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Finance for the SMEs and Credit Rating
Agencies
D S Solanky,
Small Exercise
 As an entrepreneur think of a viable business
idea
 Who according to you is an SME
 Do you think SME are important for the
country
 If you are an SME what problems you might
encounter
SMEs are…
THE MICRO, SMALL & MEDIUM ENTERPRISES DEVELOPMENT ACT, 2006

Micro Enterprises - investment in plant & machinery upto Rs. 2.5 mn

Small Enterprises - investment in plant & machinery upto Rs. 50 mn

Medium Enterprises - investment in plant & machinery upto Rs. 100
mn
Services Sector

Micro Enterprises - investment in equipment upto Rs. 1 mn

Small Enterprises - investment in equipment upto Rs. 20 mn

Medium Enterprises - investment in equipment upto Rs. 50 mn
Are SMEs are like this common man…
Importance of SME sector

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
Economic Development
 Balanced Regional Development
 Better Resource utilisation
 Generation of Employment
 Entrepreneurship Development
Industrial Growth
 Contribution to Industrial Output
 Supply of intermediates to Large Enterprises
 Exports
 Ability to adapt to changing environment
SMEs propelled the growth of leading Asian economies.
 SMEs in Asian economies account for around 40-60% of capital
investment, 60% of employment and 50% of output and 35%
exports .
Contd…
 Plays a pivotal role in the overall industrial economy
 Estimated contribution – 34% of Indian Exports
 Constitutes – 39% of the manufacturing output
 Provides employment to over 31 mn people over 12.8 mn
enterprises, labour intensity 4 times higher than large
enterprises
 Exhibiting growth rates higher than the overall industrial
sector
 Many important sectors of Indian Economy – Textiles, Biotech, IT, ITES, Auto ancillaries and other services.
SMES IN INDIA : AN OVERVIEW
Playing an increasingly important role
4500
35
Production (Rs. bn)
4000
SSI Exports (Rs bn)
3500
Employment (mn)26.0
24.9
28.3
27.4
29.5
4188
3000
30
consistent rising trend
 Production has increased from
25
23.9
Rs.1844 bn to Rs.4188 bn during
20
2000
15
2515
1500
1844
1502
2106
1000
1956
712
the period FY2001 – FY2006.

The contribution would be even better
if medium enterprises are taken into
2287
698
Production, employment, exports of
SSIs in India have all shown a
2500
500

10
consideration (definition of SMEs has
come into effect only since October
860
976
5
0
2006).
0
FY 01
FY 02
FY 03
FY 04
FY 05
FY 06
Source: Ministry of Micro, Small and Medium Industries, Govt. of India
Note: * Exchange rate : US$ 1.00 ~ RS. 39.00
Increasing importance of SMEs-Globalisation

Globalisation of the world economy has increasingly drawn the Small and Medium
Enterprises (SMEs) into global value chains.

Globalisation facilitates access to global markets – now an important part of
business strategy for many outward-looking SMEs


Access to global markets for SMEs can offer a host of business opportunities

Access to larger and new niche markets;

Help prospective high growth firms realize their potential

Possibilities to exploit economies of scale and technological advantages;

Upgrading of technological capability;

Lowering and sharing cost including R&D costs.
Globalisation can also pose challenges and threats to SMEs - exposure to
international competition from foreign firms, and may result in the loss of
traditional markets to lower-priced competition from abroad.
SMEs in India

Small Scale sector accounts for over 30% of India’s aggregate
exports.

Certain vibrant export sectors in India are dominated by SME
Sector. e.g.


Agro & Processed foods, Marine Products

Information Technology

Garments

Gems & Jewellery

Leather Products
Growth of industries in the SME sector in India has contributed
to the overall growth or the Gross Domestic Product as also in
terms of employment generation and exports.
SMEs in India..contd

Steady increase in no. of micro & small enterprise, production,
employment and exports over the years.

Number of units increased from around 2.0 million units in 199091 to 12.8 million units in 2006-07, employing more than 3.12
million persons, next only to agriculture.

Policy
support
for
promoting
small
scale
industries
– incl.
reservation of economically viable and technically feasible items for
exclusive manufacture in the small scale sector.

Performance of the small scale sector, forming part of total
industrial sector - has direct impact on the growth of the national
economy.
Issues and Challenges Facing SMEs


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


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Lack of skilled and knowledgeable labors
Inconsistency of labor supply
Lack of technology
Constrained managerial capabilities
Limited managerial bandwidth
Low productivity
Low brand value. Mainly in the lower end of value chain
Access to adequate financing
R&D–
If corporates don’t get finance they seriously need to reexamine the way out
SMES : ACCESS TO FINANCE
Credit to SMEs has been increasing in absolute terms
10000
8000
6000
4000

Credit to SSIs increased in
absolute terms from Rs. 528 bn
in 2000 to Rs. 902 bn in 2006.

Trends:
Net Bank Credit (Rs. bn)
Credit To SSI (Rs. bn)
 Graduation of SSIs to large
Corporations
 Banks have tended to lend
more to larger corporates
 Increasing role of Exim Banks
to help SMEs in globalisation
2000
0
Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06
Source: Report of the Trend & Progress of Banking in India, RBI
SME Sector: Funding Institutions
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Commercial Banks/ Cooperative Bank
Small Industries Development Bank of India(SIDBI)
National Small Industries Corporation(NSIC)
Exim Bank
State Finance Corporations/ State Level Agencies
Non Banking Finance Companies (NBFCs)
Credit Guarantee Fund Trust for Small Industries(CGTSI)
ECGC – ECA for export insurance.
Lending to SMEs in India: Challenges
 Promoters have limited managerial and financial
resources.
 In general financial statements of a typical SME do not
reveal its correct financial position. Asymmetry of
information, non-standardized financial statements.
 Most of them are partnership or proprietorship firms.
Legal problems for these forms of constitution.
 Lack of collaterals.
 Individual oriented. Lacks professionalism.
 No concrete business plan.
 Difficult to obtain quarterly information. Loan monitoring
is difficult.
 High percentage of related party transaction.
 Lack of innovation. Vulnerable to competition.
 Banks charge higher rates to factor in the risks.
The Answer is very obvious…
Credit Rating ?
What is that ?
 It is an evaluation of Credit Worthiness of a person or
company or instrument.
It indicates the capability/willingness to pay the
obligation, and
 the risk perception of the client in the eyes of the
lenders
Bipin Bhardwaj, DGM SME, SBI,
LHO, New Delhi
17
Concept of Credit Rating
rating is, essentially, an independent, unbiased and
objective opinion on the relative ability and
willingness of the issuer of a debt instrument “Credit
to meet the debt service obligations as and when they
arise.”
Concept of Credit Rating
●
●
●
●
●
●
●
Rating reflects Credit Risk
Ratings indicate Probability of Default
Does not cover market risk, reinvestment risk, pricing etc
Rating is applicable for the entire tenure of the instrument
Not a one time evaluation
Not formula-based
Credit Rating is essentially an outcome of Overall Risk Assessment of
the issuing entity
● Rating is not a recommendation to the investors to deal in the rated
security
● Does not imply rating agency performs an audit function
Credit Rating of Bank Loans :
 Reserve Bank of India, has mandated that
Banks in India shall observe the BASEL-II
norms .
 These Basel -II norms
mandate a Higher Credit Risk
for the Unrated Loans, and
Low Credit Risk for AA or AAA rated Loans
Bipin Bhardwaj, DGM SME, SBI,
LHO, New Delhi
20
Basel-II: A perspective
RBI requirement under new Basel II framework
Banks are required to arrive at their capital requirements for
loan/facility exposures to various entities using stipulated
risk weights
• These risk weights are linked to the credit ratings of
loans/facility assigned by RBI/SEBI recognized rating
agencies such as CARE
• An unrated loan/facility exposure by the Bank gets a
higher risk weight whereas a rated exposure gets lower
risk rate
Credit rating under Basel-II -Implications
• Large number of entities will have a credit rating enabling better
profiling w.r.t. credit risk
• Credit risk management in banks linked to independent risk opinions
• Banks have to set aside lower capital for higher rated entities and
vice versa, enabling appropriate benefits to borrowers in terms of
pricing of credit
• Rated entities can access debt markets easily
• Entities can assess their own financial flexibility by comparing
ratings across companies and across industries
Trusting banks can be hazardous
for their health….
Credit Rating of Bank Loans
If you want to have a loan of Rs. 50 Crore from a Bank and you are
unrated, the bank will have to cover your risk by 150% of normal,
and
If you get yourself rated, your risk may come down to just 20%(in case of
AAA).
Bipin Bhardwaj, DGM SME, SBI,
LHO, New Delhi
24
Rating Scale
Investment Grade
Speculative Grade
Long
Term
BB
AA
A
Short
Term
AA
PR1+ PR1
A
PR2
B
C
PR4
PR5
BBB
PR3
D
Ratings options for SME
 SME Ratings
 Assessing overall debt management capability
 One time assessment
 Basel II – Bank Loan Rating
 Required by banks for Capital Adequacy purpose
 IPO Grading
 Mandatory for maiden public issue
 Relative assessment of the fundamentals of the issuer
Key Demand Drivers for Credit Rating
Rapidly developing
Financial Markets
Broad Spectrum of
Issuers accessing
capital markets
New & Complex
Investment vehicles and
Financial securities
Broader investor
participation
Tightening Regulatory
requirements
Growing need for
Independent and
Objective assessment
of new type of Risks
Evolution on New
Rating/Grading
Products
Benefits of Credit Rating
Investors / lenders
• An independent, unbiased and objective opinion on risk
• To draw their credit risk policies and assess the risk premium offered by
the market on the basis of credit ratings
• To effectively monitor and manage investments in debt instruments
Issuers
• For wide access to funds
• For pricing and timing of issues correctly
• For financial flexibility
Benefits of Credit Rating
Financial Intermediaries
•
•
•
•
•
Useful in lending and investments
Business counterparties
For establishing business relationships
For opening letters of credit, awarding contracts
For entering into collaboration agreements
Regulators
• To determine eligibility criteria and entry barriers for different types of
securities
• To monitor financial soundness of organisations and promote efficiency
in the debt market
Issues in Rating of SMEs
●
Asymmetry of information – absence of well documented credit
history
●
Sectoral and sub-sectoral classification of entities for adequate
industry comparison
●
Existence of Clusters
●
Changing Economic and industry dynamics – Globalization
●
Strong linkages with the bigger corporates
●
Financial transparency versus Business model strength
●
Unavailability of authentic data
●
Large number of unregistered units
Information requirement
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Background, brief profile of the company, promoters and other
group companies
Last five years’ annual reports/ audited accounts
Copy of latest data submitted to the bank and loan repayment
schedule
Details of capex plans for the next 3 years or project/ feasibility
report
Product category-wise sales (volume & value), for last five
years.
Current order book position (Client/ Order Value/ Product
Wise), if applicable
Top 10 customers (in Value terms) for the last 3 years
Background and brief profile of the company and its promoters
and other group companies
Capital History and Shareholding pattern as on date
Process Flow
CLIENT
CARE
Request for Rating
Assigns rating team
Submits information
schedules
and
detailed
Interacts with team, responds to queries
and provides additional data necessary
for the analysis.
The team analyses the information
Team interacts with client, undertakes site visits and
analyses data submitted by client
RATING COMMITTEE awards rating.
Rating Letter & rationale issued to client
Accepts
Rating?
Yes
No
Appeal for Review of rating
(once)
Press Release, published in website, CAREVIEW and
Rating Reckoner
Rating Kept Under Periodic Surveillance
CREDIT RATING COMPANIES
IN INDIA
1.CRISIL
2.CARE
3.ICRA
4.FITCH
Bipin Bhardwaj, DGM SME, SBI,
LHO, New Delhi
34

THANK YOU