SME loans: backing the silent heroes the right way

Flow of credit is the lifeblood of any economy. And if Small and medium-sized enterprises (SMEs) fuel the growth of developing countries, then they are only too deserving of adequate credit backing at the right time.

Even now, bank lending remains the chief source of finance for many SMEs that are excessively dependent on traditional debt to fulfil their investment and cash flow needs. 

Last year, the Minister of State for MSME Bhanu Pratap Singh Verma had written to the Lok Sabha, saying that 4.9 lakh women-led micro small and medium enterprises (MSME) registered on the Udyam portal in 2020-21, and about 8.59 lakh MSMEs registered in 2021-22. The Business World reports, “At present, the 63 million MSMEs in India account for close to 30 per cent of the gross domestic product (GDP). The sector already contributed to nearly 50 per cent of its exports and in 2022, it has grown by 37 per cent year-on-year (YoY).”

However, financial institutions generally have had a conservative approach in lending to these enterprises. They’re often assessed unfavourably on financial risk, project risk, management risk and industry risk.

And since SMEs and the Ministry of Micro, Small and Medium Enterprises (MSMEs) are largely heterogeneous in nature, their evaluation is complex, thereby affecting credit delivery.

Absence of proven track records, lack of collateral, the need to present a steady sales turnover had been bottlenecks in the past, though the Indian government has made a concerted effort to resolve the financial exclusion of SMEs by offering a plethora of schemes.

More than 95% are not legally identifiable as SMEs and that prevents proper allocation of institutional support.

Understandably, not too long ago, SMEs would depend on informal sources for finances such as friends, family or money lenders. 

Is credit everything?

Like it’s the case for any business entity, a lack of timely credit to these enterprises dampens their yields and productivity.

Business loans act as a cash buffer, helping entrepreneurs meet regular expenses like salaries, rents and payments to suppliers without losing sleep.

Funding is essential to increase the capacity of businesses with regard to buying raw materials, acquiring assets, land and machinery, expanding facilities, upgrading infrastructure and marketing.

Regular expenditure on production, maintaining warehouses, manufacturing of goods and transportation can’t be met without adequate capital backing.

And thus, for credit flow to the SME sector, a need for independent third-party credible assessment of SME units was felt, upon which banks could rely and base their credit decisions.

In 2005, the Government of India, realising the need for enhanced availability of credit for the growth of this sector, had announced an SME policy package, which had outlined several initiatives to double the flow of credit to the SME sector.

As a sequel to the policy package, the Small Industries Development Bank of India, in association with Dun & Bradstreet India and public and private sector banks, had set up a rating agency SMERA exclusively for the Indian SME segment. This was the world’s first SME-focussed rating agency.

The objective of SMERA was to fill the information gap for SMEs through ratings and other information which would help them get quality credit at better terms and build capacity in the sector.

Finally, for SMEs, times seem to be changing for the better.

Now, several non-banking financial companies are emerging as financial alternatives to traditional banks, and ratings to a large extent have played a part.

Even the loan application process is simplified and made quicker and easier.

It’s often asked, what exactly is the nature of SME loans.

What is an SME loan?

Broadly, these loans provide a single line of credit to meet the borrowing needs of SMEs. They can be used as working capital as well as for long-term requirements.

These loans are approved after assessing the nature of the business, cyclical trends, cash flow projections and peak-time requirements. The loan duration, of course, varies from lender to lender.

Also, they are tailored to suit the needs and requirements of SMEs and exempted from collaterals.

What is the difference between SME micro loan and SME loan?

It must be added here that SME loans have an array of products. For instance, SME micro loans are generally small loans in the range of Rs 1 lakh. SME loans, in contrast, have a broad definition, for they could be small amounts for short tenures or huge capital for long-term.

Another difference between regular SME loans and micro SME loans is the interest rate, which is on the higher side for the latter.

Yes, lenders are within their rights to ascertain the financial situation of a business before disbursing a loan. A borrower’s credit history (track record established while making payments over time) and capacity to repay outstanding debt are taken into account. And loan eligibility remains the foremost criterion.

What is SME loan eligibility?

All SMEs defined under the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED) with a stipulated sales turnover, decided by the lender, are eligible for a loan.

In the Indian context, they ought to meet the following criteria:

  • Furthermore, the established business must be in operation for more than six months.
  • It should have a minimum turnover of Rs 90,000 or more in the three months preceding the loan application.
  • The business should not fall under the blacklisted/excluded list for Small Business Administration (SBA) finance.
  • The business should not be conducted in a location that is under scrutiny or prohibited.
  • Trusts, NGOs and charitable institutions are not eligible for small business loans.
  • The entity should not possess a default history

Lack of supporting documents often stall the loan process. It’s imperative SMEs provide:

  • KYC
  • Proof of business ownership (Business Registration Certificate/GST filing/Gumastadhara/Trade License/Drug License/ Tax Information Network (TIN) /Value-added Tax (VAT) registration.
  • Other financial documents such as bank statements, company PAN card, partnership deed etc).

How to apply for SME loans?

Nowadays the processes are such that getting a loan shouldn’t give entrepreneurs a migraine unlike in the past.

Recently, the Government of India launched a scheme called ‘MSME Business Loan for Startups in 59 Minutes’ that could be availed through a portal. The loan is disbursed to the applicant in just 7-8 working days.

Similarly, the government’s Mudra loan initiative is aimed at speeding up the MSME sector growth. Launched seven years ago to support women entrepreneurs, the scheme offers 10 lakh mudra loans from 27 government banks, 17 private banks, 31 Gramin Banks, four Sahkari Banks, 36 Micro Finance Institutes and 25 Non-bank financial institutions (NBFCs).

Here, women entrepreneurs can avail of an instant collateral-free business loan up to Rs 10 lakh to start a non-corporate and non-farming business.

However, at every step of the entrepreneurial journey, it’s essential to be mindful of the processes and the dos and don’ts.

  • Check your credit score before applying for SME loans. Most lenders rely on credit rating for preliminary loan approvals.
  • Ensure you have all the required documents in digital format since many financial institutions do not accept physical copies at the time of application.
  • Prepare a business plan that specifies how you intend to use the loan funds and how much time it might take to generate positive returns from the investment. While every lender might not ask for these details, it’s essential to have a business plan ready.
  • Do not apply with multiple lenders since it will reduce your credit score by several points. It also shows financial desperation on your part, which might make potential lenders apprehensive.
  • Do not delay your repayments for existing debts even if you are taking the SME loan for debt consolidation. It hurts your credit score and overall financial goodwill.
  • Do not liaise with lenders who charge you an upfront fee. Many fraudulent lenders in the online space may ask for huge fees for approving your SME loan application. Keep them at arm’s length.

Small business entities may have reached a flashpoint last year. Scores of startups went public – according to industry estimates, they raised a whopping $36bn from investors, which is thrice the figure achieved in 2020 – and 40 unicorns were created.

What’s in store for SMEs and MSMEs this year? These business entities continue to feel the strain of the pandemic, though retailers and suppliers extended credit to vendors during tough times, ensuring a steady cash flow.

Resilience is one quality we always associate with SMEs. It’s in our interests to back them to the hilt.

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