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MSME Finance: Importance, Advantages, Related Issues and Challenges Ahead

By T.P Misra*

Role of MSME Sector in Indian Economy:

India is a developing country but the real growth of India depends more upon the performance of primary sector such as Agriculture and secondary sector such as SME sector. The real growth of India is hampered due to large population explosion. India’s population is increasing at an unprecedented rate, which is more alarming. The growth of primary sector as Agriculture Sector is more tentative as it depends mainly on uncertainty of monsoon. Further, the economy is witnessing a mass exodus of rural and semi-urban population to urban and metros in search of jobs and better avenues as dependency on Agriculture sector is not more remunerative. Therefore, the SME sector plays a vital role in Indian economy not only for creating more job and employment avenues for growing population but also contributes significantly in the overall growth of the nation.

SME sector is the backbone of Indian economy, accounting as it does, for a major contribution to country’s production, exports & employment generation.SME is considered as the growth engine of the nation. The importance of SME sector in India as compared to the corporate giants with respect to its contribution towards Indian economy can be best understood that they contribute 17% in GDP, 45% of manufactured output, 40% of export, manufacturing over 6000products and provide employment to around 60 million people through 26 million enterprises as per the 4Th All India census of MSMEs.The sector is the second largest employment provider in our country. In view of its importance Govt. of India has undertaken few initiatives in recent past for its growth. The MSMED act which is enacted from 02.10.2006 recognizes the term enterprises instead of industry to include service sector in MSME segment. SME sector offers good scope for credit risk mitigation through diversification of loan portfolio. Schematic lending under the umbrella of CGTSME provides a good risk cover to banks as also to the borrowers. The census of MSME also revealed that only 5.2% of the units (registered and un registered) had availed finance through institution sources; the majority of the units-93% of them in fact-had either no finance or dependent on self finance. In the light of recent classification, financing to Medium sector is included under the purview of the Priority Sector Advance and hence expected to give a boost in credit deployment to MSME sector.

Keeping the importance of this sector to the Indian economy Govt. of India and RBI has taken various steps for promotion of SME sector, which are as under:

  1. Various agencies have been set up at Apex level to promote the credit flow to this sector  such as Central Silk Board, All India Handloom Board, Handicraft Board, Sericulture  Board, KVIB,Coir Board etc.
  2. RBI has prescribed various targets and sub targets for banks for lending to SME sector .
  3. Lead bank and DIC are structured to monitor and promote village and cottage industries and to implement various govt. sponsored program viz PMEGP, NRLM, KVIC etc, which directly/indirectly provides employment opportunity.
  4. Govt. has made provision for mandatory payment of interest by large industries to SME units for delayed payment for raw materials supplied. Banks have been required to earmark/reserve certain percentage of limit of large industries towards meeting their payment obligations to SME units.
  5. Under seven point program for development of SSI units, specialized SME branches for financing SME units have been opened.
  6. Various term lending institution have been opened to provide term/project finance to SME sectors such as SIDBI, SFCs and EXIM bank etc.
  7. S L Kapoor Committee has simplified the various application forms for availing finance from the banks.
  8. Nayak Committee recommendations for providing adequate and timely credit to SSI sector are strictly complied.
  9. As per RBI instruction banks are advised to extend collateral free loans to SME sector up to a limit of Rs10 lacs.
  10. A  limit of up to RS100lacs can be extended by the banks to the SME units guaranteed by CGFTSME.

The main advantage of SME units/Industries are as under:

  1. The unit can be started with low capital base, which is more suitable for our economy.
  2. Highly potential for employment generation more particularly it absorbs locally available skilled and unskilled work forces.
  3. The unit make good uses of locally available infrastructures and raw materials causing very low cost of production.
  4. Low gestation period with minimum power requirement.
  5. Ability to meet the essential requirements of rural and semi-urban areas’
  6. It also helps in reducing the regional imbalances.

Infrastructure and Institutional support to SME sector

  1. NSIC: Govt. of India have established National Small Industrial Corporation and SIDO State Industrial Development Organization with a view to provide machineries on lease or hire purchase agreement, agreement for procuring scarce raw materials and marketing of finished goods. SIDO has opened SISI(Small Industries Service Institute) in almost all the states to conduct feasibility study, product selection, acquirement of machinery and other supporting services required to the SSI units.
  2. State Govt.: State Government is also providing various types of subsidy and other benefits etc. with a view to promote SME sector. The Govt. provides capital investment subsidy, power subsidy, separate subsidy for backward areas, various tax holidays, subsidy for purchase of generator, industrial shed etc. Land also being provided by Govt. at concessional rates to industry entrepreneur. Govt. also provides seed capital or margin money to the first hand entrepreneur, waiver of sales tax for number of years.
  • State Financial Corporation: It provides term finance to medium scale units. They also provide deferred payment guarantee to medium scale industries. SFCs also provides various services like underwriting of shares, disbursement of subsidy sanctioned by state Govt. An unit whose networth exceeds 100 lacs are not eligible for finance from SFCs.
  1. Technical Consultancy Organisation: TCO is conducting feasibility report of the new units, prepare project report for the new units. TCO at various states are promoted by all India financial institutions, State Govt. and banks etc.
  2. District Industries Centre: DIC is established in each district under the control of the state industrial commissioner. They issue registration certificate, allot quota for scare raw materials, recommend applications to SFC and banks for financial assistance.
  3. Commercial Banks: Banks are also provides term loan for purchase of shed, building, machinery, equipments  etc with a lower margin and longer repayment period. Loan without collaterals are also considered by the bank upto certain limit. They also provide Working Capital finance as per Nayak Committee Recommendations.

Defining Micro, Small Scale Industry and Medium Enterprise

 Small Scale and Ancillary Industries:

Small Scale Industrial units are those engaged in manufacture, processing or preservation of goods or  is servicing and repair workshop undertaking repairs of machinery used for production, mining or quarrying or custom service units except service units) having investment in plant and machinery(original cost) not exceeding Rs100 lakhs to be classified under Small Scale Industry.The investment limit of Rs100lakhs for classification as SSI has been enhanced to Rs500 lacs in certain specified items under hosiery, hand tools,drugs & Pharmaceuticals, and stationery goods by Govt. of India

Note: Subject to the condition that the unit is not owned, controlled or subsidiary of any other industrial undertaking.

  1. Owned /owner is specified in clause 1 of section 3 of the companies act 1956
  2. Subsidiary is specified in clause 47 , section 2 of the companies act1956
  3. Controlled by any other industrial undertaking means:
    1. Where two or more industrial undertakings are set up same proprietor
    2. Where two or more industrial undertakings are set up as partnership firms and one or more partners are common partner/s.
    3. Where industrial undertakings are set up by companies under companies act 1956 and considered as controlled one ,if equity holding by other industrial undertaking is  in it exceeds 24% of its total equity. The unit also called as controlled one if the management control of an undertaking is passed on to the other industrial undertaking by way of the managing director of the first mentioned undertaking being also the Managing Director or Director in the other industrial undertaking or the majority of the directors on the board of the first industrial undertaking being the equity holders in the other industrial undertaking.
  4. While calculating the original cost of plant and machinery the cost of equipments such as tools, jigs, dies, moulds and spare parts for maintenance and cost of consumable stores shall be excluded.
  5. The cost of installation of P&M, cost of research, development equipment, pollution control equipment, cost of generator set, transformer, bank charges, service charges, cost cables,wiring,bus bars, electric control panels(not those mounted in individual machines), cost of gas producer plants, transportation charges(excluding excise and sales tax charge), charges for technical knowhow, valuation charges, legal charges, cost of storage tanks, cost of fire fighting equipments shall not be included in cost of plant and machinery.
  6. In case of imported machinery, the cost of import duty, shipping charges, custom clearance charges, sales tax, demurrage paid at the port shall be excluded.

Ancillary industrial Undertaking:

An industrial undertaking which is engaged or proposed to be engaged in the manufacture or production of parts, components, sub-assemblies tooling or intermediates or the rendering of services and the undertaking supplies or renders or propose to supply or renders not less than 50 percent of its production or services as the case may be  to one or more other industrial undertakings and whose investment in fixed assets in plant and machinery whether held on ownership terms or on lease or hire purchase, does not exceed 100 lacs.An ancillary unit should not be a subsidiary of or owned or controlled by the parent unit.

An industrial undertaking which is engaged or is proposed to be engaged in the manufacture or production of parts, components, sub assemblies , tooling or intermediaries or rendering services and the undertaking supplies or renders or proposes to supply or render not less than 50 percent of its productions or services as the case may be to one or more other industrial undertakings and whose investment in plant and machinery whether held on ownership terms or on lease or on hire purchase does not exceed Rs100lakhs.

Tiny  Enterprise:

Investment limit in plant and machinery in respect of tiny enterprises is Rs25lakhs irrespective of location of the unit.

Women Enterpreneurs:

A small scale unit/industry related service or business enterprise, managed by one or more women entrepreneurs in proprietary concern in which she/they individually or jointly have a share capital of not less than 51% as partners/share holders/directors of Pvt. Ltd. Company or members of Cooperative society.

Small Scale Service & Business(Industry related) Enterprises(SSSBEs):

SSSBEs industry related service/business enterprises with investment up to Rs5lacs in fixed assets excluding land and building are called SSSBEs. The limit has been enhanced to Rs10 lacs wef Sept.2000.

Artisans, Village and Cottage Industries:

Artisans(irrespective of their locations) or small industrial activities(viz. manufacturing, processing, preservation and servicing) in villages and small towns with population not exceeding 50,000 involving utilization of locally available natural resources and or human skills.

Medium Enterprises: At present, a small scale industrial (SSI) unit is an undertaking in which investment in plant and machinery, does not exceed Rs.1 Crore, except in respect of certain specified items under hosiery, hand tools, drugs and pharmaceuticals, stationery items and sports goods, where this investment limit has been enhanced to Rs.5 Crore. A comprehensive legislation which would enable the paradigm shift form small-scale industry to small and medium enterprises is under consideration of the Parliament. Pending enactment of the legislation, current SSI/Tiny Industries definition may continue. Units with investment in plant and machinery in excess of SSI limit and up to Rs.10 Crore may be treated as medium enterprises (ME).


 Despite of several inherent advantage in this sector, it does not prosper due to below mentioned reasons causing its failure which are as under:

  1. Banks take undue time in sanctioning the loan applications of the SME entrepreneur specially first generation entrepreneur which has innumerable disadvantage in continuing the facility in standard category. Inordinate delay causes in fluctuation of invoice price of the machineries and equipments, fluctuation in exchange rates in the event of import of machineries and many others including non utilization of land and other resources.
  2. Banks generally considers the loan amount much below the requirement of the entrepreneur which forces the entrepreneur to depend on outside loans or cut down the project below the viable level. Under financing or anxiety to secure the bank funds by the lenders is a cause of concern in growth of this sector. This not only becomes a cause of failure of the unit but also considered as in fructuous investment.
  3. Big units deliberately promote ancillaries which is a stumbling block in the growth of the SME units.
  4. Due to paucity of funds they cannot order for EOQ(economic order quantity) and hence place order in large numbers of small quantities causing the high cost of raw materials and which affects cost of production.
  5. Gets payment on the whims & fancies of big units. At times if at all they wish to take the shelter of the recent provisions contained in the MSMED act2006 but they are unable to do so under the impression that such act of their shall create impediments in marketing of their products.
  6. The SME units are placed in the market condition in such a situation that they are not able to raise their equity or funds from the market.
  7. The units are situated at remote and less prominent areas and hence possess poor infrastructures such as electricity, road, transport and many other things.
  8. The SME units still relies on old and out dated technology on account of poor capital base and denial of finance for technology up gradation. The produces are less acceptable on world market and are not competitive on account of high cost of productions.
  9. Due to globalization the marketing of the products is difficult. They are less competitive and Poorly placed in market situation.
  10. The entrepreneur possesses poor qualification and expertise. The entrepreneur himself /herself has to undertake the job of production, marketing, accounting and all other job without having specialized knowledge.
  11. The capital base of the SME units are weak and they are placed in such a situation that they cannot garner funds from the market.
  12. Due to poor realization of debt or delayed realization, most of the working funds are held up. Entrepreneurs always in search of additional finance in form of excess over the limit or ad-hoc to meet their pressing demand to pay to the supplier of the raw materials, statutory obligations and hence always have a resource crunch.
  13. Due to poor work knowledge more often entrepreneurs deploy short term funds for long term uses
  14. Pre operative expenses, contingency loan and moratorium or gestation period is not properly assessed while considering the project of the SME entrepreneurs.


 SME across the world are gaining priority for planners, policy makers as well as the regulators, who looks the sector as key to solving the challenges of improving competitiveness, raising incomes, inclusive growth, and generating employment. In present industrial contraction and slowness of economy the sector has emerged as an alternative to the banks to deploy its lendable resources more profitably than ever. Looking to the scope availability and its importance the sector is embraced by the bank as corporate strategy. However, various challenges are ahead of its successful implementations, which are as under:

  1. The entrepreneur be communicated and conveyed the sanction within stipulated time limit prescribed by the RBI.All application up to a limit of Rs5lacs are to be disposed off within a period of 2Weeks and applications from Rs2lacs to Rs25lacs are to be disposed off within a period of 4Weeks and applications above Rs25lacs are to be disposed off within 8Weeks.
  2. The entrepreneur be sanctioned a need based credit. The project is evaluated properly and ensures adequate finance for undertaking the project. Under financing or over financing is detrimental.
  3. Simplified and prescribed application forms be used by the entrepreneurs. The application forms are made available in the banks web site and also available in all the bank branches.
  4. No application of the SME entrepreneur be rejected without concurrence of the higher authority.
  5. Not to insist any collaterals for loan requirement up to Rs10 lacs. However, loans covered by CGTSME cover no collateral be insisted upon loan up to Rs100lacs. The land on which the Plant and Machineries are commissioned are only be taken as primary security.
  6. The entrepreneur be sanctioned its WC requirement as well as its Term Loan requirement preferably from single bank for proper monitoring.
  7. All the loans limit up to Rs200 lacs prescribed credit rating model be stipulated which is very facile and easily arrived at.
  8. Since SME is a component of priority sector, banks to endeavour to achieve the target of 40% of ANBC under priority sector by deploying credit to this sector. As per revised guidelines banks also to achieve target of 7.5 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher, under  Micro Enterprises. This has to be achieved in a phased manner i.e. 7 percent by March 2016 and 7.5 percent by March 2017.
  9. No entrepreneurs be insisted upon to buy the insurance and other third party products by the banks.
  10. The loans given by the banks are to be classified properly under the sector so as to enable the banks to charge proper rate of interest.
  11. Every branch to display a customer charter stating the very USPs of the products and various norms advised by RBI.
  12. Unlike other category a higher Debt equity ratio for the SME entrepreneurs be accepted, Since they being the first hand entrepreneurs are unable to contribute more towards equity and also margin for WC from long term resources.
  13. In all eligible cases depending on viability restructuring be done based on cash flow statements for survivability of the project.
  14. In genuine cases where it is observed that realization of debt is delayed, bank may consider allowing credit beyond 90 days receivables.
  15. This is a continuous phenomenon that the receivables are locked. Hence the entrepreneurs continuously in search of working funds from diversified sources .It lands the enterprise to pose a high DER and low Current Ratio due to erosion of margin. In order to evade such situation the excess borrowings be carved out in form of WCDL based on the cash flow statements.
  16. Sufficient moratorium period be allowed in case of unfinished project. As change in DCCO is not construed as re-structuring, such changes are to be made in the project finance based on the customer request and as per guidelines.
  17. Since the entrepreneurs are unaware of various facilities available in the sector, it is therefore necessary for banks to educate them about the correct levying of interest, subsidies available under TUFs, CRLCSS etc.
  18. Proposals be sanctioned expeditiously under CGFTSME scheme since the credit risk is mitigated by the trust as well as allocation of zero risk weight to SME loans guaranteed by CGTSME for Capital Adequacy requirement.
  19. Prescribed provisioning requirement for standard advances under MSE is 0.25% as against 1.00% in commercial Real Estate and 0.40% in other cases, which is a reward for the bank to make low provisioning.
  20. Banks should establish dedicated processing cells with pool of specialized and skilled man power to address the credit demands of the entrepreneur. Despite of such provisions all branches are required to exercise their lending powers for credit and ad-hoc requirement of the entrepreneurs.
  21. Buyer wise policy or WTPSG be obtained from ECGC for export credit.
  22. ECGC/CIBIL/MIRA/D&B report be obtained and examined.
  23. SME chambers, associations, NSIC,SISI should associate with banks training institutes ,management institutes and other relevant training institutes in organizing workshops, seminars to educate the entrepreneurs for easy access to bank finance, basic accounting concepts, Information Technology, Cash Flow, and various financial products and their USPs available under SME.
  24. Governments procuring policy regarding buying the products of SME should be adhered in later and spirit rather than mere restricting to guidelines. Audit report must ensure penal provisions for not achieving target by the govt. offices,PSUs and other organizations of Public interest for promoting the sector.
  25. Educating entrepreneurs should be considered as a part of Corporate Social Responsibility(CSR) in banking and other organizations.
  26. In order to streamline the uniform process of processing of loan demand of the entrepreneur, each bank to upload in their website the application forms, check list, and various documents required,
  27. Staff accountability norms framed decades before while banks were working under the seller’s market and more of in an insulated atmosphere. It now requires revision in the light of present working environment.

Banking sector has huge viable business  opportunities from SME because this sector stand as strong pillar of inclusive growth in Indian economy.Banks now have innumerable challenges and opportunities to customize their products to meet the various needs of the SME entrepreneurs. It is also observed all the times that the growth rate in this sector is higher than the credit growth in banks. Hence banks to believe that SMALL IS MIGHTY, PROFITABLE,LESS CHANCES OF BECOMING NPA AND SUSTAINABLE.

About the author: Mr. T. P Misra

Mr. T. P Misra is Principal and Deputy General Manager, Baroda Apex Academy, Bank of Baroda,Ahmedabad.

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