed her shop recently due to non-availability of adequate finance and the inability to raise the required capital to have her own license to vend milk from KMF.

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