How important are public sector banks to MSMEs?

The government has voiced its concern that micro, small and medium enterprises (MSMEs) would face difficulty in getting credit as 11 public sector banks face restrictions on their credit disbursals, with two of them already asked to stop lending.

According to reports in the media, the finance ministry is going to ask the Reserve Bank of India (RBI) to relax some of the rules under its Prompt Corrective Action (PCA) to avoid banks from clamping up loans to MSME firms.

PCA is akin to an intensive care unit whereby RBI asks banks with fractured balance sheets to repair their books before they take on fresh risks to capital through lending. Depending on how bad their books are, lenders are asked to bring the shutters down on various activities.

Under PCA, Dena Bank has already been asked to stop lending, while Allahabad Bank has been told to avoid corporate credit exposure. For all purposes, these lenders can no longer disburse loans to any kind of businesses.

Data collated from the financials of 11 lenders under PCA shows that they contributed to around 30% of the total outstanding credit to MSMEs as of December 2017. Indeed, many of the lenders under PCA have a large base of MSME borrowers. Furthermore, the geographies in which some of them operate indicate it would be difficult for local businesses to find alternative lenders. Therefore, the government’s concerns are not entirely misplaced.

But it is a myth that public sector banks are the only game in town when it comes to lending to MSMEs. In fact, the share of public sector banks has fallen to 55.4% by December 2017 from 61.5% two years ago.

Who has picked up the slack? Private sector banks and non-banking financial companies (NBFCs) are aggressively lending to MSMEs, and have the potential to dethrone public sector lenders as the largest source of funds.

In the report MSME Pulse, Small Industries Development Bank of India, which facilitates financing for such firms, has said that private sector banks are increasing their market share. According to the report, private sector lenders have a market share of 40% as of December 2017, a 6 percentage points gain in two years.

NBFCs have also made big inroads into MSME lending, with some of them focused predominantly on this segment. Therefore, it is unfair to ask the regulator to dilute its norms to enable lenders with shoddy risk management practices to extend credit to MSMEs.

The fact is that bad loan ratios of MSME loans in the books of private sector banks and NBFCs is far superior to that of public sector lenders. This means the former have a much robust risk management process in place.

Small businesses are a major source of employment for the economy and it imperative that funding to them continues. But let the funding be from a strong balance sheet.livemint