Financing SME s Alternative Strategies CAFRAL Conference on SME s - September 7 th 2012
Table of Contents Section 1: Importance of MSME s to the economy Section 2: Market Opportunity Section 3: Industry Segments Section 4: Customer Life Cycle Section 5: Identifying and managing risks Section 6: Steps to revitalize Section 7: Complementing Strategy 2
Importance of MSME s to the Economy Approximately 30 million MSME Units in India MSME's Contribution towards GDP has been growing at a consistent rate of 11% (more than the GDP growth rate) MSME contributes to 45% of total industrial output of the country Contributes to 40% of total exports. Creates 1.3 million jobs every year. Employs 69 million people Produces more than 8000 quality products for the Indian and international markets 3
Market Opportunity The sector's total finance demand is estimated to be INR 32.5 trillion ($ 650 billion ), with 80% of the demand originating from the informal sector The share of formal finance to the sector is INR 7 trillion ($ 140 million) and covers only 10-11 million enterprises. An estimated 67% of enterprises remain un served by the formal financial sector. Micro and small enterprises have limited access to equity and, in many cases their ownership structure prevents infusion of external equity Total Micro, Small and Medium Enterprise Finance Demand (in INR Trillion) Medium enterprises have better access to finance and better capacity to absorb external equity, Exclusions: Financial institutions have limited their exposure to the sector due to a higher risk perception and limited availability of immovable collaterals. An estimated 37% of the overall debt demand is considered unviable for financial institutions. In addition, nearly 25% of the total estimated demand is from micro enterprises that do not have access to the financial sector Note: Above figures do not include the Microfinance Industry Source: IFC Report 4
Addressable Finance Gap Immediately Addressable Finance Gap (INR trillion) after exclusions Equity Demand in Micro, Small and Medium Enterprise Sector (INR trillion) after exclusions Micro Enterprises Debt Gap - INR 2.3 trillion ($ 46 Billion) Small Enterprises Debt Gap - INR 0.5 trillion ($ 10 billion) Medium Enterprises Debt gap - INR 0.1 trillion ($ 2b billion) The potential demand for external equity is estimated to be INR 1.9 trillion ($ 38 billion). Entrepreneur equity (INR 4.6 trillion; $ 92 billion) in most cases is financed through debt from informal sources. Note: Above figures do not include the Microfinance Industry Source: Micro, Small and Medium Enterprise Census, SIDBI, Primary Research, IFC-Intellecap Analysis 5
MSME Vulnerability 1. At risk with economic downturn 2. Low entry barrier for new players 3. Serving predominantly local markets 4. Import & substitution threat 5. Inability to scale 6. Lack of professional management 6
Challenges in MSME Lending 1. Low capitalization 2. Poor Financial Disclosures 3. Lack of tangible collateral 4. Predominantly close family holding 5. Lack of investment in technology, infrastructure, marketing network 6. Information asymmetry 7. Unreliable financials 8. Lack of transparency 9. Vulnerable to any adverse economic, regulatory or competitive event 7 10. Operational inefficiency
Activity- wise MSME s 8
Industry Segments 9
Customer Life Cycle A typical MSME Customer Turnover (Rs Mn) Secondary Property creation 50.0 25.0 10.0 5.0 Rented premises & used machinery New Machinery & new technology Primary Property creation 1.0 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Community Borrowing / Chit Funds NBFC / co-op Banks Bank Borrowing 10
Identifying and Managing risks Differentiated Risk profiles and Finance needs: The financing needs of the sector depend upon size of operation, industry, customer segment, and stage of development The smaller the entity, greater is the reliance on debt as a primary source of finance. Micro enterprises primarily rely on debt for both early and growth-stage financing Micro and small services enterprises primarily transact in cash and tend to keep minimal records Manufacturing enterprises and those with order-driven services tend to need more finance because of longer working capital cycle and higher capital expenditure Appropriate tailor made products to match different needs 11 Source: IFC report
Differentiated Product needs 12
Mitigants to Risks Cash flow based assessment with reference based confirmation from customer & supplier (MSME) Understanding local market & trade linkages - esp. in industry clusters (Key Success Factors) Better segmentation of customer, markets, trades for risk assessment Key Success Factors (KSF) Framework Implement early warning tools to proactively detect account weakness & take necessary action Proper portfolio management in terms of risk grading, collateral basket, geographic & industry concentrations Use rehabilitation tool to help nurture cash strapped MSME back to good financial health Invest in training of sales and risk personnel on markets, early warning, alternate risk assessment techniques Localized credit delivery better than centralized credit 13
Steps to revitalize MSME Lending Relaxation of lending norms to MSME (Debt/Equity 4:1, longer working capital cycles) Develop surrogate based lending for MSME sector (cash flow basis) Collateral free lending is critical for small & medium ticket loans (up to 25 lacs) More push of credit guarantee scheme (extend benefit to NBFC s) Extend priority sector status to bank s loan to NBFC (lending to MSME s) Customer education of various financial & other schemes/assistance offered by different govt. agencies Leverage technology (mobile) & business correspondent channel 14
Complementing Strategy Banks & NBFC s should collaborate to offer full-suite of requisite financial products on a risk reward sharing basis. The options can be: 1) Securitization (already exists) 2) Segment wise alliance: -Example: Banks which are strong in supply chain financing can tie up with a NBFC for specific segment financing eg: Apparels 3) Risk- reward partnerships: - NBFC s with a proven track record of financing micro and small businesses, can be allowed to partner banks on a Risk- sharing basis 15
Shriram Capital Ltd. Chennai Mumbai New Delhi www.shriramcapital.com
Back Up Slides
Key Success Factors (KSF) Framework 18
Examples of KSFs Back to Presentation Industry Concerns KSFs Additional Checks Automobile dealerships Auto components, ancillary manufacturing Metals Excess stocking, Unrelated diversification Limited product range, Lack of technology Buying and selling of metals with a low level of value addition. 1) Owner investments in dealership 2) High Service income Linkage to top 10 Auto majors Linkage to acceptable corporate Chemicals Low capacity Longer association with existing buyers, customers total 1) Owner investment of at least 30 % of total cumulative investment in a dealership. 2) Increase in service income for the last 2 years. Minimum 20 % sales linkage to Top 10 Auto majors Minimum 20 % purchase linkage to corporate with a minimum rating of AA from Rating agencies. 1)Minimum 3 year relationship with existing buyers 2) In case of distributor, minimum 20 % purchase linkage from corporate with a minimum rating of AA from Rating agencies. Branded consumer Limited product range Weak principal Distribution infrastructure Longer experience Retail trade Low owner equity 1) Owner investment in the business 2) Variety of products Information Technology No vertical integration 1) Enabled services 2) Linkage to acceptable corporate with stable & growing end user segment manufacturing, telecom, retail and financial services 1) Distribution infrastructure of more than 1 branch; 2) Minimum vintage of 5 years with one particular brand 3) Revenue from branded products >50% of total revenue 4) CAC eligibility of maximum 30% on total sales Owner investment of minimum 40 % of total cumulative investment. 1) Linkage to acceptable corporate 2) Revenue from early stage Internet based companies <30% total revenue 3) Product revenue <30% of total Revenues 19