Adherence to the Regulations by Lenders – Enforcement is needed
The pandemic is still raging and many entrepreneurs are living under the shadow of uncertainty with regard to restructuring.
We have been assisting the couple to deal with financial distress emanated from COVID 19 pandemic and consequent lockdown in the early last year. The flourishing restaurant business nosedived to a complete standstill. Thanks to their spirited reworking of the strategy and increasing online orders, the business remains afloat. Though the profitability is still a far cry, there is a glimmer of hope and optimism that the days ahead will be better. They have few loans from NBFCs and banks as well. We all know that when the going is good, the enterprises tend to borrow a business loan that comes without any collateral security and it is quick in delivery of the loans. Unfortunately, the Covid 19 made things go very bad. NBFC which had been recovering the regular instalments till the pandemic did not show any remorse at the situation rather insisted on payment though there is not enough cash flow. The borrower made repeated requests for restructuring the loan and a softer repayment schedule for the balance outstanding which they ignore.
What is astonishing is- the approach of the NBFC to ignore RBI’s guidelines on One Time Restructuring (OTR). The subject party is eligible to seek OTR as per RBI norms. Despite repeated requests to consider under the RBI Scheme of OTR, they ignored the request.
The question is- what is the sanctity of the regulations which is not adhered to by the NBFC
In the midst of the COVID 19 pandemic and post lockdown, the Reserve Bank of India came out with series of regulatory guidelines to banks and Non-Banking Finance Companies(NBFCs) to extend relief to customers to overcome the financial distress and smoothen the process of recovery of loans in an orderly fashion. Also, Govt of India came out with many guidelines to help the MSMEs to overcome the stress.
RBI issued two comprehensive guidelines on August 6 2020. They are: Resolution Framework for COVID-19-related Stress (for personal loans and corporate exposures) and Micro, Small and Medium Enterprises (MSME) sector – Restructuring of Advances.
The circulars were very clear and unambiguous in their intent. It has given enough flexibility to enable banks and NBFCs to restructure loans with liberal terms and addressed the key concern by waiving the condition to downgrade the loan to non-performing status.
In the first reading, it sounded as if it is a panacea for avoiding conflicts between banks and borrowers. There was a great sigh of relief among MSMEs that there will not any harassment for recovery rather the process to recover from the COVID 10 pandemic will be smoothened.
Many MSMEs have given a request for restructuring in view of the delay in the onset of business recovery.
This particular couple also made a request way back in September 2020 to restructure the loan to NBFC. However, it was very agonizing to see that the lender neither took serious note of the request nor shown any inclination to implement RBI guidelines. They were absolutely cold to the proposal. In fact, there was no one to discuss the proposal.
It is not an isolated case rather than a system-wide practice. Despite the standard conditions set by RBI for identifying the eligible entities to undertake a restructuring, the banks and NBFCs are not enthusiastically taking up and do not see any obligation to act under the regulations. Their action is very patchy.
The obvious question is- what is the sanctity of the regulations issued by the RBI. Who will have to oversee the implementation?
The regulations are announced as a response to demand from industry bodies and citizens. If it is ignored by the lenders and if they focus on recovery, it will not serve any purpose.
Bank/NBFC is a party for the transaction. It is prudent to leave it to their wisdom to decide on the restructuring proposal? Is there any department or a statutory body which is having the supervisory responsibility to enforce the regulation promulgated by RBI? Indeed it is needed.
Regulations and policies are meant to remove personal prejudices, individual discretions and notably, it will facilitate the contract between two parties conflict-free. Having regulations on OTR is indeed positive for the MSMEs to overcome the covid induced stress. However, its significance is lost when there is no appetite among the lenders to implement.
An agency from Govt/Regulators will have to look at the efficacy of implementation of schemes. This is needed to eliminate the uncertainty and enable effective implementation. It requires setting up a mechanism to help the borrowers to notify their desire to seek restructuring in an independent platform and such request should be referred to Bank /NBFC headquarters for further action.
Setting up such a mechanism with the online channel is quite easy and requires minimal investment. The benefit will be multifold. Having provided the platform, the process will become more transparent and the banks & NBFCs will be compelled to take an objective view of the proposal. It will take away the uncertainty. Brining more stressed business assets into productive use will result in a more economic capacity to grow.
Restructuring is beneficial to all the stakeholders:
Restructuring of loan is one important step in the broader agenda of the revival of stressed business. Unfortunately, there is an element of restlessness among the bankers and NBFCs to undertake this. Rather many are willing to call the customers for One time Settlement of the loan; a sort of inducement. It is not correct. A business of an individual member of the society constitutes an economic asset of the whole country.
Secondly, it is in the interest of banks and NBFCs to hold a dialogue with stressed customers and create a viable path for turnaround. After all pestering, the borrower in the hour of the crisis engulfing the whole society will only lead to self-inflicted injury to these institutions than bringing meaningful recovery.
The fact is in the long run the restructuring is indeed beneficial to the banks and NBFCs though they have to endure short term mismatches in the asset-liability management.
COVID19 Pandemic is causing havoc in the economy. Small business owners are bearing with brunt. The OTR scheme is very much important for stabilising their business and finance. RBI and Govt should make its implementation very effective and facilitate fixing the stressed relationship with lenders so that they will move to revive their business. That will facilitate faster economic recovery.
A weak resolution environment is negative to promote entrepreneurship
COVID 19 exposes the vulnerability of MSMEs in the face of uncertain events. This shows a need for a robust resolution mechanism to deal with creditors and find a viable path forward.
I met with a group of partners of a restaurant business who had been doing extremely good till the COVID 19 pandemic started. The format was very unique in the industry and has the potential to be replicated elsewhere. In fact, the promoters had drawn an ambitious plan to expand the footprint through the franchisee route to take it is to different parts of the city as well as pan India. Pandemic and consequent sudden lockdown had made the calculations go haywire.
The business just slipped out of control. They could not salvage the business. The creditors and suppliers demand was too much to bear with. The bank loan which was well within the normal level till the lockdown suddenly became too much to digest as there was no income flow. The leased property, wherein they invested more than Rs 1 crore to create a unique theme, had to be demolished as the rent payment becomes burdensome. With the removal of the store from the place which was part of their brand, there was no chance to return to the normal business. The condition deteriorated to the level beyond their imagination in the wildest of dream and all happened in just a matter of a few months.
Now the partners are helplessly watching the unfolding of recovery actions from the multiple lenders who have extended business loan at a high rate of interest with a short maturity.
The absence of policy support to deal with uncertain times is the central issue
The pandemic was unanticipated rather an uncertain event. Equally the lockdown was sudden and there was no time to think of alternative options. None of these was under their control.
Today we are in a situation wherein there is no regulatory or legal framework to enable entrepreneurs troubled by uncertain events to carve out a viable path to return to normalcy. The uncertain events affect all in equal measure. However, what is missing is a legal framework that will distribute the pain without letting anyone in the contract to be benefitted or remain unaffected whereas another the party will remain in an advantageous position at the previous level or better. For instances when the lender is a party to the contract, the borrower undergoing the uncertain event will remain indebted to the fullest extent because there is no statutory binding for the bank to sacrifice a fraction of the loan to make the business viable or allow to service the debt with a haircut and a longer schedule.
This unequal position in fact deteriorates the situation further as it will bring in too much uncertainty in the minds of entrepreneurs who will have to deal with the enlarged ego of the other party. This will divert the focus away from resurrecting the troubled business and end in the destruction of the enterprise. Destruction of an economic enterprise brings agony to not only the entrepreneurs & his family but also but the larger society as it will also suffer loss in many ways.
This unequal position is not a stand-alone event affecting a few. It is visible very widely. The entrepreneur will have to answer the same question from many others such as suppliers, unsecured creditors, tax authorities etc. They in turn will have to face a similar situation with others. In all, it is a challenge for the whole society.
Thus there is a need for a standing mechanism to support those victims of uncertain events. The mechanism should be able to help them to withstand the immediate pressure on cash flow and stabilise the business. Once the business returns to normalcy they should be compelled to make the payment to obligors be it bank, creditors suppliers alike.
In the face of uncertainty, the most important support an entrepreneur require is to stand firmly against the wind flow and thus preventing the run on the business. This will create breathing space and allow the firm to review its business and find a viable path forward.
In the process, it may require the creditors have to make a sacrifice in the immediate future with or without a clawback option to recover the loss in the medium to long term depending upon the circumstances and viability.
Resolution support in India:
There were few attempts to create a window of opportunity for distressed firms to review and rework a path forward. The very comprehensive support mechanism was enshrined in the 2015 circular of the Govt of India (Framework for Revival and Rehabilitation of MSMEs). It indeed addressed the concerns. Unfortunately, it suffered from the lack of enforceability of the guidelines. Rather it remained a wishful policy framework and its adoption is purely voluntary.
However, enactment of the Bankruptcy Code in 2016 had raised hope for many. Though Insolvency and Bankruptcy Code (IBC) has the power and scope for stressed business firms to seek relief as in many advanced countries, it is not fully implemented covering all types of the constitution rather limited to LLC(Limited Liability Companies) and LLPs(Limited Liability Partnerships). For the rest, though the law provides for, Govt has not notified yet.
It is time for Govt makes IBC law accessible to all forms of businesses uniformly. There were apprehensions that bankruptcy tribunals will be overwhelmed with litigations. It is not the correct position. Because having an option in the hand will facilitate dialogue among the creditors with the firms and will help to find a viable solution voluntarily. If you look at the history of litigations in Bankruptcy Tribunals(NCLTs), the voluntary understanding that arrived among the stakeholders forms a significant proportion of resolutions than otherwise.
MSME Prepack- A welcome step
There are discussions in various fora that the Govt will bring in a Prepackaged resolution solution under IBC to simplify the process and expedite the resolution for the benefit of MSMEs. The process under the pre-pack insolvency envisages formulation of a resolution plan before the initiation of a formal court process. It is a welcome step and it should be made available to all forms of the business including proprietorship firms and partnership firms along with LLCs and LLPs.
Resolution support de-risks the operating environment and hence promotes entrepreneurship:
A populous country like India needs to encourage entrepreneurship to create employment opportunity and improve the competitiveness of the economy. However the journey of entrepreneurship is filled with experiments, adventurism, and itself is a learning curve for many. It is unlikely to be smooth and cannot be predicted to proceed as planned.
Having a support mechanism for those who may suffer along the path of the entrepreneurship journey to revisit the journey will create a great enabling environment for many to take entrepreneurship. In the long run, the country will win.
A law like IBC is much needed for businesses at this point in time than ever in the history of organized business because the uncertainty in the operating environment is at an elevated level. The entrepreneurs require a sense of assurance through the legal framework to seek a solution if the business proposition fails to yield the desired result. This way the resolution support can promote entrepreneurship.
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.
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.
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.
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.
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.
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.
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.
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
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.
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.
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
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])