For millions of small businesses, the economic slowdown posed a potential threat. That has been compounded due to COVID-19 pandemic that is now raising the existential questions. Small businesses face huge difficulty in access to formal credit. Micro, Small & Medium Enterprises (MSMEs) now want the government to be proactive in implementing relief measures on top of the existing painpoint, viz., credit.

It is perhaps the biggest pain point for the Micro, Small & Medium Enterprises (MSMEs) in India. In the Union Budget for 2020-21, Finance Minister Nirmala Sitharaman announced that an app-based financing system would be launched in order to ease the access of formal credit to small businesses. This may usher in a renaissance for MSMEs. It is good to note that the Finance Minister has recognised the problem but a lot of clarity is needed on how to implement it and what are the concerns of different stakeholders including Chartered Accountants, industry associations, policy experts and MSMEs themselves.

However, as is often the case, best intentioned policies fall victim to champions of status quo through building in points of failure to ensure that the policy is not implementable or enforced. The worst fears of MSME sector could be here.

MSMEs fear that such an invoice financing facility may get linked to collateral or made a part of the existing cash credit limits making the entire effort, an exercise in futility. They worry that sanctioning power intermediaries will come in thus opening up rent-seeking opportunities. This is more so as the current credit chain involves various finance intermediaries who may oppose this move to delay and bring credit to people who need it the most. 

Based on past two years of ground research, workshops, MSME clinics and conferences, we find that the two biggest problems being faced by MSMEs is a requirement of huge collateral for credit and delayed payments. Even when banks lend against CGTSME scheme that covers 75 per cent of the risk, banks take 125 per cent collateral for their 25 per cent share of risk, getting loans secured against 200 per cent collateral. SKOCH had  recommended this to Reserve Bank of India (RBI) way back in March 2019 that 25 per cent collateral should be sufficient for MSMEs with a good credit track record. It also said that a concept of margin collateral should be introduced, e.g., the cash-credit limit could be 2x higher than the collateral value.

It was also recommended that since most MSMEs, in a particular sector, tend to do similar things, the opportunities for windfall due to innovations, efficiencies etc are rather limited. What is possible, however, is that these organisations can scale and create more jobs. This sector then becomes the lowest priority for investors. It is here that the banking system can play a major catalytic priority sector development role by directing the treasuries to make 5 per cent from their investments in SME stocks.

Our major recommendation has been that of GST trusted invoice financing. India Economic Forum in November 2019 and Public Policy Forum in January 2020 with a body of stakeholders and experts from all across the country endorsed this demand.  The MSME related announcements in the budget gladdened our hearts as they address large problems. First, it enabled invoice-based financing, which was a significant recommendation of U K Sinha Committee Report; and, second, it enabled more NBFCs to get active in MSME Finance, a poorly served segment by the banking sector.

Critical Issues for MSMEs

The MSME Development Act, 2006 (MSMED Act) is the cornerstone legislation for MSMEs in India. It provides for facilitating the promotion and development and enhancing the competitiveness of MSMEs. The industry has been demanding the strengthening of provisions related to delayed payments and public procurement. It provides the definition of MSMEs in India currently on the basis of investment in plant and machinery (excluding investments in land and building) for manufacturing and service enterprises separately. The current thresholds of investments for manufacturing are: Micro up to 25 lakh, Small up to 5 crore and Medium up to 10 crore. Corresponding thresholds for service enterprises are:  Micro 10 lakh, Small 2 crore and Medium 5 crore.

Although the Cabinet had cleared replacement of investment based definition with one based on turnover, yet the Act could not be amended through the Parliament. There is an urgent need to look into change in criteria of definition. As it holds today, it so appears that the manufacturing industry has hijacked the MSME policy. While a manufacturing unit may still have investment in plant and machinery, what about the services or trading companies, who have close to nil investment in plant and machinery, question experts. Therefore, what is recommended that the definition is based on turnover keeping in mind GST filing rather than investments, which generally are depreciating assets.

Another area of concern for MSMEs is friction with the system. More often, MSMEs are seen hiding from the government or resisting / hating to deal with it. A large number of these problems are at district and municipal levels. For example, a Doctor or Chartered Accountant can operate from the basement in a residential area, an MSME in consulting business can’t! While the former, which will have regular and daily visitors are taken as ‘non-nuisance’ activity the latter with rare visitors or none, is not.

SKOCH’s studies have revealed that the biggest felt-needs of the MSMEs in the country today are the access to credit and delayed payments from buyers particularly the government departments and the PSUs. There are various schemes and regulations related to these issues. Are they helpful in addressing the felt-needs of the MSMEs? Our ground level studies show, it is not.

“Although MSMED Act, 2006 contains provisions related to penalty in case of delayed payments by the buyers, weak bargaining power and the fear of losing the business prevents MSMEs to invoke this provision,” said Shaktikanta Das, Governor, Reserve Bank of India (RBI) while speaking at Annual Banking Summit in Mumbai in March 2020. “MSMEs suffer mostly due to delayed payments at the end of the government. If the payments are getting delayed, who is going to bear the interest burden?” asked Rohit Vasvani, President, Bhartiya Vitt Salahkar Samiti (BVSS) and Founder Partner, Raj K Sri & Co.

Cash Flow Lending

Almost the entire sector today is dependent on loan against property. Over the past one year, SKOCH has advocated for a cash-flow lending system based on GST paid invoices that are accepted by the buyer. This could be achieved through a second window on TReDS, possible due to a combination of liberated data and agreement between MSME seller and TReDS platform Lenders, for obtaining cash-flow lending for its invoices.

“In order to address this, we have recommended that all the invoices raised by the MSMEs to the government departments are given to an information utility, the idea of which has emanated through IBC and due to GST, data support is available, all these invoices are posted to be handled by one officer from the MSME Ministry. We have recommended that there is possibility of a second window because of the combination of liberated data and agreement between MSME Seller and TReDS platform Lenders, for obtaining cash-flow lending for its invoices,” said U K Sinha, Chairman, Expert Committee on Micro, Small and Medium Enterprises. Various India Stack Open APIs integration into TReDS Platform will facilitate MSME on-boarding, invoice verification via GST, MSME bank transactional cash flow data, GST data, past loans and credit history, repayments tied to electronic liens on cash inflows and more. “GST will allow through its API, the ability to verify MSME Invoices on TReDS platform. It will also support ‘matched invoice’ validation of MSME Seller and Buyer,” he added.

The concept of ‘GST Trusted Invoice’ into TReDS, obviates the need for Buyer in the TReDS lending transaction. The veracity of the Invoice is ascertained from GST submissions for Input Tax Credit, and payments are enforced through a lien on the Buyer’s bank account, hence this process just needs the MSME Seller and Lenders involved in a transaction. The invoice is required to have a pay-by-date for this purpose.

“In the scenario of an SME receiving the order from large industry but not able to deliver for want of credit; for this, the Panel has recommended the method of cash-flow based lending and found that technology can facilitate this. For this RBI has come up with a policy on aggregators,” explained Sinha. 

Various India Stack Open APIs integration into TReDS platform will facilitate MSME on-boarding, invoice verification via GST, MSME bank transactional cash-flow data, GST data, post loand and credit history, repayments tied to electronic liens on cash inflows and more. GST will allow through its API, the ability to verify MSME invoices on TReDS platform.

The ability of data to transform the country has not been either realised or completely contemplated. “We are at a point, the resources that we are dealing with, is something never seen before. Even from the regulatory standpoint, we are using older formats of policymaking to deal with this newer entity called new oil and trying to figure out how this works and what needs to be done with it. The current privacy laws are protectionist and validly so, because the exploitation of private data is substantial,” said Saranaya Gopinath, Co-Founder, Digital India Collective for Empowerment (DICE) & Research Fellow, Bharat Inclusion. There are a number of enterprises that are not in the formal economy. The ability data brings to the system is to change that, she added.

To come to the question of what the API economy unfolds, there are several aspects where I see API economy really blowing up, said Gopinath. According to her, “If I have to come to one instance in terms of relevance, it would be in the context of RegTech. Innovation in India starts to come to the forefront when we see the obvious conversations on the cost of compliance to privacy and how we enable smaller enterprises.”  

What Issues Remain?

In order to secure the privacy and sanctity of data, the service providers could be given ‘Read Only’ access to the bank details of the MSMEs purely for validation purposes. The proponents of the new regime also recommend that the invoice financing as proposed by the U K Sinha Panel as well as Finance Minister, be treated under priority sector lending. It will make CFL to MSMEs more efficient, transparent and high priority.

The new platform seems to be good but whether the banks will come forward to finance these small suppliers remains to be seen. While TReDS has been there for a while, very few transactions have taken place. Out of approximately 1,881 companies, which are eligible to be registered on TReDS, only 350 have registered. This apart, very few transactions have taken place. This, because the bankers are selective. “Invoice financing is a good idea but I am sceptical about banks lending to small businesses and vendors without due diligence, CIBIL search, credit rating and collateral security,” said a worried Mukesh Mohan Gupta, President, CISSME. Further, a merchant banker who has helped a number of SMEs to list on the national exchanges, Madhu Lunawat, Director, Pantomath Advisory Services Group, asked, “In TReDS, lenders are not financing tier-3 and tier-4 businesses. It is not clear how they would lend to small businesses under a cash flow financing system.”

When it is CFL, the entire workflow process of the manufacturing sector has to be captured by the banker. Banks will have to identify the areas where money needs to be lent and act accordingly. “Receivable discounting has been happening in India for decades. What we are talking about is to be able to digitise it and make it simple,” emphasised Vivek Aggarwal, Partner – Government Advisory Practice, KPMG. In the same vein, Vasvani of BVSS added, “The concept is good. Having liability is not a bad sign. The bad sign is the cash flow. If you are not able to repay your commitments, that is a problem.”

Trust deficit in the system is another issue. This, along with other issues need to be tackled simultaneously. On the policy side, the definition of identification of MSME has to be output oriented, to be defined based on turnover. TReDS may be in its infancy, but its acceptance is increasing by the day. “Objections relate to pre-GST, pre-IBC, pre-Aadhaar era. These can be easily addressed as it is now possible to create a financial trail to prevent misuse of funds,” said an optimistic Anil Bhardwaj, Secretary General of FISME. Despite challenges, TReDS is working and participation is increasing.

Bankers on the other hand favour integrating the new system with couple of other databases like RBI’s Central Repository for Information on Large Credits (CRILC) where limit availability is captured on a real-time basis. This provides an up-to-date information on a company’s exposure to various lenders.

Access to Finance

One of the main reasons for the banks to refrain from lending to small businesses is the lack of reliable financial information. The Goods and Service Tax Network (GSTN) could solve this problem. For this the capacity of the GSTN needs to be enhanced significantly. It is increasingly seen that during peak, the system become erratic and sometimes even stops to respond. Credit system that is based on such a system needs to be robust and reliable. Experts also maintain that the app-based credit network should be linked with all the banks. It will really help get credit details of sellers as well as buyers. Linking it with the Income Tax system will help validate the tax records. Lenders will be more forthcoming in case the creditworthiness of the borrower is established, said Priya Kapoor, an Independent Consultant.

Most of the RBI guidelines are aligned for handling lending needs of the large corporates. “We can’t mindlessly apply those credit evaluation methods for the MSMEs,” said Milan Mehra, Founder of Alternate Finance & Investment. Echoing a similar concern, Deepak Aggarwal, Co-Founder and Director, Moneyboxx Finance said, “In addition to the Income Tax and GST data, it should take into account the balance sheets, ratios and credit history.” Credit can be extended to the companies whose score is above a particular limit. In case NBFC’s or private banks are not forthcoming, the PSU lenders could take the lead. Once the track record is built, the private lenders will get aligned.

What is also needed is to plug loopholes like fake invoices—issuance of invoice without the supply of goods and services. “While, there is need to bring openness and transparency in putting all data in public domain in a secured way, the same can be done for the partnership and proprietorship firms,” submitted Arun Ahuja, Promoter & Senior Partner, Ahuja Arun & Company and General Secretary, Tax Law Educare Society. It is important to oversee the sales ledger, it must have a column on invoice factoring.

Stakeholders like P K Singh, Managing Partner, PKS SIMPLY GST, question, “MSMED 2006 does not even clearly define MSME. The MSME is also not defined in GST. There is no mechanism to identify whether a particular invoice is from MSME.”

With the situation changing almost every day, much of the economy is coming to a grinding halt and businesses are not facing the brunt of the brutal virus that is ravaging the nation. The government has to proactively work towards introducing a solution to the mounting problems of MSMEs. Apart from speeding up cash flow lending and App based financing, it may also be prudent for Finance Minister to look into providing moratorium to the existing loans.