India Markets closed

Strengthening the SME loan infrastructure in India

Nikita Kwatra
To address lender uncertainty around SMEs, the government can guarantee to repay a substantial portion of SME debt

From kirana stores to local businesses, small and medium-sized enterprises (SMEs) are central to the Indian economy. According to the ministry of micro, small and medium enterprises, these firms contribute about 30% to India's economic output and provide employment to over 111 million people. But despite this importance, India's small firms are starved of funds.

One way to address this, according to a new study by the Asian Development Bank (ADB), is to establish credit-information infrastructure for SMEs and provide credit guarantees to ease their access to finance.

In the study, Naoyuki Yoshino and Farhad Taghizadeh-Hesary say SMEs face difficulties in accessing cheap finance because creditors lack clarity about the financial health of SMEs. Assessing financial health requires audited accounts and financial statements which SMEs often do not maintain. This increases collateral requirements for lending to SMEs and higher interest rates to compensate creditors for the increased risk.

The authors suggest that the development of SME credit risk databases, credit bureaus and credit ratings can help lenders gauge the risk associated with lending to small companies.

For instance, in Japan, the “credit risk database” association uses scoring models to evaluate creditworthiness of SMEs and align loan prices with credit risk. Similarly, in Thailand, a National Credit Bureau collects and processes credit information of financial institutions' clients.

While these may be long-term measures, the authors suggest there are short-term methods for analysing SME credit risk by using financial data which captures SME activity, profitability and liquidity.

The authors also highlight the importance of credit guarantee schemes for lowering credit risk. To address lender uncertainty around SMEs, the government can guarantee to repay a substantial portion of SME debt. This will ease lender concerns and attract more finance to the sector.

Also read: The Role Of SMEs In Asia And Their Difficulties In Accessing Finance (bit.ly/2VuwTaf)