Choose your banker prudently- A crucial decision to shape the future of business for SMEs in India
Banker plays an important role in the success for SMEs in India. SMEs should take
Recently I met an entrepreneur who has been in the business of manufacturing of plastic racks for retail shops. The business has been doing well since the time new age of organised retailing started taking roots.
In view of the burgeoning business, the entrepreneur decided to expand the capacity by going for the new plant for which he had been a holding allotment of an industrial unit for long. He approached his banker happens to be a public sector bank and had been their customer since long. The bank readily agreed to give term loan and working capital for the project.
As the implementation started, the promoter was getting suggestions from various quarters to include another line of new products and upgrading the technology. Tempted by assurances and offers, he decided to do so which resulted in the revision of project cost. He went ahead with the plan to expand without waiting for sanction from the bank.
However, Bank had a different perception about the revision. They did not find it is desirable to finance the additional investment. In the meantime, sensing the mood of the bank in delaying the sanction, entrepreneur asked his advisors to scout for a bank which can sanction the higher amount. Advisors got the sanction for the higher amount from another Bank.
As the new investment started flowing, entrepreneur found himself in a stressful situation as the new loan was insufficient to meet the project requirement and there are creditors for capital goods who are threatening to take legal action.
New Bank declined to extend further support. More than that he has been finding it is difficult to converse with the new bank in view of not so much familiarity. Now he is looking for taking over of the loan with an additional loan to retire the creditors in just six months of relationship with the new bank.
Key Issue- was it appropriate to leave the Bank where he had a long relationship:
He is finding difficulty in the new Bank due to the following:
A) He is new to the Bank and the credit history is short: He is a new customer to the bank. Obviously, this makes communicating with them to seek additional funding very difficult. As such, they were very cold to the proposal for additional funding.
B) The loan was sanctioned mainly on the strength of collateral security than on the sound assessment of economic viability and technical feasibility of the project. In other words, the sufficiency of the loan was not assessed properly.
(We have been emphasising that SMEs must undertake a comprehensive assessment of financial requirement and achieve financial closure before embarking on the growth plan. Once the assessment is done, SMEs should not go for any revision while implementing the project. The detailed thought process must be in place while planning the project. It is part of preparedness of the new business/expansion)
C) There are no procedures to hand hold and restructure distressed businesses in the bank: Though the bank restraints from initiating any recovery action and also gives some breathing space in repayment of loans, there is no system of undertaking a holistic review of the situation and implementing the corrective action plan. It is a practice in the commercial banks in India to handhold the distressed businesses by giving them reliefs like rescheduling the repayment plan, selectively extending additional funding, etc.
How to choose a Banking partner:
The incident has prompted us to analyse the considerations one should keep in choosing a bank for financing his business. There is no uniform approach for doing so because every entrepreneur is unique with reference to financing flexibility including his net worth, business- stage & strategy and industry characteristics.
On the other hand, all banks have a different approach on how to respond to various demands, challenges and opportunities from the borrowers.
We believe that the following are important considerations, SMEs should keep in mind while choosing their banking partner:
- If the need is only current account and not having any other services, the cost of service and conveniences such as digital banking should be analysed.
- If you need funding to start the business, look for those who have to enable the policy for supporting start-ups.
- If you are looking for aggressive growth, look for a bank having strong capabilities to understand such businesses. Some banks have a strong presence in certain sectors, geographies, segments (Ex MSMEs).etc. They respond to demands very fast.
- If you are looking for a range of services than just loans, explore the banks that have well-developed business banking culture.
- You may yearn for advisory support which some banks are extending to their clients. Such support helps you in having a third party review of your plan as these banks have rich experience in project appraisals and funding. Look for such services while selecting banking partner.
- SMEs must look for the policy of bank to support if business slows down. In the present volatile environment, the preparedness to face the distress also mean being associated with the bank having the explicit policy to help in nursing back the business to good health if slips to distress.
Why bank finance so important for SMEs in India:
SMEs are relying on banks for funding because the financial market has not grown to offer diverse types of products as in the western countries. Secondly, many SMEs are privately held partnership firms and family concerns which obviously deprive themselves of other forms of funding support.
However, there is progress made in this direction by encouraging Private equity/Venture Capital investment and promoting SME platform among leading stock exchanges such as BSE and NSE.
Despite all these, for many years into future, bank funding is likely to remain major source.
Good Bank Vs Bad Bank:
There is no good bank or bad bank either. Every bank has the strategic focus on certain segments, special emphasis on certain sectors, and market leader in certain geographies.
Some banks will not lend unless the project is found to be economically viable and technically feasible in their eyes irrespective of the value of collaterals, the net worth of promoters and period of banking relationship with them.
Some banks take a decision on the strength of financials and credibility of borrower irrespective of project’s viability leaving that aspect to entrepreneurs to take care. This trend, we can see among the many cooperative banks which emphasise serving the community and hence stresses on the relationship.
There are banks which focus only products and look for borrowers who meet the eligibility and take no interest in the other areas.
There are certain lending institutions have products to meet the niche areas (ex SIDBI supports new products development and commercialisation through lending unsecured loans to technology-intensive areas).
Hence there is no good or bad bank. Entrepreneurs need to assess his needs and choose the bank to seek financial support. Closer the compatibility with their policies, higher the chances of getting support.
Can the relationship be perpetual with any bank?
Unwarranted, we believe. With the passage of time, the requirement of your business will change and your existing banker may not be able to support you. This calls for reviewing the relationship once a while. On the other hand, faster churning is not desirable because it will hurt you as banks may not support those in distress who keep shifting their relationship.
Secondly, banks also keep revising their business focus and shift the priorities. If you are in the segment or sector which is not their preferred area at that point of time, it is likely that they may not be interested in taking the further exposure.
Thus we suggest review the relationship and reassess your need once in few years.
We used the phrase “Primary Banker” in the beginning. It is used in the context that it is not uncommon to find many SMEs diversifying their borrowing for a variety of reasons. We suggest that keep majority of banking relationship with one bank to earn their goodwill and support in distress if need be.
SMEs should avoid shifting relationship from one bank to another frequently and study the suitability before shifting if require. Merely shifting the bank for higher borrowing is not desirable.