Private sector banks witnessed a rise in non-performing assets (NPA) in respect of large borrowal accounts with exposure of Rs five crore or above.
A recent report by the Reserve Bank of India (RBI), cited that gross NPA ratio, as well as the ratio of restructured standard assets to total funded amounts emanating from larger borrowal accounts in the public sector banks, have gone down.
At the end of September 2020, large borrowal accounts constituted 79.8 per cent of NPAs and 53.7 per cent of total loans, it said.
"During 2019-20, PSBs' GNPA ratio, as well as the ratio of restructured standard assets to total funded amounts emanating from larger borrowal accounts, trended downwards. On the contrary, PVBs experienced an increasing share of NPAs in respect of such accounts," it said.
Further, the share of special mention accounts (SMA-0) witnessed a sharp rise in September 2020, which, according to the report, may be an initial sign of stress after lifting of moratorium on August 31, 2020.
However, the share of other categories of SMAs i.e., SMA-1 and SMA-2 remained at a relatively lower level, it said.
The RBI report also showed that the decline in NPAs in the last financial year was achieved largely on the back of write-offs.
As per the data, that both public and private sector banks wrote off NPAs worth over Rs 2.37 lakh crore.
The banks' net NPA stood over Rs 2.89 lakh crore in 2019-20 as against Rs 3.55 lakh crore in 2018-19.
In terms of lenders, out of the total write-off of Rs 2.37 lakh crore loans, NPAs worth over Rs 1.78 lakh crore were written off by public sector banks, while private sector banks wrote off loans worth Rs 53,949 crore.
Mumbai. Dec 20 (IANS) In a dubious distinction of sorts, the Bharatiya Janata Party-led NDA rule achieved the highest loans write-off between 2015 and 2019, which is more than three times compared to the figures of bad loans written off during the previous Congress-led UPA regime from 2004-2014, as per an RTI revelation. During the UPA's 10-year rule, around Rs 2,20,328 crore was written off by various banks, and this figure shot up to Rs 7,94,354 crore during the NDA regime from 2015-2019, resulting in a corresponding reduction in the banks' NPAs.
The data was provided under an RTI query by Pune-based businessman Prafful Sarda, giving some shocking insights into the state of affairs of not only public sector banks, but also those in the private sector and foreign banks. The RTI reply figures around two-dozen public sector banks, some three-dozen in private sector, nine Scheduled Commercial Banks, and a whopping four-dozen foreign banks, and includes several in each category which have not written off any loans. Of the loan write-offs in the Congress' decade (2004-2014), the PSBs accounted for approximately Rs 1,58,994 crore, while the amounts written off by the private banks was Rs 41,391 crore and for foreign banks it was Rs 19,945 crore, with no write-offs by Scheduled Banks.
Later, in the NDA regime (2015-2019), the figures provided show a phenomenal increase with the PSBs accounting for a stupendous Rs 6,24,370 crore loan write-off, with the private banks writing off Rs 1,51,989 crore and the foreign banks shared the remaining 17,995 crore, (Total -- Rs 7,94,354 crore), besides an additional write-off by Scheduled Banks totalling Rs 1,295 crore (Total - Rs 7,95,649 crore).
In a silver lining, however, during the BJP rule, there was some recovery from the write-offs between 2015 and 2019 -- a paltry Rs 82,571 crore or roughly 12 per cent of the total Rs 7,94,354 crore written off, according to the RTI reply. "The official data is not only revealing but very distressing. During the 10 years of UPA government (2004-2014), the total loans written off was Rs 2,20,330 crore, but during less than five years of the NDA (2015-2019), the figures zoomed up by almost 350 per cent to Rs 7,94,354 crore," Sarda told IANS.
The surprising aspect is the huge increase in the write-offs by foreign banks -- from 2004-2014, it was Rs 19,945 crore in the UPA's 10-year tenure (Rs 1,995 crore each year on an average), but shot up to Rs 17,995 in the NDA's four years between 2015-2019 (Rs 4,499 crore annual average). Several global giants like HSBC, Barclays, CitiBank and Standard Chartered Bank apparently gained due to the write-offs, among many others, in the past 15 years of the UPA-NDA governments.
Sarda questioned why the government should permit such write-offs by the financially sound foreign banks instead of concentrating on the financial health of the Indian PSBs, private, scheduled and cooperative banks which directly concern a majority of the countrymen. "In 2020, it seems we still follow the 1995 policies for loan recoveries or write-offs rather than innovating to ensure relief to the common masses instead of select corporate houses and bankrupt businessmen like Vijay Mallya, Mehul Choksi, Nirav Modi etc.," Sarda said.
Worse -- many of these bank defaulters are absconding since years and the government has also admitted that it has caught only two of the 72 fugitives in the past five years.
(Quaid Najmi can be contacted at: email@example.com)
New Delhi, Dec 8 (IANS) Alleging 63 Moons was hampering the resolution process of DHFL for their "illegal and malifide" intentions, DHFL's erstwhile promoter Kapil Wadhawan has written to capital market regulator SEBI, the Reserve Bank of India and DHFL administrator asking them to take steps to prevent actions which may obstruct the resolution process.
Last month, 63 Moons had filed a writ petition before the Madras High Court seeking direction to the Tamil Nadu government and the competent authority to attach various assets belonging to DHFL or in which DHFL holds direct or indirect interest or the assets offered by Wadhawan.
Wadhawan alleged that 63 Moons is seeking to get precedence over every other creditor of DHFL including the FD holders who won't be able to get their dues if any order is passed as prayed for by 63 Moons.
"It is imperative that immediate steps be taken by every regulatory authority to prevent the malafide actions of 63 Moons," he said in his letter.
Copies of the letter have also been marked to the Prime Minister's Office and the Ministry of Corporate Affairs.
63 Moons Technologies had invested Rs 200 crore in non-convertible debentures issued by DHFL with the payment to be made since 2023.
There were multiple litigations filed by various parties including 63 Moons. DHFL is currently undergoing resolution process at the Mumbai-bench of National Company Law Tribunal (NCLT).
Wadhawan has also alleged that the firm filed a false complaint with EoW in Chennai to get precedence in the repayment of its dues over every other creditor.
Earlier, countering DHFL promoter Wadhwan's settlement offer to the RBI administrator by transferring his rights in properties worth over Rs 43,000 crore, 63 Moons had served a notice against any such move citing Madras High Court's injunction order barring the NBFC from selling, alienating or encumbering any asset.
Wadhawan appealed to the regulators to intervene and prevent 63 Moons disrupting the resolution process.
He reiterated that if the 2019 resolution plan prepared along with the COC and approved then, can avoid any such issues. According to him, it can also help the creditors get 100 per cent payment.
He has written to the administrator and the NCLT offering to settle the dues through the 2019 resolution and has said that the current bids, although revised, would come with around 70 per cent haircut for the lenders.
The key Indian equity indices opened on a positive note on Tuesday with the BSE Sensex trading above the 45,500 mark. The Sensex touched a record high of 45,572.28 points.
Healthy buying was witnessed in auto and realty stocks. However, banking and energy stocks were under pressure.
Around 9.30 am, Sensex was at 45,553.52, higher by 126.55 points or 0.28 per cent from the previous close of 45,426.97.
It opened at 45,568.80 and touched an intra-day low of 45,459.74 points.
The Nifty50 on the National Stock Exchange was trading at 13,392.80, higher by 37.05 points or 0.28 per cent from the previous close.
The top gainers so far on the Sensex were Maruti Suzuki India, Bajaj Auto and Mahindra & Mahindra, while the major losers were Sun Pharmaceutical, Tech Mahindra and IndusInd Bank.
The Reserve Bank's directive to HDFC Bank for temporarily stopping all launches of the Digital Business generating activities and sourcing of new credit card customers is "credit negative for the lender", Moody's Investors Service said on Monday.
According to Moody's Investors Service, the move is credit negative as the bank is increasingly relying on digital channels to source and service its customers.
"The recurring outages also risk hurting the bank's brand perception among a growing and increasingly digitally savvy customer base, and increases the potential that clients switch to other banks, which would lead to a reduction in revenue and low-cost retail funding," Moody's said.
"We do not expect the regulators' action to materially affect the bank's existing business and financial profile."
Nevertheless, it pointed out that RBI's action will delay the launch of HDFC Bank's Digital 2.0 initiative, under which the bank aims to consolidate all customers' digital transactions, including payments, savings, investments, shopping, trade, insurance and advisory services, into one platform.
"This has the potential to increase spending to improve the bank's digital infrastructure, which would strain its profitability,"
HDFC Bank, the second-largest bank in India by deposits, leads in terms of digital transactions processed.
In the fiscal year that ended in March 2020 (fiscal 2020), about 95 per cent of the bank's retail transactions were conducted digitally, up from about 85 per cent in fiscal 2018.
On December 3rd, the lender had announced that the RBI asked the bank to stop temporarily all launches under its Digital 2.0 initiative and stop sourcing new credit card customers.
The announcement came after the bank experienced multiple outages in its internet banking, mobile banking and payment utility services over the past two years.
The Reserve Bank of India (RBI) expects resolution plans for Mumbai-based Punjab and Maharashtra Co-operative (PMC) Bank soon as initial response from investors have been positive. At the post MPC meeting conference, RBI Governor Shaktikanta Das said that response to expression of interest (EoI) invited from investors looked positive at this juncture and this has given confidence that a banks resolution would go through as planned.
Last year RBI superseded the board of (PMC) Bank after discovering major financial irregularities and fraud. Ever since then, the RBI-appointed administrator is yet to succeed in finding a resolution plan for the bank. The administrator had approached major banks with a merger request, but so far nothing had materialised. RBI's efforts to find a merger plan involving a PSB has also not frictified.
The last date for submission of EoIs from prospective investors for PMC emended on November 30. Based on the interest, December 15 is the last date for submission of financial bid. Das said that bank management are in touch with investors and future course of action would depend on the developments on December 15. He agreed that case for resolving PMC was different from other two banks that RBI had resolved.
The RBI superseded PMC Bank board in September 2019. Of its total loan book of Rs 8,383 crore, as on March 31, 2019, about 70 per cent had been taken by the real estate firm HDIL. During investigations, it was found that the bank had been allegedly running fraudulent transactions for several years to facilitate lending to HDIL through fictitious accounts and violating single-party lending rules. The RBI has imposed restrictions on deposit withdrawals and superseded its board after the fraud was detected.
The Reserve Bank of India (RBI) on Friday retained its key short-term lending rates to subdue the unabatedly high inflation rate.
However, the Monetary Policy Committee (MPC) of the central bank maintained the growth-oriented accommodative stance, thus opening up possibilities for more future rate cuts.
Resultantly, MPC voted to maintain the repo rate -- or short-term lending rate for commercial banks, at 4 per cent.
Likewise, the reverse repo rate was kept unchanged at 3.35 per cent, and the marginal standing facility (MSF) rate and the 'Bank Rate' at 4.25 per cent.
It was widely expected that the Reserve Bank's MPC will hold rates as recent data showed that retail inflation has been at an elevated level during June.
As per recent data, the Consumer Price Index (CPI), which gauges the retail price inflation, spiked in October to 7.61 per cent from 7.27 per cent in September.
Though not-comparable, India had recorded a retail price inflation of over 3 per cent in the corresponding period of previous year.
The RBI maintains a medium-term CPI inflation target of 4 per cent. The target is set within a band of +/- 2 per cent.
In an online address detailing the MPC's decision, RBI Governor Shaktikanta Das said: "At the end of its deliberations, the MPC voted unanimously to leave the policy repo rate unchanged at 4 per cent."
"It also decided to continue with the accommodative stance of monetary policy as long as necessary - at least through the current financial year and into the next year - to revive growth on a durable basis and mitigate the impact of Covid-19, while ensuring that inflation remains within the target going forward."
According to Das, the MPC was of the view that inflation is likely to remain elevated, with some relief in the winter months from prices of perishables and bumper kharif arrivals.
"This constrains monetary policy at the current juncture from using the space available to act in support of growth. At the same time, the signs of recovery are far from being broad-based and are dependent on sustained policy support,".
"A small window is available for proactive supply management strategies to break the inflation spiral being fuelled by supply chain disruptions, excessive margins and indirect taxes. Further efforts are necessary to mitigate supply-side driven inflation pressures. The MPC will monitor closely all threats to price stability to anchor broader macroeconomic and financial stability."
Besides, Das said that India's economy has witnessed a faster than anticipated recovery and its expected Real GDP growth rate will be at (-) 7.5 per cent in FY21.
He cited that several high frequency indicators have pointed to growth in both rural and urban areas.
"Consumers remain optimistic about the outlook and business sentiment of manufactuing firms is gradually improving. Fiscal stimulus is increasingly moving beyond being supportive of consumption and liquidity to supporting growth-generating investment," he said.
"On the other hand, private investment is still slack and capacity utilisation has not fully recovered. While exports are on an uneven recovery, the prospects have brightened with the progress on the vaccines."
"Taking these factors into consideration, real GDP growth is projected at (-) 7.5 per cent in 2020-21, (+) 0.1 per cent in Q3:2020- 21 and (+) 0.7 per cent in Q4:2020-21; and 21.9 per cent to 6.5 per cent in H1:2021- 22, with risks broadly balanced."
Furthermore, Das elaborated that RBI will take additional measures to enhance liquidity support to targeted sectors having linkages to other sectors, deepen financial markets and conserve capital among banks, NBFCs through regulatory initiatives amongst other steps.
Was the selection of DBS India a rational consideration? Did LVB’s pre-amalgamation valuation justify the denial of compensation to shareholders? These are big questions
On November 17, the Central Government imposed restrictions on the withdrawal of funds from the Lakshmi Vilas Bank (LVB) till December 16, (except for a maximum Rs 25,000 per account as relief to small depositors) on the advice of the Reserve Bank of India (RBI). Plus, the LVB’s Committee of Directors was superseded. The RBI invited suggestions and objections “within three days” on a draft scheme of amalgamation of LVB with DBS Bank India. On November 25, the Central Government approved the scheme proposed by the RBI. The LVB-DBS merger came into force on November 27 and the moratorium imposed on withdrawals was lifted. Foreign banks may operate in India either by having their branches in the country directly owned/operated by them or by creating a wholly-owned subsidiary (WOS) registered here. The Singapore-based DBS Group Holdings Limited has been operating in branch mode since 1994 but switched to WOS model in March 2019.
All the assets and liabilities of LVB now stand transferred to DBS India. By June, DBS India had a sizeable customer deposit base of Rs 24,700 crore, including Rs 5,700 crore as low-cost deposits. It is now busy rebranding LVB branches and ATMs with its logo. The parent foreign bank is expected to bring an additional investment of Rs 2,500 crore. DBS India, with just over 30 branches in the country (most of its business is in the branchless mode) now gets ownership of the LVB’s fixed assets (historical, depreciated cost of Rs 463 crore on March 31, mainly comprising 560 branches and 970 ATMs); cash and investments with the RBI (Rs 1,048 crore on March 31) and other investments (Rs 5,384 crore on March 31). The LVB gets access to deposits of Rs 21,443 crore, including about Rs 6,000 crore low-cost CASA (current and savings accounts) deposits. On the flip side, DBS has to service LVB’s borrowings (Rs 756 crore on March 31). Out of the total advances (Rs 13,828 crore outstanding on March 31), about one-fourth were Non Performing Assets (NPAs). The gross NPA ratio had deteriorated from 15.3 per cent on March 31, 2019 to 25.39 per cent on March 31 this year and remained high at 24.45 per cent on September 30.
While the LVB’s 20 lakh depositors and 4,000 employees can heave a sigh of relief, its over 97,000 investors have been hit hard. Forced mergers of banks are nothing new but in an unprecedented action in the LVB’s case, the shareholders have been divested of their equity shareholding, reserves and surpluses. Since the value of equity shares is officially decreed to be zero, the erstwhile owners of the LVB will not get any share in the LVB+DBS banking entity. Also hurt are bondholders as all of LVB’s Basel-III compliant Tier-2 bonds worth Rs 318 crore were written down. Bond-holders will not get back their invested money, nor interest on them. Significantly, srapping Tier-2 bonds is an unprecedented action. The move was thus both, swift and uncommon, but the problem had been brewing for some time. The LVB had been incurring losses for the past 10 quarters and the RBI initiated Prompt Corrective Action (PCA) in September 2019, which asked the bank to bring in additional capital, restrict further lending to corporates, reduce NPAs and improve the Provision Coverage Ratio to 70 per cent.
These actions/decisions of the Central Government and the RBI have been challenged by the LVB’s shareholders in Mumbai and Madras High Courts (HCs). The Mumbai HC declined to stay the amalgamation but kept the plea filed before it for monetary compensation pending. The Madras HC, too, declined to stay the amalgamation but passed some interim orders giving some relief to the LVB’s shareholders on a petition filed by AUM Capital Market Private Limited, a retail investor holding shares in LVB.
Shareholders contend that they have been deprived of the LVB’s ownership without any monetary compensation. This amounts to unjust enrichment of a foreign bank. The manner of selection of DBS India as the transferee company has also been questioned. What has frustrated the LVB shareholders is the fact that the same DBS that has now acquired the bank with zero compensation to shareholders had offered to buy 50 per cent of the LVB’s shares for at least Rs 100 per share in 2018. Since then, the LVB’s value deterioration has been fast. The share price of the LVB lost 58 per cent this year and went to less than Rs 10 a share. The LVB’s total business shrank from Rs 47,115 crore at the end of September 2019 to Rs 37,595 crore at the end of September this year.
By then, the LVB’s Tier-1 Capital Ratio and overall Capital Adequacy Ratio (CAR) as per Basel-III norms had turned negative. With a large gross NPA ratio of 24.45 per cent, the LVB had a negative net worth of Rs 699 crore. Therefore, scrapping the shares and Tier-2 bonds of the LVB means that the bank has been practically wound up, with core investors asked to bear the accumulated losses. And the junked entity has been handed over to a white knight investor to take over in the interest of the LVB’s 20 lakh depositors. Aggrieved shareholders contend that even if the authorities have the power to reduce the share value during an amalgamation, reducing share value to zero cannot be done without very compelling reasons. And these reasons (if any) have not been disclosed.
Instances of commercial banks failing are rare. As the Government and the RBI are empowered to order consolidation, compulsory amalgamation and liquidation of small banks, no commercial bank has failed. Forced mergers of weak banks with stronger ones are a normal practice to safeguard depositors’ interest.
The LVB is one of the oldest private banks. It was founded in 1926 with a fairly distributed ownership. At the end of March 2012, the LVB had 12.92 per cent non-resident shareholding, which increased to 43.1 per cent by March 2019. During the period, resident individual shareholding came down from 56.73 per cent to 27.7 per cent. Resident financial institutions increased their stake from 8.47 per cent to 20.9 per cent.
The 20.9 per cent Indian Financial Institutions and 38.4 per cent foreign companies, together commanding majority control of the LVB, failed to exercise due diligence and control the management even as the bank’s lending portfolio became problematic. The LVB is a banking company registered under the Companies Act, 1956. Banking companies are governed differently from other companies in India. They are regulated by both the Companies Act and the Banking Regulation Act, 1949. And the Banking Regulation Act, being a specialised law, takes precedence over the conflicting provisions of the Companies Act. Section 45 of the Banking Regulation Act, 1949 empowers the RBI to apply to the Central Government “for suspension of business by a banking company and to prepare a scheme of reconstitution of amalgamation.” So the triggers, processes, control mechanism and so on for mergers and acquisitions are different than those for non-banking companies.
Just like the Companies Act, the Insolvency and Bankruptcy Code applies to banking companies, too, but the Banking Regulation Act prevails over the other two Acts. The one month “moratorium” imposed on the LVB on November 17 was akin to anaesthesia that is given before a surgery. Keeping the LVB under a moratorium for too long would have affected 20 lakh depositors. The RBI had to find an able and willing investor ready to take over. For the last two years, the LVB and its promoters have been trying to lure investors to infuse additional capital to meet regulatory norms.
For the takeover of financially-distressed non-banking companies, resolution professionals are appointed by the National Company Law Tribunal (NCLT). This invites tenders from potential investors and the company is handed over to the highest bidder. In the case of weak banks that are in need of rescue, there is no such practice of inviting tenders. The transferee banking company is selected based on the professional judgment of the RBI. Whether the selection of DBS India was based on rational considerations and whether the LVB’s pre-amalgamation valuation justified shareholders/bondholders being denied any monetary compensation are now sub-judice. Judicial review of regulatory wisdom is not unprecedented.
(The writer is former Special Secretary, Ministry of Commerce and Industry)
The Reserve Bank has asked HDFC Bank to temporarily stop all launches of the ‘Digital Business generating activities and sourcing of new credit card customers.
The RBI's order dated December 2 comes after outages in the bank's online facilities or payment utilities occurred over the past 2 years, including the recent incident in the internet banking and payment system on November 21, 2020 due to a power failure in the primary data centre.
In a regulatory filing, HDFC Bank on Thursday said: "The RBI vide said ‘Order' has advised the Bank to temporarily stop i) all launches of the Digital Business generating activities planned under its program - Digital 2.0 (to be launched) and other proposed business generating IT applications and (ii) sourcing of new credit card customers. In addition, the Order states that the Bank's Board examines the lapses and fixes accountability."
Furthermore, the filing said that these measures shall be considered for lifting upon satisfactory compliance with the major critical observations as identified by the RBI.
"The Bank over the last two years has taken several measures to fortify its IT systems and will continue to work swiftly to close out the balance and would continue to engage with the Regulator in this regard.
"The Bank has always endeavoured to provide seamless digital banking services to its customers. The Bank has been taking conscious, concrete steps to remedy the recent outages on its digital banking channels and assures its customers that it expects the current supervisory actions will have no impact on its existing credit cards, digital banking channels and existing operations."
In addition, the bank said these measures will not materially impact its overall business.
Lakshmi Vilas Bank (LVB) is now amalgamated with DBS Bank India Limited (DBIL), the wholly owned subsidiary of Singapore-based DBS Group Holdings Ltd.
In a statement on Monday, DBS Bank said that the scheme of amalgamation is under the special powers of the Government of India and Reserve Bank of India under Section 45 of the Banking Regulation Act, 1949, India, and has come into effect on 27 November, 2020.
It added that the amalgamation provides stability and better prospects to LVB's depositors, customers and employees following a period of uncertainty. The moratorium imposed on LVB was lifted from November 27, 2020 and banking services were restored immediately with all branches, digital channels and ATMs functioning as usual.
LVB customers can continue to access all banking services. The interest rates on savings bank accounts and fixed deposits are governed by the rates offered by the erstwhile LVB till further notice. All LVB employees will continue in service and are now employees of DBIL on the same terms and conditions of service as under LVB.
The DBS team is working closely with LVB colleagues to integrate LVB's systems and network into DBS over the coming months, the statement said.
Once the integration is complete, customers will be able to access a wider range of products and services, including access to the full suite of DBS digital banking services which have won multiple global accolades, it added.
Moreover, the bank asserted that it is well-capitalised and its capital adequacy ratios (CAR) will remain above regulatory requirements even after the amalgamation.
Additionally, the DBS Group will inject Rs 2,500 crore into DBIL to support the amalgamation and for future growth. This will be fully funded from DBS Group's existing resources.
DBS has been in India since 1994 and converted its India operations to a wholly owned subsidiary (DBIL) in March 2019.
Surojit Shome, CEO of DBS Bank India Limited, said, "The amalgamation of LVB has enabled us to provide stability to LVB's depositors and employees. It also gives us access to a larger set of customers and cities where we do not currently have a presence. We look forward to working with our new colleagues towards being a strong banking partner to LVB's clients."
It is crucial to understand the financial behaviour and practices of SMEs which are totally separate from those of larger firms
Although capital is a scarce resource for any business, it is even more scant for small and medium enterprises (SMEs). Therefore, cash flow and working capital management are the most crucial challenges of organisations in general and SMEs in particular. Working capital is short-term in nature and refers to the funds required for the daily functioning of a firm. In business parlance it consists of accounts receivables (debtors and any pre-payments, stock or inventory) and accounts payable (creditors and short-term provisions). The lifeline of any enterprise is the flow of cash and other liquid assets through a business cycle — a journey of collecting receivables from the debtors to pay off the creditors. This is also known as the cash conversion cycle. The efficiency and, therefore, the success of a business depends upon how fast the goods are converted into cash.
SMEs differ in many ways from large firms in terms of their financial behaviour and decision-making, mainly because of their characteristics and ownership. This ultimately reflects in their financial habits. So, what are the factors that affect the availability of capital to small enterprises? One of the most important issues is the size. According to researchers, during the start-up phase, the owner’s personal savings are an important source of funds. Young and small firms do not have an established track record and may be characterised by informational opacity, making banks and other financial institutions reluctant to lend to them. In general, firms which are less than four years old, rely more on informal sources of funding.
However, when the SMEs increase in size and become larger, they have a greater network of banks willing to fund their business. The firm’s ability to deal with multiple banks and other credit agencies generally grows with size, too. So, they rely more on long-term debt and external financing, including bank loans.
Second, the type of ownership is another important determinant for the source of funding. Any SME with a concentrated ownership, like in a proprietorship, should be more prepared to use bootstrap financing, as it would have greater difficulty in accessing a formal source of credit. From the lender’s perspective, in such SMEs, there is no clear distinction between the owner and the firm, information asymmetry is prevalent and an ability to provide collateral is missing. On the other hand, a private limited SME may be viewed by financing agencies as more structured and credible. As a result, formal financing options are freely available to it. Third, the location of the start-up makes a huge impact. A firm’s proximity to the banks has an influence on its ability to gain external funding. Research also suggests that one of the reasons for a company’s failure is poor location that prevents customers and suppliers from reaching it. Therefore, despite high rentals, SMEs prefer to move to urban areas for the sake of better infrastructure and the ease of raising external finance.
Fourth, several researchers have provided evidence that the sector where the SME is operating has an impact on the short and long-term debt available to it. For example, short-term credit is used more in wholesale and retail trade as compared to manufacturing SMEs. Whereas the construction sector, hotel, hospitality and mining industries appear to depend more on long-term finance. And finally, availability of assets plays an important role in raising funds. From a lender’s point of view, collateral, which is also known as the lender’s second line of defence, is highly relevant while approving loans. Researchers Ono and Uesugi studied the Japanese SME loan market and found a positive relationship between the use of collateral and the ease of access to bank loans and external financing. It can also be understood that firms with lower tangible assets would face difficulties in accessing funds.
Additionally, the characteristics and gender of the owner too influence a firm’s capability to raise external funding. According to several researchers in different countries, men and women differ in the way they raise cash for their businesses. There is empirical evidence that women entrepreneurs start their business with a smaller start-up capital, in fact less than half of the amount used by men. In addition, women also face discrimination from banks and other financial institutions. This is evident from the higher rates of interest charged from women entrepreneurs, the requirement of additional collateral, higher loan denial rate and so on. The age of the owner, too, impacts the personal financing preference. Older SME owners are less likely to take additional finance into their firms. Younger owners tend to use a variety of external cash sources like loans, overdrafts, credit cards and personal savings.
SMEs are the backbone of any growing economy. Therefore, it is crucial to understand their financial behaviour and practices which are very different from the financial management of large corporations. This would help policymakers come up with ways to improve the external financing scenario for such firms, as stronger SMEs make a stronger economy.
(The writer is Associate Professor, Amity University, Noida)