Financial Markets- MSME Financing Project

8/9/2019 Financial Markets- MSME Financing Project

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Project

On

Financial Markets

Topic:

MICRO , SMALL AND MEDIUM ENTERPRISE (MSME)

FINANCING

Year:

March 2010

By

Sanjay Sinha and Dr.Neerja Sinha

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MICRO , SMALL AND MEDIUM ENTERPRISE (MSME)

FINANCING

Micro, Small and Medium Enterprises (MSMEs) have been recognised as

one of the most important sectors for the development of any economy all over the

world. This sector constitutes more than 80% of all business organisations all over

the world. In India too, its share is more than 90 %. This sector ensures that the

processes of economic growth in our country are inclusive, employment-friendly

and they contribute to greater regional balance in levels of development.

During the last decade alone, the MSME sector has progressed from the

production of simple consumer goods to the manufacture of many sophisticated

products like T.V. Sets, micro-ware components, electro-medical equipment etc.

Product range varies from simple items produced with traditional technology to

high-tech products, produced with sophisticated state of the art technology. Other

than this, the micro, tiny and small scale sector have been engaged in the

production of goods like wood products, hosiery and garments, cotton textiles,

beverages and tobacco products, food products, jute textile, leather & leather

products, transport equipments etc. These industries produce over 7500

commodities.

Understanding the importance of this sector the government has brought

about the enactment of the Micro, Small and Medium Enterprises Development

Act. To strengthen this important sector and to create more national awareness

about its growing importance in our national economic life there have been

amendments to the Khadi and Village Industries Commission Act, a

comprehensive Package for Promotion of Micro and Small Enterprises has been

announced and a National Commission for Enterprises in the Unorganized Sector

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have been set up. The National Manufacturing Competitiveness Programme has

contributed to the graduation of tiny and small scale units in micro and medium

enterprises and in the process strengthened the industrial base of our economy. As

per the very latest statement of issued by SIDBI, the MSME sector currently

contributes 8 percent of the country's GDP, 45 percent of the manufactured output

and 40 percent of its exports providing employment to about 60 million persons

through 26 million enterprises.

With the passing of Micro, Small and Medium Enterprises Development

Act in June 2006, various components of this sector have been given a clear

cut definition.

Definition of Micro, Small and Medium Enterprises(MSME)

(a) Enterprises engaged in the manufacture or production, processing or

preservation of goods as specified below:

i. A micro enterprise is an enterprise where investment in plant and

machinery does not exceed Rs. 25 lac;

ii. A small enterprise is an enterprise where the investment in plant and

machinery is more than Rs. 25 lac but does not exceed Rs. 5 crore; and

iii. A medium enterprise is an enterprise where the investment in plant and

machinery is more than Rs.5 crore but does not exceed Rs.10 crore.

In case of the above enterprises, investment in plant and machinery is the

original cost excluding land and building and the items specified by the

Ministry of Small Scale Industries.

(b) Enterprises engaged in providing or rendering of services and whose

investment in equipment (original cost excluding land and building and

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furniture, fittings and other items not directly related to the service rendered

or as may be notified under the MSMED Act, 2006) are specified below:

i. A micro enterprise is an enterprise where the investment in equipment

does not exceed Rs. 10 lac;

ii. A small enterprise is an enterprise where the investment in equipment is

more than Rs.10 lac but does not exceed Rs. 2 crore; and

iii. A medium enterprise is an enterprise where the investment in equipment

more than Rs. 2 crore but does not exceed Rs. 5 crore.

The enterprises included under this sector are:

small road & water transport operators. (owning a fleet of vehicles

not exceeding ten vehicles)

retail trade. (with credit limits not exceeding Rs.10lakh)

small business. (whose original cost price of the equipment used for

the purpose of business does not exceed Rs.20 lac) and

professional & self employed persons. (whose borrowing limits do

not exceed Rs.10 lac of which not more than Rs.2 lac should be for

working capital requirements except in case of professionally

qualified medical practitioners setting up of practice in semi-urban

and rural areas, the borrowing limits should not exceed Rs.15 lac with

a sub-ceiling of Rs.3 lac for working capital requirements.

As may be seen from the above definition, the segment which was earlier

known as tiny sector, have been recognized through a formal definition

(investment in plant and machinery upto Rs. 25 lac) and has been given the term

Micro Enterprise. The investment ceiling in investment in plant and machinery has

been raised upto Rs.5.0 crore for small enterprises engaged in production or

manufacturing as against Rs.1.0 crore earlier. It is expected that this enhancement

will allow these enterprises to go for technology upgradation and modernization

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which is one of the prime requirements for enhancing competitiveness in the

context of liberalization, globalization and to fulfil the conditions of WTO. Also,

for the first time, official recognition and definition has been given to medium

enterprises engaged in production or manufacturing as those having investment in

plant and machinery between Rs. 5 crore and Rs. 10 crore. The term industries has

been replaces by the concept of enterprises to include the service sector.

MSME finance and credit issues :

Finance forms the most critical input for a business enterprise whether

large or small. All firms require financing to grow and survive. Sources may

be external, such as loans, equity infusions, subsidies and government grants,

or internal such as generated cash flows. Many firms are self financed in the

beginning. Once the firms reach certain degree of maturity in the development

of their product line and customer base, external finance becomes available.

The problem of MSMEs regarding their need for finance is peculiar and very

different from the requirement of finance by the large scale enterprises. The reason

for peculiarity is that most of the SSIs operate on tight budgets and the business is

often financed through the owners own contribution and loans from friends and

relatives. They avail the minimum possible bank credit. In this scenario they

sometimes need working capital loan under emergency situations for a short term.

These situations may arise due to an unexpected large order, or due to

rejection of a consignment or an inordinate delay in payments. It is under such

situations that they look for institutional finance but the flow of institutional

finance is linked with the creditworthiness of the enterprise. Small enterprises,

due to their small size and low capital base, generally find it difficult to satisfy

the conditions laid down by the banks, particularly, in establishing the viability

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of the project, meeting collateral requirements and making timely repayment of

loans. Hence, they do not find a place among the preferred clients of the banks.

These problems have not gone unnoticed by the Government of India. it has

recognised the need for a focused credit policy for MSMEs and earlier more

importantly the SSIs. The Government has realised that timely availability of

credit is one of the most important factors for a small scale unit.

To improve the flow of credit, the RBI has constituted several committees

and working groups since 1991. Notable among the committees are Nayak

Committee, Kapur Committee and Ganguly Committee. Appropriate measures

are taken by the RBI and Government from time to time based upon the

decision of the Standing Committee on SSI set up at the RBI.

A multi-level institutional structure exists for financing of small

enterprises and non-farm enterprises in India. This consists of commercial

banks, cooperative banks, RRBs, State Financial Corporations. Credit to Micro

and Small enterprises comes under priority sector lending programme of

banks. The Reserve Bank of India (RBI) constantly reviews the flow of credit

to this sector. An exclusive refinancing bank, called Small Industries

Development Bank of India (SIDBI) was set up in 1990. The issue of providing

micro credit to micro enterprises through development of SHG-Banks Linkagerests mainly with National Bank for Agricultural and Rural Development

(NABARD).

Priority Sector Lending

The Government of India through the instrument of Reserve Bank of

India (RBI) mandates certain type of lending on the Banks operating in India

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irrespective of their origin. RBI sets targets in terms of percentage (of total

money lent by the Banks) to be lent to certain sectors, which in RBI's

perception would not have had access to organised lending market or could

not afford to pay the interest at the commercial rate. This type of lending is

called Priority Sector Lending. Financing of Small Scale Industry, Small

business, Agricultural Activities and Export activities fall under this

category. This is also called directed credit in Indian Banking system.

Financing Priority Sector in the economy is not strictly on commercial basis

as not only the general approach is liberal but also the rate of interest charged on

such loans is less. Part of the cost of these concessions are borne by RBI, by means

of refinancing such loans at concessional rate. Indian Banks, therefore, contribute

towards economic development of the country by subsidizing the business

activities undertaken by entrepreneurs in the areas which are consider "priority

sector" by RBI. The Reserve Bank of India is making an all out effort to increase

the role of the financial institutions in the small scale sector. It has asked the

commercial banks to chalk out their branch expansion strategies keeping in mind

the growth potential and the economic development needs of MSME. The RBI

wants that this expansion should be specially in the case of the under-banked

regions where the population per branch is more than the National average of

16000 person per branch.

Policy Package for Stepping up Credit to Small and Medium Enterprises

(SMEs), was launched with the objective of doubling the flow of credit to this sector

within a period of five years.

The main objectives of this policy are as follows:

i. Banks to achieve a minimum 20% year-on-year growth in credit to the

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MSME sector, and

ii. Cover on an average at least 5 new MSMEs at each of their semi-

urban/urban branches per year.

iii. In order to ensure that credit is available to all segments of the Small

Enterprises sector, banks should ensure that :-

40 per cent of the total advances to small enterprises sector

should go to micro (manufacturing) enterprises having

investment in plant and machinery up to Rs. 5 lakh and micro

(service) enterprises having investment in equipment up to Rs.

2 lakh.

20 per cent of the total advances to small enterprises sector

should go to micro (manufacturing) enterprises with investment

in plant and machinery above Rs. 5 lakh and up to Rs. 25 lakh,

and micro (service) enterprises with investment in equipment

above Rs. 2 lakh and up to Rs. 10 lakh. (Thus 60 per cent of

small enterprises advances should go to the micro enterprises)

SCHEMES UNDER THE ABOVE POLICY PACKAGE

Scheme of Small Enterprises Financial Centres (SEFCs):

As per announcement made by the Governor in the Annual Policy Statement

2005-06, a scheme for strategic alliance between branches of banks and SIDBI

located in clusters, named as Small Enterprises Financial Centres has been

formulated in consultation with the Ministry of SSI and Banking Division,

Ministry of Finance, Government of India, SIDBI, IBA and select banks .SIDBIhas so far executed MoU with 15 banks so far (Bank of India, UCO Bank, YES

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Bank, Bank of Baroda, Oriental Bank of Commerce, Punjab National Bank, Dena

Bank, Andhra Bank, Indian Bank, Corporation Bank, IDBI Bank, Indian Overseas

Bank, Union Bank of India, State Bank of India and Federal Bank).

Deposit by Foreign Banks with SIDBI towards shortfall in priority sector

lending

The foreign banks having shortfall in lending to stipulated priority sector

targets /sub-targets will be required to contribute to Small Enterprises

Development Fund (SEDF) to be set up by Small Industries Development Bank of

India (SIDBI), or for such other purpose as may be stipulated by Reserve bank of

India.

The corpus of SEDF shall be decided by Reserve Bank of India on a year-to-

year basis. The tenor of the deposits shall be for a period of three years or as

decided by Reserve Bank from time to time. Fifty percent of the corpus shall be

contributed by foreign banks having shortfall in lending to priority sector target of

32 per cent of ANBC. The balance fifty per cent of the corpus shall be contributed

by foreign banks having aggregate shortfall in lending to Small Enterprises sector

and export sector of 10 per cent and 12 per cent respectively, of ANBC or credit

equivalent amount of Off-Balance Sheet Exposure, whichever is higher, on a pro-

rata basis. The contribution required to be made by foreign banks would, however,

not be more than the amount of shortfall in priority sector lending target/sub-targetof the foreign banks.

Role ofSmall Industries Development Bank of India (SIDBI) to be enhanced

SIDBI was set up with the mission to empower the Micro, Small and

Medium Enterprises (MSME) sector with a view to contributing to the process of

economic growth, employment generation and balanced regional development. It is

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the principal financial institution responsible for promotion, financing and

development of the sector. Apart from extending financial assistance to the sector,

it coordinates the functions of institutions engaged in similar activities.

The four basic objectives of SIDBI for orderly growth of industry in the

small scale sector are:

Financing

Promotion

Development

Co-ordination

Taking into account the fact that the majority of such enterprises are at the

lower-end of the sector and are outside the ambit of institutional finance. Hence,

concerted efforts have been made by SIDBI to promote micro finance across the

country to enable the unemployed persons to set up their own ventures. There are

more than 100 Micro Finance Institutions (MFIs) developed by SIDBI that are

engaged in implementation of its micro finance programme.

Also, Credit Guarantee Cover Fund Scheme for Small Industries was

launched jointly by the Government of India and SIDBI (on a 4:1 contribution

basis) in August 2000, with a view to ensure greater flow of credit to the sector

without collateral security. It picked up during the last two years of the Tenth Plan

and till the end of March 2007, 68062 proposals were approved and guaranteecovers for Rs 1705 crore were issued.

Common guidelines/Instructions for Lending to Small Enterprises by RBI

1. Disposal of Applications

All loan applications for MSE units upto a credit limit of Rs. 25000/- should

be disposed of within 2 weeks and those upto Rs. 5 lakh within 4 weeks

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provided, the loan applications are complete in all respects and accompanied

by a " check list".

2. Collateral

The RBI has instructed that no collateral security is required for obtaining

loans till Rs.5 Lac by MSE (both manufacturing or production and providing

or rendering of services, including those units financed under the Prime

Minister Employment Generation Programme of KVIC). Banks may on the

basis of good track record and financial position of the MSME units,

increase the limit of dispensation of collateral requirement for loans up to

Rs.25 lac (with the approval of the appropriate authority).

3. Composite loan

A composite loan limit of Rs.1 crore can be sanctioned by banks to enable

the MSME entrepreneurs to avail of their working capital and term loan

requirement through Single Window.

4. Specialised SME branches

Public sector banks have been advised to open at least one Specialised

branch in each district. Further, banks have been permitted to categorise

their SME general banking branches having 60% or more of their advances

to SME sector in order to encourage them to open more specialised SMEbranches for providing better service to this sector as a whole.

5. Delayed Payment

Under the Amendment Act, 1998 of Interest on Delayed Payment to Small

Scale and Ancillary Industrial Undertakings, penal provisions have been

incorporated to take care of delayed payments to MSME units which inter-

alia stipulates

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agreement between seller and buyer shall not exceed more than 120

days

payment of interest by the buyers at the rate of one and a half times the

prime lending rate (PLR) of SBI for any delay beyond the agreed period

not exceeding 120 days. Further, banks have been advised to fix sub-

limits within the overall working capital limits to the large borrowers

specifically for meeting the payment obligation in respect of purchases

from SSI.

After the enactment of the Micro, Small and Medium Enterprises

Development (MSMED), Act 2006, the existing provisions of the Interest on

Delayed Payment Act, 1998 to Small Scale and Ancillary Industrial Undertakings,

have been strengthened as under:

i. In case the buyer to make payment on or before the date agreed on

between him and the supplier in writing or, in case of no agreement

before the appointed day. The agreement between seller and buyer shall

not exceed more than 45 days.

ii. In case the buyer fails to make payment of the amount to the supplier, he

shall be liable to pay compound interest with monthly rests to the

supplier on the amount from the appointed day or, on the date agreed on,at three times of the Bank Rate notified by Reserve Bank.

iii. For any goods supplied or services rendered by the supplier, the buyer

shall be liable to pay the interest as advised at (ii) above.

iv. In case of dispute with regard to any amount due, a reference shall be

made to the Micro and Small Enterprises Facilitation Council, constituted

by the respective State Government.

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6. Guidelines on rehabilitation of sick SSI units (based on Kohli

Working group recommendations)

As per the definition, a unit is considered as sick when any of the borrowed

account of the unit remains substandard for more than 6 months or there is

erosion in the net worth due to accumulated cash losses to the extent of 50%

of its net worth during the previous accounting year and the unit has been in

commercial production for at least two years. The criteria will enable banks

to detect sickness at an early stage and facilitate corrective action for revival

of the unit.

As per the guidelines, the rehabilitation package should be fully

implemented within six months from the date the unit is declared as

potentially viable/viable. During this six months period of identifying and

implementing rehabilitation package banks/FIs are required to do holding

operation which will allow the sick unit to draw funds from the cash credit

account at least to the extent of deposit of sale proceeds/ RBI has framed

broad parameters for grant of relief and concessions for revival of

potentially viable sick SSI units.

The FIs and commercial banks have been advised to put in place loan

policies governing extension of credit facilities, Restructuring/Rehabilitation policy for revival of potentially viable sick units/enterprises and

nondiscretionary One Time Settlement scheme for recovery of non-

performing loans for the MSE sector, with the approval of the Board of

Directors and implement recommendations with regard to timely and

adequate flow of credit to the MSE sector.

7. State Level Inter Institutional Committee

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In order to deal with the problems of co-ordination for rehabilitation of sick

micro and small units, State Level Inter-Institutional Committees (SLIICs)

have been set up in all the States. The meetings of these Committees are

convened by Regional Offices of RBI and presided over by the Secretary,

Industry of the concerned State Government. It provides a useful forum for

adequate interfacing between the State Government Officials and State

Level Institutions on the one side and the term lending institutions and banks

on the other. It closely monitors timely sanction of working capital to units

which have been provided term loans by SFCs, implementation of special

schemes such as Margin Money Scheme of State Government, National

Equity Fund Scheme of SIDBI, and reviews general problems faced by

industries and sickness in MSE sector based on the data furnished by banks.

8. Empowered Committee on MSMEs

As part of the announcement made by the Union Finance Minister, at the

Regional Offices of Reserve Bank of India, Empowered Committees on

MSMEs have been constituted under the Chairmanship of the Regional

Directors with the representatives of SLBC(State Level Bankers Committee)

Convenor, senior level officers from two banks having predominant share in

MSME financing in the state, representative of SIDBI Regional Office, the

Director of Industries of the State Government, one or two senior levelrepresentatives from the MSME/SSI Associations in the state, and a senior

level officer from SFC/SIDC as members. The Committee will meet

periodically and review the progress in MSME financing as also

rehabilitation of sick Micro, Small and Medium units. It will also coordinate

with other banks/financial institutions and the state government in removing

bottlenecks, if any, to ensure smooth flow of credit to the sector. The

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committees may decide the need to have similar committees at

cluster/district levels.

9. Debt Restructuring Mechanism for SMEs

As part of the policy for stepping up credit to small and medium enterprises,

a debt restructuring mechanism for units in SME sector has been formulated

by Department of Banking Operations & Development of Reserve Bank of

India and advised all commercial on 2005-06. These detailed guidelines

have been issued to ensure restructuring of debt of all eligible small and

medium enterprises.

10. Cluster Approach

60 clusters have been identified by the Ministry of Micro, Small and

Medium Enterprises, Government of India for focused development of

Small Enterprises sector. All SLBC Convenor banks have been advised to

incorporate in their Annual Credit Plans, the credit requirement in the

clusters identified by the Ministry of Micro, Small and Medium Enterprises,

Government of India.

As per Ganguly Committee recommendations banks have been advised thata full-service approach to cater to the diverse needs of the MSE sector may

be achieved through extending banking services to recognized MSE clusters

by adopting a 4-C approach namely, Customer focus, Cost control, Cross

sell and Contain risk. A cluster based approach to lending is considered to be

beneficial:

a. in dealing with well-defined and recognized groups;

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b. availability of appropriate information for risk assessment and

c. monitoring by the lending institutions.

Clusters may be identified based on factors such as trade record,

competitiveness and growth prospects and/or other cluster specific data.

Apart from the above , the Ministry of Micro, Small and Medium

Enterprises has approved a list of clusters under the Scheme of Fund for

Regeneration of Traditional Industries (SFURTI) and Micro and Small

Enterprises Cluster Development Programme (MSE-CDP) located in 121

Minority Concentration Districts.

Accordingly, appropriate measures have been taken to improve the credit

flow to the identified clusters of micro and small entrepreneurs from the

Minorities Communities residing in the minority concentrated districts of the

country.

11. Continuation of the Credit Linked Capital Subsidy Scheme ( CLSS)

for Technology Upgradation of Micro and Small Enterprises

Government of India, Ministry of Micro, Small and Medium Enterprises has

approved CLSS for the XI th Plan with the condition of ceiling on the loanunder the scheme is Rs. 1 crore.with the rate of subsidy being 15% for all

units of micro and small enterprises. Calculation of admissible subsidy will

be done with reference to the purchase price of plant and machinery instead

of term loan disbursed to the beneficiary unit and SIDBI and NABARD will

continue to be implementing agencies of the scheme.

Though the Indian Government along with the Reserve Bank of India it has

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come to the conclusion that non-availability of timely and adequate funds at

reasonable cost is one of the most important problems facing the MSME

sector. Take, for instance, credit. Since the nineties the share of commercial

bank credit that goes to the SSI sector is falling (though growing in absolute

terms). Some of the major causes for low availability of bank finance to this

sector are the high-risk perception, inadequate data and usage of external

credit rating (there is need to scale up external ratings), weak corporate

financial systems, early stage high transaction cost for small loans and high

costs of the banks in lending to MSMEs. The lack of adequate collateral

further hampers availability of funds to the sector.

Innovative Financing

The small enterprises have, so far, depended mostly on banks and

traditional modes of financing namely term loan and working capital from

banks. Micro finance through MFIs (Micro Financing Institutions) and SHGs,

(Self-Help Groups) is an innovative means of financing, but is its initial stage

and at best only an indirect form of bank finance. Unlike large enterprises which

raise finance from capital market and external sources like foreign financial

investors besides commercial banks, small enterprises and other non-farm

enterprises are solely dependent on banks.

With the growing financial need, emergence of new product lines,

emergence of risky and untried ventures, it is high time that some innovative

means of financing for the non-farm unorganized enterprises are explored.

SIDBI, the premium institute in the country, dealing with alleviating the

problems of the MSME sector is exploring all the possibility of linking SMEs, with

capital market. Financial instruments have to be designed to link SMEs with the

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huge amount of money of capital market. The emergence of clusters and with

emphasis on making them as the strategy of SME development, would make

it possible to rope in capital market to SME financing. This will bring new capital

to this sector.

Making various Risk-capital options available to the MSME sector is

essential and a lot of them are being tried internationally and now in India. They

may be summarised as follows:

Risk Capital Options

Some of the major risk capital options available for MSME sector

internationally and in India are given below. These need to be introduced and/or

strengthened:

Venture Capital

Venture funds typically provide equity and may or may not also provide tied

credit. Good quality venture funding can improve the credit rating of the

company allowing it to access commercial loans or other forms of finance.

However, there are some expected problems with exit that can impact funds

entry into these areas. For the MSME, it has possible disadvantages of

reduced operational flexibility, etc.

Ventures like bio-tech, food processing, IT, pharmaceutical and other

knowledge based sectors in India need creation of venture capital funds

to meet the equity requirements. In the initial phase of their working.

Knowledge sector including BPO, KPO, Life sciences, on-line business,

technology-enabled design and manufacturing as well as in emerging areas

of Nano-technology and environmental technology.

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Factoring Service

Third area of innovative financing, which needs popularization in India, is

the development of factoring services. This is necessary since a major

problem faced by MSMEs, is delayed payment from the units to whom they

have supplied goods. Banks can work as factors on behalf of

MSMEs, to collect the dues on their behalf by discounting the bills at

nominal service charge. Likewise, other means of financing SMEs, such as

lease finance, hire-purchase finance and propagation of incubation centres

could be undertaken to inject additional fund to the MSMEs in order to

bridge the financial gap.

Angel Investors

Angels are typically high net worth individuals who wish to invest some of

their surplus funds in new ventures. They can prove to be a good source of

capital and advice at an early stage in the development of the company. For

the investor, they bring opportunity to make high returns from investing at

an early stage in an MSME. The problem areas are unwillingness of MSME

to bring in an external investor in case of equity sale, the high risk for

investor and risk of relationship between the investor and the MSME

manager breaking down.

Public ListingMSMEs with a good track record can access funding from the public

through the public listing process first through the initial public offer (IPO).

A functioning IPO regime for MSMEs will enable the entry of other types of

risk capital in the earlier stages. However, the IPO route is limited to bigger

MSMEs having an established strong record of past performance and

reputation in the market.

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Following supplements to risk capital can also be explored:

Loan Funds

A pure loan fund supported by the Structural Funds can be leveraged by

using private capital. While Loan schemes are a major source of capital for

MSMEs, usually lenders will require collateral or will go through a credit

scoring process which may discriminate against start-up companies.

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Guarantee Associations

Guarantee Funds or Guarantee Associations issue guarantees to MSMEs in

order to facilitate access to external finance (mainly loan-based, but also

equity) in return for a fee to cover both the risk and administrative and

processing costs. They facilitate access to loan finance on improved

financial terms for MSMEs and reduce the degree of risk for the lending

institution. However, they cover only part of the credit risk and often apply

to only a limited range of financial instruments. Requires the creation and/or

existence of strong associations which typically take many years to set-up

and operationalize.

Micro Finance

Micro finance is typically designed for businesses with small financing

requirements. It can meet the market failure in starting and developing micro businesses. However, apart from high cost of setting and administering

loans, it caters to only small requirements and generally requires the

presence of a homogenous and well networked social group.

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Changes required in the FI/Banking System to implement the schemes of

SIDBI

To enable the FII or the Banks to bring about these innovative tools of

innovative financing a risk-credit ecosystem needs to have the following elements:

Availability of risk capital at every stage.

Availability of good quality entrepreneurs.

Mentoring/advisory credit with hand holding.

Appropriate and adequate exit options for all stakeholders. Appropriately incentivising risk-capital providers.

Reducing informational imperfections.

Ability to accept risks failure in early stage financing.

To enable the supply of good 'quality' entrepreneurs and projects, following

areas need to be focused upon:

Incubators

Business incubators need to be set in partnership with technical and higher

educational institutions to help the potential entrepreneur in the early stages.

They aid the creation of higher 'quality' projects for later stage funding.

Recognition of incubators as a priority sector activity can help in spreading

incubators both in the public and private sectors. The incubators in India

primarily provide the infrastructure setup with hand holding. There is need

to linkup to risk capital for incubatee companies, particularly start-ups, to

take care of expenses relating to manpower, IPR, initial marketing, product

development etc. Further, the incubators need to develop strong linkages

with Angel Networks and Venture Capital Funds to provide equity at start-

up stage.

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Angel Networks

Internationally, these have been highly successful in providing both risk-

capital as well as mentoring for budding entrepreneurs, many of them at the

seed stage itself. There are certain taxation and exit issues affecting the

growth of this sector in India. Appropriate and adequate policy action aimed

specifically at this source of funds is required.

Small Cap Exchange

As the characteristics of small companies do not match the requirements of

the stock exchanges servicing larger companies, there is a need to accelerate

the setting up of a small cap exchange, either independently or as a part of

the established exchanges. Equally important is ensuring easier IPOs for

MSMEs as exit will make it easier for VCs and other types of risk capital

providers to unlock their investment in the units.

Incentives for institutional and individual risk-credit providers

The risk capital in early stage investment particularly in small companies

have a high risk high return portfolio with a small number of ventures

succeeding. Appropriate tax and other incentives need to be designed for

different types of risk-capital providers. Incentives of Risk capital have been

devised in some countries to encourage entrepreneurship and start-upventures. Such models can be studied for possibility of replication in India.

Publishing Success Stories

Publishing success stories particularly of first generation entrepreneurs, is a

high motivator for job seekers to take risk and set up ventures.

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Corporatisation

Awareness needs to be created among MSMEs about advantages of

conversion from Proprietorship / Partnership to a corporate entity (after

reaching a certain size of stature). The corporate structure with greater

transparency enables flow of capital vis-a vis Partnership / Proprietorship

concerns

Insolvency

In early stage financing, the failures due to technology, marketing etc are

high. This requires a regime that allows for second chance options in case of

genuine failures.

Information/Skill Gaps

Institutional solutions as outlined above would be much more effective if

they are also accompanied by capacity improvements. Moreover, there are

also gaps in information and skill availability both for entrepreneurs as well

as finance providers.

Some examples discussed were:

Entrepreneurship development programs at graduate level

Organizing of Business Plan Competitions in colleges

R&D centres and technical institutions

Institute referral services, laboratory facilities

Process certifications via technical institutions and universities

Promotion of greater faculty and industry interaction by building in

appropriate flexibilities and incentives for research staff in research and

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academic institutions Strengthening the entrepreneurs accessibility to

expertise in a range of areas such as assistance with IPR filings

Enable access to marketing, HR and other business development services

etc

Ensuring risk-capital provider's easy access to multiple sources of

information on the industry, activity and the entrepreneur (Government

support is required for such information to be made available on a large

enough scale)

Conclusion

With greater emphasis on a market based economy that addresses the

requirements of rapid and equitable progress, the role of MSMEs has only become

more important. However, this also requires that there be greater entry and spread

of the MSME sector. This, in turn, requires their access to financing with minimal

transaction costs. It is well recognized that unlike in many developed countries,

Indian MSMEs do not currently have access to a well funded ecosystem of risk-

capital availability. India, therefore, needs a properly designed and adequately

resourced risk-capital regime. It will need to be a combination of many different

routes. However, it will need to be based on Indian realities and the reality of the

Indian MSME sector.

Merely creation of greater number of financing bodies is not the solution.

The systems, rules, procedures, and practices governing the granting of capital,

monitoring, and exiting will need to be thought through carefully. This, in turn,

will require a multi-dimensional and multi-departmental approach, where human

capital, expertise, financing, legal regimes, all need to be changed to suit the

requirements of India's new MSMEs. These will not be dependent on government

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largesse and subsidies, but on the entrepreneurs ability to harness all available

technologies and resources.

Already with government support, and also newer private initiatives, such an

ecosystem is emerging. The government needs to catalyze these activities by

removing the bottlenecks that prevent the market for risk capital from evolving.

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Documents

Financial Markets- MSME Financing Project