A STUDY ON THE CREDIT REQUIREMENTS OF

MICRO, SMALL & MEDIUM ENTERPRISES FROM

BANKS

We Shape Future

ASIA-PACIFIC INSTITUTE OF MANAGEMENT

1 | Page

EXECUTIVE SUMMARY
The role of micro, small and medium enterprises (MSMEs) in the economic and social
development of the country is well established. The MSME sector is a nursery of
entrepreneurship, often driven by individual creativity and innovation. Significantly, the MSME
sector has maintained a higher growth rate vis--vis the overall industrial sector during the past
decade. According to a survey, exports from these enterprises have been on the rise, despite
increased cost of raw materials, sluggish global demand and stiff international competition.
Today, the sector produces a wide range of products, from simple consumer goods to high
precision, sophisticated finished goods. The five major challenges of MSMEs are access to
finance, access to markets, access to infrastructure, access to technology & environmental
constraints and issues regarding regulatory facilitation.
The present market conditions do not provide enough opportunities for the MSME sector for
raising low cost funds. To improve the flow of credit there is a need to provide low cost finance
to the MSME sector, which has limited working capital and is dependent exclusively on finance
from public sector banks. A transparent credit rating system, simplification / reduction in
documentation for accessing finance, providing interest rate subvention to the MSME sector
must be taken into consideration in order to maintain the growth of the MSME sector.
The most important issue hindering the growth, however, is the timely and adequate availability
of finance to MSMEs. According to the Prime Ministers Task Force on MSME report, although
bank credit to the sector has significantly increased from Rs 70,787 crore in March 2000 to Rs.

2 | Page

2,69,153 crore in March 2009, access to credit needs to further increase given the size of the
MSME sector.
This study discusses various credit requirements of MSMEs vis-a-vis the existing facilities
provided by the banks. There is a need for banks to focus their attention on the MSME sector
without affecting their profitability and without compromising on the quality of lending.
Financing this sector calls for an innovative approach far different from financing large corporate
sector as this sector heavily depends on debt instead of equity. There is also lack of information
on the part of MSMEs on the loan products, however, traditional schemes like Term Loans,
Demand Loans, Cash Credit etc are giving way to new and customized products.

INTRODUCTION
3 | Page

CONTENTS
Acknowledgement
Executive Summary
SECTION A
1. Introduction
1.1
1.2
1.3

About the Project

Objectives of The study
Scope of the Study

2. An Overview of the Banking Sector in India

3. Profile of the Organization (Central Bank of India)
4. Micro, Small & Medium Enterprises
4.1
4.2
4.3

Introduction
Role & Significance of MSMEs
Key Challenges for MSME sector

5. Review of Literature
6. Highlights of the MSMED Act

2
4
5

6
12
17
18
21
23

27
32

SECTION B
7. Financial Requirements of MSMEs
8. Processing of Credit Application
9. Research Methodology

34
39
50

9.1
9.2
9.3

Sampling
Data Collection
Limitations of the Study

51
52
53

9.4

Diagrammatic Representation of the Sample

54

10. Data Analysis

11. Findings
12. Conclusion
13. Recommendations
14. References
15. Appendix

4 | Page

56
62
63
64
66
67

1.1 ABOUT THE PROJECT

In recent years, while the Indian economy has been growing at over 6%, the production
from micro, small and medium enterprises has been growing at over 11% between 2002-03 and
2009-10 (Ministry of Micro, Small and Medium Enterprises, 2010-2011). In India, Banks are the
dominant channel for providing funds to industry. However their importance in funding smaller
rms is even more pronounced since most small and medium enterprises (SMEs) are not able to
access the capital markets for funds. In recent years, governments and policy makers have been
giving considerable attention to facilitate the development of the SME sector, as a strong and
vibrant SME sector provides a good foundation for entrepreneurship and innovation in the
economy.
This study aims at understanding the credit requirements of Micro, Small & Medium
Enterprises. One of the major bottlenecks in the growth of the MSMEs is the access to finance.
As this sector has a very limited access to equity capital, the role of Banks in providing them
credit is very important. The Reserve Bank of India in its Master Circular issued on July 1, 2010
made it mandatory for domestic banks to give at least 40% of its advances to priority sectors
while for the foreign banks, the limit was at least 32%. It also gave guidelines for the mandatory
limits of micro, small and medium enterprises individually.
In this paper, the various requirements of the MSMEs like the requirements for capital assets and
working capital has been broadly discussed. The various steps involved in a credit appraisal
process are also described. There are various important factors which are taken into
consideration by a bank while granting a loan to the MSME sector, which have also been
discussed. After repeated attempt by policy makers for easy flow of credit to the MSMEs, still

5 | Page

this sector accounts for a small percentage of the Net Bank Credit. This is perhaps due to the
credit risk attached to it.
Financing this sector calls for an innovative approach far different from financing large corporate
sector as this sector heavily depends on debt instead of equity. There are many past studies that
focus on the credit requirements of MSMEs and have helped in understanding about the issue.
This project an attempt has been made to identify various financial requirements of the sector
and the concerns attached both on the parts of the Banks and the MSMEs on the credit process.

6 | Page

1.2 OBJECTIVES OF THE STUDY

To study the credit requirements of Micro, Small & Medium Enterprises.
To understand the credit appraisal process for financing Micro, Small & Medium
Enterprises.
To find out the gaps between the existing facilities of credit and ideal requirements of the
sector.
To recommend certain measures for better credit facilities to MSMEs on the basis of
finding of this study.

7 | Page

1.3 SCOPE OF THE STUDY

Despite a number of studies done till now on this subject, it is not clear about the exact loopholes
in the process that leads to the underdose of credit for the MSMEs. This sector is very important
to any economy as it provides large employment and entrepreneurial prospects, hence the growth
of this sector is also of high concern. Adequate and timely availability of credit to the MSMEs
can contribute to the growth to a larger extent as it is the main concern for the sector. Thus, this
research examines various credit requirements of the sector, various steps in the credit appraisal
process by the banks and recommends certain measures for the better flow of credit to these
enterprises.

8 | Page

OVERVIEW OF THE BANKING SECTOR IN INDIA

Without a sound and effective banking system in India it cannot have a healthy economy. The
banking system of India should not only be hassle free but it should be able to meet new
challenges posed by the technology and any other external and internal factors. For the past three
decades India's banking system has several outstanding achievements to its credit. The most
striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in
India. In fact, Indian banking system has reached even to the remote corners of the country. This
is one of the main reason of India's growth process.
The banking system in India is significantly different from that of other Asian nations because of
the countrys unique geographic, social, and economic characteristics. India has a large
population and land size, a diverse culture, and extreme disparities in income, which are marked
among its regions. There are high levels of illiteracy among a large percentage of its population
but, at the same time, the country has a large reservoir of managerial and technologically
advanced talents. Between about 30 and 35 percent of the population resides in metro and urban
cities and the rest is spread in several semi-urban and rural centers.
The countrys economic policy framework combines socialistic and capitalistic features with a
heavy bias towards public sector investment. India has followed the path of growth-led exports
rather than the export-led growth of other Asian economies, with emphasis on self-reliance
through import substitution. These features are reflected in the structure, size, and diversity of the
countrys banking and financial sector. The banking system has had to serve the goals of
economic policies enunciated in successive five year development plans, particularly concerning
equitable income distribution, balanced regional economic growth, and the reduction and

9 | Page

elimination of private sector monopolies in trade and industry. In order for the banking industry
to serve as an instrument of state policy, it was subjected to various nationalization schemes in
different phases (1955, 1969, and 1980). As a result, banking largely remained internationally
isolated because of preoccupations with domestic priorities, especially massive branch expansion
and attracting more people to the system. Moreover, the sector has been assigned the role of
providing support to other economic sectors such as agriculture, small-scale industries, exports,
and banking activities in the developed commercial centers (i.e., metro, urban, and a limited
number of semi-urban centers).
The banking systems international isolation was also due to strict branch licensing controls on
foreign banks already operating in the country as well as entry restrictions facing new foreign
banks. A criterion of reciprocity is required for any Indian bank to open an office abroad. These
features have left the Indian banking sector with weaknesses and strengths. A big challenge
facing Indian banks is how, under the current ownership structure, to attain operational efficiency
suitable for modern financial intermediation. On the other hand, it has been relatively easy for
the public sector banks to recapitalize, given the increases in nonperforming assets (NPAs), as
their Government dominated ownership structure has reduced the conflicts of interest that private
banks would face.

10 | P a g e

FINANCIAL STRUCTURE
The Indian financial system comprises the following institutions:
1. Commercial banks
a. Public sector
b. Private sector
c. Foreign banks
d. Cooperative institutions
(i) Urban cooperative banks
(ii) State cooperative banks
(iii) Central cooperative banks
2. Financial institutions
a. All-India financial institutions (AIFIs)
b. State financial corporations (SFCs)
c. State industrial development corporations (SIDCs)
3. Nonbanking financial companies (NBFCs)
4. Capital market intermediaries

11 | P a g e

About 90 percent of the countrys banking segment is under State control while the balance
comprises private sector and foreign banks. The public sector commercial banks are divided into
three categories.
State bank group (eight banks): This consists of the State Bank of India (SBI) and Associate
Banks of SBI. The Reserve Bank of India (RBI) owns the majority share of SBI and some
Associate Banks of SBI.1 SBI has 13 head offices governed each by a board of directors under
the supervision of a central board. The boards of directors and their committees hold monthly
meetings while the executive committee of each central board meets every week.
Nationalized banks (19 banks): In 1969, the Government arranged the nationalization of 14
scheduled commercial banks in order to expand the branch network, followed by six more in
1980. A merger reduced the number from 20 to 19. Nationalized banks are wholly owned by the
Government, although some of them have made public issues. In contrast to the state bank group,
nationalized banks are centrally governed, i.e., by their respective head offices. Thus, there is
only one board for each nationalized bank and meetings are less frequent (generally, once a
month).
The state bank group and nationalized banks are together referred to as the public sector banks
(PSBs).

12 | P a g e

OFFICES OF COMMERCIAL BANKS IN INDIA - 2006 TO 2010

(source : Reserve Bank of India)

Bank Groups

2006
(1)

As on March 31
2007
2008
2009
(2)
(3)
(4)

2010
(5)

14310

14673

15846

16878

18114

35858
50168
4819
2016
6835
259
14807
41
72110

37431
52104
4826
2598
7424
272
14843
46
74689

39234
55080
4690
3632
8322
279
15070
46
78797

40854
57732
4908
4328
9236
295
15485
46
82794

43187
61301
5174
5213
10387
310
15723
47
87768

State Bank of India and its

Associates
Nationalised Banks $
Public Sector Banks
Old Private Sector Banks
New Private Sector Banks
Private Sector Banks
Foreign Banks
Regional Rural Banks
Non-Scheduled Commercial Banks
All Commercial Banks

Regional Rural Banks (RRBs): In 1975, the state bank group and nationalized banks were
required to sponsor and set up RRBs in partnership with individual states to provide low-cost
financing and credit facilities to the rural masses.

STRUCTURE OF THE BANKING INDUSTRY IN TERMS OF TOTAL ASSETS. As of

March 2010.
Source: Reserve Bank of India.
Bank

Number

Total Assets(Rs Crore)

State Bank of India and associates

1412515

Nationalized banks

19

3028599

Old private sector banks

25

268977

13 | P a g e

New private sector banks

881831

Foreign banks

39

433219

All Scheduled Commercial Banks

6025141

GRAPH 1 (Source : Reserve Bank of India)

PROFILE OF THE CENTRAL BANK OF INDIA

Established in 1911, Central Bank of India was the first Indian commercial bank which was
wholly owned and managed by Indians. The establishment of the Bank was the ultimate
realisation of the dream of Sir Sorabji Pochkhanawala, founder of the Bank. Sir Pherozesha
Mehta was the first Chairman of a truly 'Swadeshi Bank'. In fact, such was the extent of pride felt
by Sir Sorabji Pochkhanawala that he proclaimed Central Bank of India as the 'property of the

14 | P a g e

nation and the country's asset'. He also added that 'Central Bank of India lives on people's faith
and regards itself as the people's own bank'.
During the past 100 years of history the Bank has weathered many storms and faced many
challenges. The Bank could successfully transform every threat into business opportunity and
excelled over its peers in the Banking industry.
A number of innovative and unique banking activities have been launched by Central Bank of
India and a brief mention of some of its pioneering services are as under:
1921

Introduction to the Home Savings Safe Deposit Scheme to build saving/thrift habits in all

sections of the society.

1924

An Exclusive Ladies Department to cater to the Bank's women clientele.

1926

Safe Deposit Locker facility and Rupee Travellers' Cheques.

1929

Setting up of the Executor and Trustee Department.

1932

Deposit Insurance Benefit Scheme.

1962

Recurring Deposit Scheme.

Subsequently, even after the nationalisation of the Bank in the year 1969, Central Bank
continued to introduce a number of innovative banking services as under:
1976

The Merchant Banking Cell was established.

1980

Central card, the credit card of the Bank was introduced.

1986

'Platinum Jubilee Money Back Deposit Scheme' was launched.

15 | P a g e

1989

The housing subsidiary Cent Bank Home Finance Ltd. was started with its headquarters

at Bhopal in Madhya Pradesh.

1994

Quick Cheque Collection Service (QCC) & Express Service was set up to enable speedy

collection of outstation cheques.

Further in line with the guidelines from Reserve Bank of India as also the Government of India,
Central Bank has been playing an increasingly active role in promoting the key thrust areas of
agriculture, small scale industries as also medium and large industries. The Bank also introduced
a number of Self Employment Schemes to promote employment among the educated youth.
Among the Public Sector Banks, Central Bank of India can be truly described as an All India
Bank, due to distribution of its large network in 27 out of 29 States as also in 3 out of 7 Union
Territories in India. Central Bank of India holds a very prominent place among the Public Sector
Banks on account of its network of 3656 branches and 178 extension counters at various centres
throughout the length and breadth of the country.
Customers' confidence in Central Bank of India's wide ranging services can very well be judged
from the list of major corporate clients such as ICICI, IDBI, UTI, LIC, HDFC as also almost all
major corporate houses in the country.
PERFORMANCE HIGHLIGHTS Q4 2010-11 AND FY 2010-11
BUSINESS

The Total Business of the Bank crossed Rs. 3,00,000 crores and increased to Rs. 3,10,763
crores as on March 31, 2011 from Rs. 2,69,225 crore as on March 31, 2010 registering a
growth of 15.43% (Y-o-Y basis).

16 | P a g e

Total Deposits as on March 31, 2011 stood at Rs.1,79,356 Crore in comparison to Rs.
1,62,107 Crore as on March 31, 2010 showing a growth of 10.64% over 2009-10.

CASA Deposits comprised 35.17% of the Total Deposits as on 31st March 2011 as
compared to 34.45% as on March 31, 2010.

The Total Advances of the Bank increased from Rs 1,07,118 crore as of March 31, 2010
to Rs. 1,31,407 Crore registering a Y-O-Y growth of 22.67%.

Gross Income in 2010-11 registered a growth of 19.47% from Rs. 13799 crore to
Rs.16486 crore on Y-o-Y basis.

Net Interest Income of the Bank registered a significant growth of 109.27% from Rs.
2545 crore to Rs. 5326 crore on Y-o-Y basis.

Operating Profit of the Bank was up by 25.90% at Rs. 2591 crore as on March 31, 2011
from Rs. 2058 crore as on March 31, 2010 on Y-o-Y basis.

The Operating Profit is after making full provision as per RBI guidelines for Pension and
Gratuity liability. During the year 2010-11, the additional provision made for pension
liability/2nd option amounted to Rs. 809.60 crores and gratuity Rs. 119.36 crores.

Net Interest Margin for the Q4 (2010-11) was 3.47% up from 1.81% for the Q4 2009-10.
For the year 2010-11 NIM increased to 3.31% from 1.86% for the year 2009-10.

The Net Profit for the year 2010-11 amounts to Rs. 1252 crore as compared to Rs. 1058
crores for the year 2009-10, a growth of 19% on Y-o-Y basis.

Net NPA ratio declined to 0.65% as on March 31, 2011 from 0.69% as on 31.03.2010.

17 | P a g e

HEALTHY ASSET QUALITY

Net NPA stood at Rs. 847 crore as on March 2011 against Rs. 727 crore as on March 31,
2010. The percentage of net NPA as on March 31, 2011 is 0.65 % of Net Advances.

NPA Coverage cum - Provision is 67.64% as on March 31, 2011.

NEW INITIATIVES

100% CBS during Centenary Year

Educational Loans in the range of Rs. 5000 to Rs. 1,50,000 for vocational training lacs to
the beneficiary according to the project.

FINANCIAL INCLUSION

Bank has been allotted 3741 villages having population more than 2000 under FIP for
coverage by March 2012. Bank had planned to cover 1766 villages by March 2011.
Against this target Bank has covered 1776 by appointing 1761 BCs as on March 31,
2011. As on date Bank has covered a total of 5696 villages.

Under Brick and Mortar Model, Bank has been allotted 20596 villages under earlier
SLBC Program. Bank has already covered 15999 villages.

Bank has opened 46 RUDSETIs as on 31.03.2011.

Bank has opened 3 Cent Sahayog centres at Vadkun, Ratlam and Hoshangabad.

100% financially included villages 15999. No. of No Frill Accounts 5714283. No. of
Accounts opened & Smart Cards activated 1331602

18 | P a g e

RURAL BANKING

Collaboration with Commonwealth Secretariat for Youth Entrepreneurship Development

in four districts- Murshidabad (WB), Sultanpur (UP), Sawai Madhopur (Rajasthan),
Ernakulam (Kerala).

Rendering of Technology Consultancy Services for Micro-Finance in St.Lucia in West

Indies under Commonwealth Games Association.

Organised inclusive and integrated programme on Small Business Competitiveness

Development Programme in Jaipur under Commonwealth Games Association.

AWARDS /RECOGNITION

Skoch Financial Inclusion Award 2011 for implementing the Bihar Rural Livelihood
Project also known as JEEVIKA Project.

SKOCH Award for Best Business Model: 2010

My FM stars of the Industry Retail Leadership Award in Feb. 2011.

19 | P a g e

MICRO,

SMALL

&

MEDIUM ENTERPRISES

INTRODUCTION
MSME stands for Micro, Small & Medium Enterprises. The more popular acronym SME has
turned out to be a worldwide champion for the cause of development of entrepreneurship in the
underdeveloped and developed countries.

20 | P a g e

There is no standard, universal definition of small & medium enterprises. In June 2004, the Basel
Committee stated in the BASEL ACCORD : SME borrowers are defined as those with annual
sales of less than 50 mn. Euros. However, this limit is too high, especially in the case of India.
The working group constituted by the RBI (Ganguly Committee) has recommended
TURNOVER as a measure of defining SME. According to them, the outer limit of annual sales
for the recognition of SME status should be fixed at Rs 50 crore.
The role of micro, small and medium enterprises (MSMEs) in the economic and social
development of the country is well established. The MSME sector is a nursery of
entrepreneurship, often driven by individual creativity and innovation. This sector contributes 8
per cent of the countrys GDP, 45 per cent of the manufactured output and 40 per cent of its
exports. The MSMEs provide employment to about 60 million persons through 26 million
enterprises. The labour to capital ratio in MSMEs and the overall growth in the MSME sector is
much higher than in the large industries. The geographic distribution of the MSMEs is also more
even. Thus, MSMEs are important for the national objectives of growth with equity and
inclusion.
The State-wise distribution of MSMEs show that more than 55% of these enterprises are in 6
States, namely, Uttar Pradesh, Maharashtra, Tamil Nadu, West Bengal, Andhra Pradesh and
Karnataka. Further, about 7% of MSMEs are owned by women and more than 94% of the
MSMEs are proprietorships or partnerships..
The MSME sector may concern itself with any commercial activity permissible under law.
Hence, any type of manufacturing, processing or industrial activity, or trading or allied operation,

21 | P a g e

may be the domain of the MSME sector. However, the following activities may be encouraged
for the MSME sector :

Servicing and Repairing machinery and equipment, including agro service units.

Village & Cottage Industries

Computer Software development & Computer Services

Data Conversion / Data Processing Service

Medical / Legal Transcription Activities

Website Design & Development

Consultancy services including management services ( Also Marketing & Industrial

Consultancy)

Content Development & Animation

Video Film making

Advertising Agencies

Equipment Rental & Leasing

Typing / Photocopy centres / PCOs

Industrial R & D laboratory

Laundry & Dry Cleaning

22 | P a g e

X Ray / Pathology labs

Studios

Cable TV Network
Besides the above in general, the services sector, i.e. telecom, transport etc remain the
focus for SME related business activities.

ROLE & SIGNIFICANCE OF MSMEs

As per the quick estimates of 4th All-India Census of MSMEs, the number of enterprises is
estimated to be about 26 million and these provide employment to an estimated 60 million

23 | P a g e

persons. Of the 26 million MSMEs, only 1.5 million are in the registered segment while the
remaining 24.5 million (94%) are in the unregistered segment.
Significantly, the MSME sector has maintained a higher growth rate vis--vis the overall
industrial sector during the past decade. According to a survey, exports from these enterprises
have been on the rise, despite increased cost of raw materials, sluggish global demand and stiff
international competition. The sector produces over 6,000 products ranging from simple
consumer goods to high precision, sophisticated finished goods. Some of the major subsectors in
terms of manufacturing output are food products (18.97%), textiles and readymade garments
(14.05%), basic metal (8.81%), chemical and chemical products (7.55%), metal products
(7.52%), machinery and equipments (6.35%), transport equipments (4.5%), rubber and plastic
products (3.9%), furniture (2.62%), paper and paper products (2.03%) and leather and leather
products (1.98%).

GRAPH : CONTRIBUTION OF MSME ( %) IN TOTAL INDUSTRIAL PRODUCTION & GDP. (Source : Annual
Report, 2009-10, Ministry of Micro, Small & Medium Enterprises)

The MSME sector in India is highly heterogeneous in terms of the size of the enterprises, variety
of products and services produced and the levels of technology employed. While one end of the
MSME spectrum contains highly innovative and high growth enterprises, more than 94 per cent
24 | P a g e

of MSMEs are unregistered, with a large number established in the informal or unorganized
sector. Besides the growth potential of the sector and its critical role in the manufacturing and
value chains, the heterogeneity and the unorganised nature of the Indian MSMEs are important
aspects that need to be factored into policy making and programme implementation.
MSME constitute over 90 % of total enterprises in most of the economies and are credited with
generating high rates of employment and account for a major share of industrial production and
exports. In India too, MSMEs play a vital role in the overall industrial economy of the country.
Apart from providing the support to the large industries, MSMEs have played an important role
in employment generation.

(SOURCE : Annual Report 2009-10, Ministry of Micro, Small & Medium Enterprises)

KEY CHALLENGES FOR MSME SECTOR

25 | P a g e

Although Indian MSMEs are a diverse and heterogeneous group, they face some common
problems, which are briefly indicated below:

Lack of availability of adequate and timely credit;

High cost of credit;

Collateral requirements;

Limited access to equity capital;

Problems in supply to government departments and agencies;

Procurement of raw materials at a competitive cost;

Problems of storage, designing, packaging and product display;

Lack of access to global markets;

Inadequate infrastructure facilities, including power, water, roads, etc.;

Low technology levels and lack of access to modern technology;

Lack of skilled manpower for manufacturing, services, marketing, etc.;

Multiplicity of labour laws and complicated procedures associated with compliance of

such laws;

Absence of a suitable mechanism which enables the quick revival of viable sick
enterprises and allows unviable entities to close down speedily; and

Issues relating to taxation, both direct and indirect, and procedures thereof.

26 | P a g e

The present market conditions do not provide enough opportunities for the MSME sector for
raising low cost funds. To improve the flow of credit there is a need to provide low cost finance
to the MSME sector, which has limited working capital and is dependent exclusively on finance
from public sector banks. A transparent credit rating system, simplification / reduction in
documentation for accessing finance, providing interest rate subvention to the MSME sector
must be taken into consideration in order to maintain the growth of the MSME sector.
The most important issue hindering the growth, however, is the timely and adequate availability
of finance to MSMEs. According to the Prime Ministers Task Force on MSME report, although
bank credit to the sector has significantly increased from Rs 70,787 crore in March 2000 to Rs.
2,69,153 crore in March 2009, access to credit needs to further increase given the size of the
MSME sector.
The share of the credit to the MSME sector in Net Bank Credit (NBC) has declined from 22.3 %
to 15.9 % during the same period. The Govt is taking proactive steps to ensure better access to
credit. Despite these measures, banks are reluctant to lend to MSMEs due to their high risk
profile owing to zero collateral or their limited years of operation. In a recent study by Indian
School of Business (ISB) , in case of the MSMEs, only 15 % of funding came from internal
sources, 25 % from banks & Financial institutions and 10% from capital markets. Around 50%
of the funding has been sourced through alternative funding sourcesincluding friends & family,
trade credit etc. Alternative sources are typically far more expensinve and are dependent on
prevailing market conditions and are rarely a guarenteed source. This clearly implies that
MSMEs face very high interest cost due to the lack of availability of adequate credit.

27 | P a g e

TABLE: SCHEDULED COMMERCIAL BANKS ADVANCES TO SMALL SCALE INDUSTRIES

AND ALLIED SERVICES OUTSTANDING

(Rupees Crore)

( SOURCE : Reserve Bank Of India)

28 | P a g e

TABLE : DISTRIBUTION OF OUTSTANDING DIRECT & INDIRECT ADVANCES OF

PUBLIC SECTOR BANKS TO SMALL ENTERPRISES IN 2010.
(No of accounts in lakh and Amount in Rs. Crore)

( SOURCE : Reserve Bank of India )

29 | P a g e

REVIEW
OF
LITERATURE

30 | P a g e

The role of micro, small and medium enterprises (MSMEs) in the economic and social
development of the country is well established. The MSME sector is a nursery of
entrepreneurship, often driven by individual creativity and innovation. This sector contributes 8
per cent of the countrys GDP, 45 per cent of the manufactured output and 40 per cent of its
exports.
However, there are a lot of problems faced by the MSMEs. The present market conditions do not
provide enough opportunities for the MSME sector for raising low cost funds. To improve the
flow of credit there is a need to provide low cost finance to the MSME sector, which has limited
working capital and is dependent exclusively on finance from public sector banks. There are a lot
of studies taken up in various parts of the world on the credit requirements of MSMEs.
According to Allen N. Burger & Gregory F. Udell (2004) in their presentation A more complete
conceptual framework for SME finance, a chief area of concern regarding SME credit
availability is the lending infrastructure of a nation, which defines the rights and flexibility of
financial institutions to fund SMEs using the lending technology that best fits the institution and
the borrower. This infrastructure includes the commercial and bankruptcy laws that affect
creditor rights and their judicial enforcement; the regulation of financial institutions, including
restrictions on lending, barriers to entry, and direct state ownership of financial institutions; the
information infrastructure, including the accounting standards to which potential borrowers must
comply as well as the organizations and rules for sharing information; the taxes that directly
affect creditextension; and so forth that provide the economic environment in which financial
institutions may lend in a given nation.

31 | P a g e

As examples, weak accounting standards may restrict financial statement lending; restrictions on
the sharing of credit information may restrict small business credit scoring; weak commercial
laws and enforcement of collateral rights may inhibit asset-based lending; and poorly-designed
creditor rights and judicial enforcement of these rights may limit most types of lending. In some
cases, restrictions that inhibit the use of one lending technology may encourage the use of others.
For instance, poor creditor rights with respect to security interests may promote the use of
factoring in which the receivables are sold, rather than pledged as collateral.
The study also focuses on financial institution structure and SME lending. It reviews some of the
literature related to the comparative advantages of large versus small financial institutions,
foreign-owned versus domestically-owned institutions, and state-owned versus privately-owned
institutions in lending to SMEs. It also reviews the literature on the effects of bank market
concentration on the supply of SME credit. The report also focuses on the lending infrastructures
of nations and how they affect the financing of SMEs. Here it discusses the indirect effects of
lending infrastructure on SME credit through regulatory restrictions on the financial institution
structure. The report also focuses on the lending technologies used to finance SMEs. We describe
the 5 transactions lending technologies (financial statement lending, small business credit
scoring, asset-based lending, factoring, trade credit) and the relationship lending technology. For
each of these 6 technologies, it discusses the primary source of information used in underwriting
the credit and the extent to which the technology is used to lend to transparent and opaque SMEs.
According to Thorsten Beck & Asli Demirguc-Kunt in their article Small and medium-size
enterprises: Access to nance as a growth constraint (June 2006) published in the Journal of
Banking & Finance improving the business environment for all rms is more important than
simply trying to promote a large SME sector which might be characterized by a large number of
32 | P a g e

small but stagnant rms. Although SMEs constitute a signicant part of total employment in
many countries, one of the reasons they may not be able to contribute to economic growth is
because they face greater growth obstacles. Indeed, compared to large rms, SMEs are more
constrained by dierent obstacles, and limited access to nance is an important one of these.
Research suggests improving legal and nancial institutions helps all deserving rms access
nance and grow, but the eect is greatest on smaller rms. Both rm-level and industry-level
studies suggest that small rms do relatively better compared to large rms in countries with
better-developed institutions. Furthermore, we see that in the absence of well developed nancial
markets and legal systems, it is dicult for rms to grow to their optimal size since outside
investors cannot prevent appropriation by corporate insiders, limiting rm size. This is important
for SME-promotion strategies, since if it is optimal for rms to stay small when the business
environment has weaknesses, subsidizing SMEs may be at best ineective, but at worst,
counterproductive.
The literature suggests that a focus on improving the institutions and the overall business
environment is probably the most eective way of relaxing the growth constraints SMEs face
and facilitate their to contribution to economic growth. However, institution building is a long
term process and in the interim innovative lending technologies hold promise, providing marketfriendly ways of relaxing the constraints SMEs face. Factoring is an example of a technology
that is particularly promising in the absence of developed institutions, as it relies on them to a
lesser extent. Others, such as credit-scoring and leasing can also be useful and be more eective
with development of institutions over time. A contestable nancial system makes it more likely
that such technologies will be adopted more rapidly, with foreign banks playing an important
role in facilitating this process, whereas public banks have been less useful in the past. The

33 | P a g e

research summarized in this article is only the rst step on a long term research agenda. Much
more analysis, particularly using time-series variation, microeconomic data, and country case
studies, is needed to explore in more detail the policies and nancing tools that can help SMEs
overcome nancing constraints and expand their access to external nance. In this context, it
seems especially relevant to focus on institutions that are important for SMEs access to nance.
Going along with institution-building, however, the search has to be continued for nancing tools
that can work around institutional deciencies.
According to Banerjee A. , Cole S. and Duflo E. (2003) in Bank Financing in India (paper
produced in MIT Dept of Economics), one of the prominent measures used to ensure adequate
ow of funds to the SME sector is through regulation requiring banks to provide at least 40% of
loans to targeted areas which include the micro, small and medium enterprises. Although directed
lending would increase the ow of funds to the SME sector, studies suggest that SME rms are
credit constrained. One of the signicant issues in lending to SMEs is the use of both hard data
such as nancial information, as well as soft data such as feedback from vendors and other
family members, which become important inputs towards understanding the credit risk of the
business. The challenge for banks is to bridge the information asymmetry so as to take the
appropriate lending decision so that the good rms are not nancially constrained, and at the
same time, cut down on exposures to bad credit risks. Measures such as credit scoring for SMEs
should improve the quality of nancial information and enable greater funding for the sector. The
SARFAESI Act and the strengthening of legal provisions to take possession of assets used as
security has improved the legal environment for lending in India, thus lowering the cost of
lending and enforcement of contracts.

34 | P a g e

MICRO, SMALL AND MEDIUM ENTERPRISES DEVELOPMENT ACT,

2006
The MSMED Act was enacted by Govt of India for the better functioning and development of
the Micro, Small & Medium Enterprises. The Act is operational from 2nd October ,2006.
Classification of Enterprises
Concept of 'Enterprises' as against 'Industries'. Enterprises classified broadly into:
i) Enterprises engaged in the manufacture/production of goods pertaining to any industry &
ii) Enterprises engaged in providing/rendering of services.
Manufacturing Enterprises: Defined in terms of investment in plant and machinery (excluding
land & buildings) and further classified into:
Micro Enterprises - investment up to Rs.25 lakh.
Small Enterprises - investment above Rs.25 lakh & up to Rs.5 crore.
Medium Enterprises - investment above Rs.5 crore & up to Rs.10 crore.
Service Enterprises: Defined in terms of their investment in equipment and further classified
into:
Micro Enterprises - investment up to Rs.10 lakh.
Small Enterprises - investment above Rs.10 lakh & up to Rs.2 crore.
Medium Enterprises - investment above Rs.2 crore & up to Rs.5 crore.

35 | P a g e

36 | P a g e

FINANCIAL
REQUIREMENTS
OF MSMEs

37 | P a g e

As for any other business segment, SMEs may require cash/ cash equivalents for acquisition of,
holding and dealing with various categories of tangible assets for commencing and sustaining
business operations. Thus, they may require funds for :
i.

Acquisition of capital assets, e.g. land/ building / machinery / equipments etc.

OR

ii.

Purchase of stocks of raw materials / finished goods, extending credit to trade debtors
and for other day-to-day business operations. OR

iii.

Both ( i ) and ( ii ) above.

FUND FOR CAPITAL ASSETS

Capital assets such as land & building, machinery, equipments, computers etc. may be required
by any SME at the commencement stage or at later stage, depending on the circumstances of the
case. For a pure trading unit, the requirement may be linked to land & building, computers etc.
while in case of manufacturing / industrial units, in addition to the same, the dominant category
may be machinery and equipment. Therefore, the size of credit limit for capital assets may vary
from case to case.
In particular, the applicant must specify the following information along with the application for
loan for capital assets :

In the case of land / building :

i.

38 | P a g e

Break-up of cost for land and building location.

ii.

Specific benefits that are likely to accrue on purchase of land / building with loan,
in place of having a rental agreement.

In case of machinery / equipments / computers / other items of Fixed Assets :

i.

Details of each item with cost, name / addresses of suppliers, etc.

ii.

How technical viability of the items is ensured. In case a viability report is

available, it should be furnished.

iii.

Details of periodic servicing arrangements and their likely costs.

iv.

Whether use of machinery / equipment will be in conformity with pollution

control guidelines. If any.

v.

Details of Technical staff / skilled staff to be deployed, if necessary, for operating

machinery & equipments.

Margin Money : Since banks / financial institutions generally extend financing upto 75%
of total cost of capital assets, the applicant is required to indicate the source for the
balance amount of 25%.

FUND FOR WORKING CAPITAL

Depending upon the past / projected scale of business operations, SMEs may need
institutional working capital support to take care of :
i.

39 | P a g e

Optimum holding level of stocks.

ii.

Optimum / safe level of trade debtors outstanding.

iii.

Minimum cash holding.

The quantum of finance required for each of the three stages is linked with following factors :

A manufacturing / industrial units requirement for inventory holding will be generally

higher than that of a trading unit.

Trade debtors holding in a trading unit will be generally be higher than that of a
manufacturing / industrial unit.

Market standing / track record / items of manufacture / trade may determine the varying
degrees of working capital requirements of SMEs.

The availability of the owners funds towards working capital may be different in
different SMEs. Those who have a larger financial base may require less funding.

Service based SMEs, like professionals / consultants, may require a lower working
capital fund, when compared with other sectors.

Under the theory of Finance, institutional working capital support is greatly necessary for
one working capital cycle in a period of 12 months, and such a cycle comprises :

Period of holding of inventory / book debt.

Minimum cash holding period.

40 | P a g e

Recovery cycle from trade debtors

Payment cycle to trade creditors.

To start with, funds (cash), are deployed in the purchase / holding of inventory, which when
sold out get partially converted to trade debtors, who pay the same cash as per trade practice.
This amount is utilized in payment of trade creditors / meeting sundry business
requirements, like payment of staff salary, etc.
The duration of a working capital cycle in an SME may be different from a cycle in another
SME, mainly in view of the following :

Location / Place of Business.

Items of trade

Market strength / weakness of SME.

Type of trade debtors ( if Govt / PSUs are main debtors, the period of realization may be
longer ) and trade creditors.

SME applicants are required to indicate the basis of their computing for a specific amount of
working capital fund, keeping in view their business fundamentals. While banks / financial
institutions may follow a certain rule-of-thumb in their own interests, SMEs should be
realistic in order to avoid an underdose / overdose of funds.

41 | P a g e

PROCESSING OF
CREDIT APPLICATION

42 | P a g e

Application for credit facilities, preferably in a standardized format of a bank , from a MSME
has to pass through an organized route to reach the stage of approval/rejection. The processing
of a credit application by a bank is really a scrutiny of various particulars attached with the
application.
1. SUBMISSION OF LOAN APPLICATION
An SMEs application for credit facilities is the basic and primary document for the lenders to
proceed with. It should be focused while making it convenient for the applicant to furnish the
essentials to support the need-based requirement. The application form covers the following
aspects

Promoters Background - The promoters of the company must give their detailed biodata.

Particulars of the Industrial Concern- The products to be manufactured and the market
that need to be penetrated must be stated. Also the forecast the growth in that industry as
well as their opportunities (export potential) must be mentioned.

Past performance in case existing units.

Expected/Future Performance of both the existing and new units, stating the basis of
computation of the next one year.

43 | P a g e

Particulars of The Project- Capacity, process, technical arrangement , management ,

location, land and buildings, plant and machinery , raw materials , effluents, labor
,housing and schedule of implementation.

Cost Of The Project- The cost taking all factors to account must be arrived at. For new
units the initial contribution of capital from the owners/ promoters.

Means Of Financing- Details of the debt equity ratio, capital structure and sources of
financing. Names / Addresses of existing bankers, if any, of the borrowing concern /
promoters , owners, and the nature of the account relationship.

Marketing and Selling Arrangement If the company has appointed any wholesalers or
distributors for its goods or if it has tied up with another company for marketing its
product.

Names, addresses, occupation/business of guarantors, if offered and their relationship

with the promoters/owners.

Government Approvals- The promoters should have obtained the necessary government
approvals for the project.

2. INITIAL PROCESSING OF THE LOAN APPLICATION

When the application is received, an officer of the financial institution reviews it to
ascertain whether it is complete for processing. If it is incomplete the borrower is asked to
provide the required additional information. When the application is considered complete, the
financial institution prepares a report which is essentially asummarization of the loan application.
On the basis of the report, it is decided whether the project justifies a detailed appraisal or not.
44 | P a g e

3. APPRAISAL OF THE PROPOSED PROJECT

The detailed appraisal of the project covers scrutinizing the track record, analysis of the
past / projected financial statements alongwith marketing, technical, financial, managerial and
economic aspects of the project. It also includes site visit by the concerned officers of the bank.
CREDENTIALS / TRACK RECORD : Usually SMEs are set up as sole proprietary,
partnership or private limited companies. For a new SME business, performance data and other
avenues for the study of the credentials / track record of an SME would not be available. In such
cases, the study of the credentials / track record are to be carried on with respect to :
A ) Sole Proprietor / partners / directors, etc. in their individual capacities ;
B ) Any existing associate concern having market dealings, where the sole proprietor /
partners / directors are directly or indirectly interested.
However, if the applicant SME is an existing unit, the study of credentials / track record will be
more broad-based. Not only would the market report / business report of the SME be examined,
but that of the sole proprietor / partners / directors would also be subject to similar scrutiny.
Besides this, it would also be necessary to study the credit-worthiness of its sole proprietor /
partners / directors. The banks would be more interested, from a safety point of view, that they
are sufficiently wealthy, although wealth is not considered a dominant factor in financing an
SME.

45 | P a g e

SITE VISIT : As a valuable input in the process of scrutiny of an SME borrowers application, it
is required that a site visit by officials of the bank be organized.
A ) For an existing unit, the business assets and records to be inspected / verified.
B ) For a new unit, the suitability of the place, and of the arrangements in place for
starting the business to be examined.
As per the guidelines of the RBI on credit risk management, site visits must be done periodically,
both pre-sanction as well as periodic post-sanction visits.
For a manufacturing / industrial unit, in case of an existing one, the condition & efficiency of
plant & machinery, equipment etc should be satisfactory. For a new unit, the locational advantage
/ constraints for operating the machinery is to be examined. Also the pollution control angles are
considered while a site visit.
ANALYSIS OF PAST & PROJECTED FINANCIAL STATEMENTS : As for other business
units, financial statements of SME applicants would cover :
A ) The Balance Sheet on a particular date ( which is period specific) reflecting the
position of assets and liabilities.
B ) The Profit & Loss Account, reflecting the end-result of the operation in terms of
profit & loss during the particular period.
C ) Statement of Cash Flows reflecting cash inflows and cash outflows, segregated into
operating, investing and financing activities. The statements are prepared on past date
basis as actual. Also, projected statements for future period can also be prepared on some
structure.
46 | P a g e

The aforesaid financial statements serve many purposes, like how assets / liabilities are balanced
from the safety angle, to assess the operating efficiency of the applicant, with regard to past
business performance in terms of sales / main income vis--vis net profit for an existing unit, and
future date analysis for new units, keeping prevailing market situation in a view. It also assesses
the quality of liquidity management of the owner / management and how the firm is equipped
to face a sudden financial stress due to an adverse market movement. It also looks into how the
firm undertakes operating, investing and financing activities, as shown by its statement of cash
flows.
Hence, the existing SME units have to submit the financial statements in a conventional and
structured manner, based on Double entry system of Book Keeping. In case of a limited company
SME applicant, audited statements should be available. However, new units should preferably
submit projected statements for at least three years, so that a meaningful analysis can be made
thereon.
However, the financial statements may be of limited value unless a comparative analysis of one
year with another is made, in order to find out the trend. The most pronounced tool in the
matter of analysis of financial statements, are the accounting ratios.
ACCOUNTING RATIO
A ratio conveys the quantitative inter-relationship between two attributes / variables for eventual
comparison against a benchmark, and for trend analysis. Accounting ratios facilitate meaningful
and purpose-oriented decision making in a business situation. In that respect, their utility is
determined on the basis of the purpose of the computation of the ratio.

47 | P a g e

A commercial bank may lay higher stress on some ratios (e.g Current Ratio, Acid Test ratio) for
working capital finance, while a developmental financial institution may consider other ratios
more relevant (e.g. debt service coverage ratio, Cash Flow Ratios etc.). From the angle of
evaluating credit risk, accounting ratios have a significant bearing for a lending / investing bank,
since the overall computation of credit rating of their accounts/ exposure is also aided by the
outcome of the ratio analysis. Hence, not only it is necessary to identify relevant and more
impacting ratios depending on the purpose, quantum and tenure of exposure etc. but also to
attach weight variant between / amongst ratios.
Generally, there are no such prescribed ratios for SME financing. Banking Regulatory
Authorities have left such matters to the judgement and discretion of concerned banks / financial
institutions.
Some specific ratios for evaluation of SME applicants are stated below. However, there can be
exceptions depending upon the industry / business model :
1. SHORT TERM SOLVENCY ANGLE :
A ) Current Ratio

Current Assets / Current Liabilities

(Minimum Expected Level may be 1.10 : 1)

B ) Acid Test Ratio

Quick Assets / Quick Liabilities

(Minimum Expected Level may be 0.8 : 1)

2. LONG TERM SOLVENCY ANGLE :

48 | P a g e

A ) Debt Equity Ratio

Total Debt / Equity

( Maximum may be 4 : 1 )

B ) Debt Service Coverage

Ratio

PAT + Depreciation + Interest on Total Liability /

Interest on Total Liability + Installment
( Ideal is 1.5 : 1 )

C ) Interest Coverage Ratio

PBIT / Debt Interest

( Ideal is 2 : 1 )

3. PROFITABILITY ANGLE :
A ) Operating Profit Ratio

Operating Profit / Sales

(at least a margin of 25 % or 30 % )

B ) Net Profit Ratio

Net Profit / Sales

The Technical Appraisal focuses mainly on the following aspects, product mix, capacity, process
of manufacture, engineering know-how and technical collaboration, raw materials and
consumables, site and location, building, plant & equipments, manpower requirements and the
break-even point.
The Financial Appraisal focuses mainly on the cost of the project, capital structure, cash flow
estimate, return of investment on the project and tax benefits.

49 | P a g e

The Economic Appraisal involves analysis of critical factors such as socio-economic benefit,
availability of labor, import substitution, technology absorption, impact on ecology, value
addition, forex earnings, economies of scale, development of backward region, effective
utilization of resources.
The Managerial Appraisal includes the assessment of skills of the promoters. The success of a
business enterprise depends largely upon on the resourcefulness, competence and integrity of its
management. However the assessment of managerial competence has to be necessarily
qualitative calling for understanding and judgement.
The Marketing Appraisal examine the reasonableness of the demand projections by utilizing the
findings of the available market survey findings / reports, industry association projections,
planning commission and independent market surveys. Assess the adequacy of the marketing
infrastructure in terms of promotional efforts, distribution network, transport facilities, stock
levels.
CREDIT RATING : Credit rating is an important tool for the assessment of any credit account,
as well as for undertaking any post-disbursement monitoring and follow-up. This system is very
important as it should be strong enough to support the identification and measurement of risk
from credit exposures.
The credit rating mechanism for MSMEs enables :
i.

Bifurcation of accounts into graded risk attributes

ii.

Pricing of credit based on risk grade.

iii.

Focusing higher order attention on monitoring poorly graded accounts.

50 | P a g e

Various parameters are considered in the process of credit rating, like the projected net sales
growth in percentage terms over the next three years (in case of a new unit ), the PAT of the
firm, the debt-equity ratio, access to inputs like Labour, Raw materials, power etc, access to
market for products, the experience of promoters in the industry and importantly the
collateral / guarentees available for the loan.
4. ISSUE OF THE LETTER OF SANCTION
If the project is accepted, a financial letter of sanction is issued to the borrower. This
communicates to the borrower that the project has been sanctioned and the terms and conditions
thereto.
5. ACCEPTANCE OF TERMS & CONDITIONS BY THE BORROWING UNIT
On receiving the letter of sanction from the financial institution, the borrowing unit accepts the
terms & conditions and this is conveyed to the financial institution within the stipulated time.
6. EXECUTION OF LOAN AGREEMENT
The financial institution after receiving the acceptance from the borrower, sends the draft of the
agreement to the borrower to be executed by authorized persons and properly stamped as per the
Indian Stamp Act, 1899. The agreement properly executed and stamped along with other
documents as required by the financial institution must be turned to it. Once the financial
institution also signs the agreement, it becomes effective.
7. DISBURSEMENT OF LOANS
Periodically the borrower is required to submit information on the physical progress of the
projects, financial status of the project, arrangements made for financing the project,
51 | P a g e

contributions made by the promoters, projected fund flow statement, compliance with various
statutory requirements and fulfillment of the pre-disbursement conditions. Based on the
information provided by the borrower, the financial institution will determine the amount of loan
to be disbursed from time to time. Before the loan is disbursed, the borrower must fully comply
with all terms and conditions of the loan agreement.
8. MONITORING
Monitoring of the project is done at the implementation stage as well during the operational
stage. During the implementation stage, the project is monitored through regular reports
(furnished by the promoters), periodic site visits, discussion with promoters, bankers, suppliers,
creditors and others connected with the project, audited accounts of the company. During the
operational stage, the project is monitored with the help of quarterly progress report on the
project, site inspection, audited accounts of the company etc. However, the most important
aspect of monitoring, of course, is the recovery of dues represented by interest.

52 | P a g e

RESEARCH
METHODOLOGY

53 | P a g e

SAMPLING
Sampling is the process of using a small number of items or parts of a larger population to make
conclusions about the whole population.
TARGET POPULATION : The specific group relevant to the research project is called the
target population. In this project, the target population is the micro, small & medium enterprises
which take loans from Banks & Financial institutions for meeting the demands of their capital
assets as well as working capital.
SAMPLING UNIT : A single element or a group of elements subject to selection in the sample
is called the sampling unit. Here the sampling unit consists of the micro, small & medium
enterprises in the sample area, i.e. Shahdara Industrial area. This industrial area comprises a
number of micro, small and medium enterprises and is one of the prominent industrial areas of
Delhi. This area hosts a number of manufacturing units. This survey also reflects the nature of
this area and the sample population consists more of manufacturing units.
SAMPLE SIZE : Total respondents were 50 micro, small & medium enterprises which took
loan from Banks & Financial Institutions.
SAMPLING METHODOLOGY : The sampling method used for the research is Convenient
Sampling. It is also called accidental or haphazard sampling. In this sampling procedure which
people or units are obtained that are most conveniently available. In this research paper, the
sampling was done through database provided by the Bank, websites which have the addresses

54 | P a g e

and the contact numbers of the business enterprises (like www.indiamart.com) and by cold
calling.

DATA COLLECTION
The primary instrument for data collection in this research was questionnaires, which contained a
mixture of closed and open ended questions. Questionnaire method has advantages in terms of
versatility of the method as well as speed and cost. However, it may have disadvantages as a
result of unwillingness of respondents to provide information, inability of respondents to provide
information and influence of the questioning process.
Scale used in this questionnaire is a Likert Scale. The respondents were provided with a list of
attributes on which they have to give their feeling using five options like very good, Fairly Good,
Neutral, Not good and Not good at all. viz. . A lower preferance exhibits that the customers are
less satisfied with the concerned attribute of their financial institution while a higher indicates
increased levels of satisfaction.

TOOLS & TECHNIQUES USED FOR DATA ANALYSIS

The data analysis has been done by using pie charts, column charts and bar graphs.

55 | P a g e

LIMITATIONS
A large no. of MSMEs were reluctant to talk about their issues regarding the credit
process. Due to lack of their own time, many of them were not ready to fill the
questionnaire.
The data may be biased as it solely depends on the information provided by the
concerned persons.
The study was limited to only Shahadara Industrial Area. Hence, it cannot be summarized
that it shows the requirements of all the MSMEs.

56 | P a g e

DIAGRAMMATIC REPRESENTATION OF THE SAMPLE :

TYPE OF ENTERPRISE

Of the 50 respondents, 33 were manufacturing enterprises while 17 were services enterprises.

KIND OF ENTERPRISE

57 | P a g e

Of the 50 respondents, 23 were micro enterprises, 16 were small while 11 were medium
enterprises. This classification was done according to the guidelines of the MSMED Act, 2006.
TYPE OF OWNERSHIP

Out of the 50 enterprises, 26 were proprietary while 16 were partnership firms. Only 8 units were
private limited firms. It shows that a large number of MSMEs are proprietory concerns.

58 | P a g e

DATA
ANALYSIS

59 | P a g e

Q. From where you have taken financial assistance ?

86% of the enterprises said that they have taken financial assistance from public sector banks
like the SBI, PNB, Canara Bank, Indian Bank, Central Bank of India etc while 10% said that
they have taken assistance from private sector banks like the ICICI Bank and HDFC Bank and
4% said that they have taken loans from other sources. This reveals that the public sector banks
are still the first choice among the MSMEs for their credit requirements while private sector
banks still are not hold a good chance among the MSMEs.

Q. Which kind of loan you have taken ?

60 | P a g e

Out of the 50 respondents, 21 respondents said that they have taken a term loan while 16 said
they have opted for a working capital loan. 13 respondents said that they have gone for both term
and working capital loan. The extent of an external infusion of funds into any MSME is
primarily dictated by the nature of activities with which it is engaged, in addition to many factors
like owners stake. Also, the financial requirements of an MSME ( Manufacturing) are
significantly different when compared with an MSME (Services).

Q. Give your opinion about the following services of your bank.

61 | P a g e

Here in this question, respondents were asked to give their opinion on the four facilities by their
respective banks from where they have opted for loan. The four attributes are Customized
products, Interest rates, documentation process and disbursement process. Most of the
respondents were giving neutral opinions on the facilities, however most of the respondents were
satisfied with the disbursement process while a considerable no of respondents were dissatisfied
with the loan products and the documentation process.

Q. What worries you more while taking a loan ?

To answer this question, five options were given, viz. Customized options, Documentation
process, Interest Rates, Support from Banks and Availability of collateral security. The major
concerns were again related to the availability of collateral security and documentation process.
18% of the respondents also felt that support from the bank staff is the biggest concern for them.

Q. Are you aware of the various credit schemes specially designed for the
MSMEs ?

62 | P a g e

Around 27 of the respondents were aware of the various schemes designed for them while 23
were not aware. It shows that there is a great lack of unawareness on the part of MSMEs on the
credit schemes designed for them and the various facilities and guidelines issued by the govt. for
their benefit. The lack of awareness is a big problem in fulfilling the credit requirements of the
MSMEs from different financial institutions.

Q. Does your Bank provide you with useful and regular information about
different schemes ?

63 | P a g e

In answer to this question, 32 of the respondents felt that their bank provide them with useful and
regular information about different schemes while 18 respondents felt that the banks are unable
or not interested in providing them with useful information on their queries. Information
provided by the Banks can be very useful in solving the queries and understanding the
requirements to a great extent.

Q. What other financial options you have ?

In answer to this question, 24 of the respondents said that personal savings are the major other
source of finance for them while 10 respondents said that lending from relatives are the other
major source of finance.

64 | P a g e

FINDINGS
Most of the enterprises depend on banks or other financial institutions to start or operate
their business.
Public sector banks remain the first choice for the MSMEs especially due to their low
rates of interest. However, they bring their own set of problems like delay in the
documentation process.
Credit options, interest rates, collateral security and documentation process are the chief
concerns among the MSMEs. Micro enterprises feel that banks stress a lot on collateral
security and lend each pie on the basis of it.
A considerable no of MSMEs especially in the micro sector are unaware of credit
schemes designed for them.
Personal savings are still the major other source of finance for them.
65 | P a g e

CONCLUSION
SMEs make a major contribution to the growth and employment and their ability to grow
depends on their potential to invest in technology, restructuring, innovation and human resource
development. All these investments need capital, and, therefore, access to finance. Recent and
ongoing developments in the financial sector and in particular, banking will further impact on
the access to finance. The main changes in the banking sector that will influence MSME finance
are like Globalization intensified the competition and the profit orientation in this sector, the ups
and downs of some sectorslike in the IT, real estate and lately, even retail business sector, tend to
make the banks more focused on profitability of their operations.
So there is a need for banks to focus their attention on the MSME sector without affecting their
profitability and without compromising on the quality of lending. Financing this sector calls for
an innovative approach far different from financing large corporate sector as this sector heavily
depends on debt instead of equity. There is also lack of information on the part of MSMEs on the

66 | P a g e

loan products, however, traditional schemes like Term Loans, Demand Loans, Cash Credit etc
are giving way to new and customized products.
Due to higher risk awareness of the finance sector and the needs of Basel II, many MSMEs are
confronted for the first time with internal rating procedures or credit scoring system by their
banks. The banks require more and better quality of information from their clients and assess
them. The banks will have to communicate the relevant criteria affecting the rating of MSMEs
and should inform them about its assessment in order to allow MSMEs to improve.

RECOMMENDATIONS
More customized products can be designed for this sector. However, this sector is so
diversified in nature that the list of products can be exhaustive. So the products can be
designed looking at the requirements of groups or clusters.
The loan should be more of secured by a charge of overall assets of a business. The
CGTMSE scheme which insists on primary security is a very good step towards this.
Due to the high risk profile of the MSMEs, banks use the balance sheet approach to
assess the financial worth of an enterprise and insist on collateral securities for every pie
they lend. This can be replaced with a cash flow approach. The appraisal process should
consider the sectors limited access to equity finance and high dependence on debt
markets, blocking or delayed payments by vendees etc.

67 | P a g e

 Banks should gear up to offer entrepreneurs information about industry, products,

markets etc in addition to financial assistance. They can make use the services of
responsible small enterprise associations for such purposes.
The banks should communicate the relevant criteria affecting the rating of MSMEs and
inform them about its assessment in order to allow MSMEs to improve.
The documentation process should be faster. Most of the MSMEs while talking revealed
that the documentation takes a lot of time and leads to delay in fulfilling their
requirements.
The Bank should always provide prompt response to the queries on loans with the
simplified details. Many of the respondents felt, especially in case of public sector banks,
that the bank staff should provide prompt response to their queries and needs.

68 | P a g e

REFERENCES

Vision 2020 : Implications for MSMEs, A FICCI Survey

Indian Economy, Performance & Policies : B.K.Bhargava & Vandana Sethi, Page 311322, The Small Scale Sector

Analysis of Balance Sheet, N.S.Toor, Skylark Publications.

Financial Requirements of Micro, Small & Medium Enterprises, S.K.Bagchi

Know Your Banking Micro, Small & Medium Enterprises, Taxmann Publications

Economic Survey 2009-10

The Indian Banking Sector On the Road To Progress, G.H.Deolalkar

www. Finance. Indiamart.com/investment_in_india/banking_in_india.html

www.rbi.org.in

www.msme.gov.in

A more complete conceptual framework for SME finance, Allen N. Burger & Gregory
F. Udell,

69 | P a g e

www.siteresources.worldbank.org/.../Financing_Framework_berger_udell.pdf

www.indiastat.com

www.centralbankofindia.com

APPENDIX
70 | P a g e

QUESTIONAIRE
Dear Respondent,
I, Krishna Kumar Sakunia, a student of Asia Pacific Institute of Management, New Delhi and
currently a summer intern in Central Bank of India is conducting a survey to understand the
Credit Requirements of Micro, Small and Medium enterprises. Please fill the questionnaire for
the survey.

1. What kind of a firm you are ?

i)
Manufacturing

2. What type of enterprise you are ?

i)
Micro
ii)

ii)

Small

3. From where you have taken financial assistance ?

i)
Public Sector Banks
ii)
ii)
Other Financial Institutions

71 | P a g e

Services

iii)

Medium

Private Sector Banks

4. Which kind of loan you have taken ?

i)
Term Loan
ii)
Both (i) and (ii)

ii)

Working Capital Loan

5. Give your opinion on the following facilities of your Bank ?

Very

Fairly

Good

Good

Neutral Not very

Not Good

Good

at all

i)
Customized Products
ii)
Interest Rates
iii)
Documentation Process
iv)
Disbursement Process
6. What worries you more while taking a loan ?
i)
Credit Options
ii)
Documentation Process
iii)
Interest Rates
iv)
Lack of support from Banks
v)
Availability of collateral security

7. Are you aware of various credit schemes specially designed for MSMEs ?
i)
Yes
ii)
No

8. Does your Bank provide you useful and regular information about different schemes ?
i)
Yes
ii)
No

9. What other financial options you have ?

i)
Personal Savings
ii)
Joint Ventures

ii)
iv)

Relatives
Lending from other sources.

10. What other suggestions you have for better MSME Lending by Banks ?

72 | P a g e

________________________________________________________________________
________________________________________________________________________
PERSONAL INFORMATION :
Name of the Firm

Type of Organization

Number of Employees

Address

4.3 RBI GUIDELINES REGARDING LENDING TO MSME SECTOR

The Reserve Bank of India on July 1, 2010 issued a master circular incorporating the existing
guidelines/instructions/directives on various lending norms and targets to Banks on the issue of
lending to MSMEs. This Master Circular consolidates the instructions issued by the RBI up to
June 30, 2010.
Targets for priority sector lending by Domestic Commercial Banks
The domestic commercial banks are expected to enlarge credit to priority sector and ensure that
priority sector advances (which include the micro and small enterprises (MSE) sector) constitute
40 per cent of Adjusted Net Bank Credit (ANBC) or credit equivalent amount of Off-Balance
Sheet Exposure, whichever is higher. In terms of the recommendations of the Prime Ministers
Task Force on MSMEs, banks are advised to achieve a 20 per cent year-on-year growth in credit
to micro and small enterprises and a 10 per cent annual growth in the number of micro enterprise
accounts.

73 | P a g e

In order to ensure that sufficient credit is available to micro enterprises within the MSE sector,
banks should ensure that:
(a) 40 per cent of the total advances to MSE sector should go to micro(manufacturing)
enterprises having investment in plant and machinery up to Rs. 5 lakh and micro (service)
enterprises having investment in equipment up to Rs. 2 lakh;
(b) 20 per cent of the total advances to MSE sector should go to micro(manufacturing)
enterprises with investment in plant and machinery above Rs. 5 lakh and upto Rs. 25 lakh, and
micro (service) enterprises with investment in equipment above Rs. 2 lakh and up to Rs. 10 lakh.
Thus, 60per cent of MSE advances should go to the micro enterprises.
(c) While banks are advised to achieve the 60% target as above, in terms of the recommendations
of the Prime Ministers Task Force, the allocation of 60% of the MSE advances to the micro
enterprises is to be achieved in stages viz. 50% in the year 2010-11, 55% in the year 2011-12and
60% in the year 2012-13.
Targets for Foreign Banks
Foreign banks are expected to enlarge credit to priority sector and ensure that priority sector
advances (which includes the MSE sector) constitute 32 per cent of Adjusted Net Bank Credit
(ANBC) or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher.
Within the overall target of 32 per cent to be achieved by foreign banks, the advances to MSE
sector should not be less than 10 per cent of the adjusted net bank credit (ANBC) or credit
equivalent amount of Off-Balance Sheet Exposure, whichever is higher.

74 | P a g e

In terms of the recommendations of the Prime Ministers Task Force on MSMEs, banks are
advised to achieve a 20 per cent year-on-year growth in credit to micro and small enterprises and
a 10 per cent annual growth inthe number of micro enterprise accounts.
In order to ensure that sufficient credit is available to microenterprises within the MSE sector,
banks should ensure that:(a) 40 per cent of the total advances to MSE sector should go to
micro(manufacturing) enterprises having investment in plant and machinery upto Rs. 5 lakh and
micro (service) enterprises having investment in equipment up to Rs. 2 lakh.
(b) 20 per cent of the total advances to MSE sector should go to micro(manufacturing)
enterprises with investment in plant and machinery above Rs. 5 lakh and upto Rs. 25 lakh, and
micro (service) enterprises with investment in equipment above Rs. 2 lakh and up to Rs. 10 lakh.
Thus, 60per cent of MSE advances should go to the micro enterprises.
(c) While banks are advised to achieve the 60% target as above, in terms of the recommendations
of the Prime Ministers Task Force the allocation of 60% of the MSE advances to the micro
enterprises is to be achieved in stages viz. 50% in the year 2010-11, 55% in the year 2011-12 and
60% in the year 2012-13.
COMMON GUIDELINES / INSTRUCTIONS FOR LENDING TO MSME
Disposal of Applications : All loan applications for MSE units upto a credit limit of Rs. 25,000/should be disposed of within 2 weeks and those upto Rs. 5 lakh within 4 weeks provided , the
loan applications are complete in all respects and accompanied by a " check list".
Collateral : Banks are mandated not to accept collateral security in the case of loans upto Rs.10
lakh extended to units in the MSE sector. Banks are also advised to extend collateral-free loans
75 | P a g e

upto Rs. 10 lakh to all units financed under the Prime Minister Employment Generation
Programme of KVIC. Banks may, on the basis of good track record and financial position of the
MSE units, increase the limit of dispensation of collateral requirement for loans up to Rs.25 lakh
(with the approval of the appropriate authority).
Banks are advised to strongly encourage their branch level functionaries to avail of the Credit
Guarantee Scheme cover, including making performance in this regard a criterion in the
evaluation of their field staff.
Composite loan : A composite loan limit of Rs.1 crore can be sanctioned by banks to enable the
MSE entrepreneurs to avail of their working capital and term loan requirement through Single
Window.
Specialised MSME branches : Public sector banks have been advised to open at least one
specialized branch in each district. Further, banks have been permitted to categorise their MSME
general banking branches having 60% or more of their advances to MSME sector in order to
encourage them to open more specialised MSME branches for providing better service to this
sector as a whole. As per the policy package announced by the Govt of India for stepping up
credit to MSME sector, the public sector banks will ensure specialized MSME branches in
identified clusters/centres with preponderance of small enterprises to enable the entrepreneurs to
have easy access to the bank credit and to equip bank personnel to develop requisite expertise.
The existing specialised SSI branches may also be redesignated as MSME branches. Though
their core competence will be utilized for extending finance and other services to MSME sector,
they will have operational flexibility to extend finance/render other services to other
sectors/borrowers.

76 | P a g e

Delayed Payment : Under the Amendment Act, 1998 of Interest on Delayed Payment to Small
Scale and Ancillary Industrial Undertakings, penal provisions have been incorporated to take
care of delayed payments to MSME units. After the enactment of the Micro, Small and Medium
Enterprises Development(MSMED), Act 2006, the existing provisions of the Interest on Delayed
Payment Act, 1998 to Small Scale and Ancillary Industrial Undertakings, have been strengthened
as under:

(i)In case the buyer to make payment on or before the date agreed on between him and the
supplier in writing or, in case of no agreement before the appointed day. The agreement between
seller and buyer shall not exceed more than 45 days.
(ii)In case the buyer fails to make payment of the amount to the supplier, he shall be liable to pay
compound interest with monthly rests to the supplier on the amount from the appointed day or,
on the date agreed on, at three times of the Bank Rate notified by Reserve Bank.
(iii) For any goods supplied or services rendered by the supplier, the buyer shall be liable to
pay the interest as advised at (ii) above.
(iv)In case of dispute with regard to any amount due, a reference shallbe made to the Micro and
Small Enterprises Facilitation Council, constitutedby the respective State Government.Further,
banks have been advised to fix sub-limits within the overall workingcapital limits to the large
borrowers specifically for meeting the paymentobligation in respect of purchases from MSMEs.

77 | P a g e

4.4 CREDIT GUARENTEE FUND TRUST FOR MICRO & SMALL

ENTERPRISES
The GOI set up CGTMSE with the aim to ensure that project viability remains main criteria to
secure credit for micro and small enterprises. It also ensures that loans and credit facility should
be secured on primary security of the assets financed.
TO ENSURE first generation entrepreneurs and businessmen are able to realise their dream of
setting up small and micro enterprises, the Credit Guarantee Fund Trust for Micro and Small
Enterprises (CGTMSE) ensures easy bank credit without hassles of collaterals and third party
guarantees is made available to the borrowers. The government of India set up the CGTMSE
with the aim to ensure that project viability remains the main criteria to secure credit for micro
and small enterprises. It also ensures that loans and credit facility should be secured purely on
the primary security of the assets financed. Another objective is that lender should give
composite loan to the borrowers so that they obtain term loan and working capital from the same
agency.

78 | P a g e

As per the Credit Guarantee Scheme (CGS), if a Micro or Small Enterprise (MSE) avails loans
without collateral and fails to pay back the money, then the Guarantee Trust will make good the
loss suffered by the lender up to 75/80/85 per cent of credit facility.
The CGTMSE covers credit up to 100 lakh extended by eligible institutions to new as well as
existing micro and small enterprises. The guarantee cover available under the scheme is up to
75/80 per cent of the sanctioned amount of the credit facility, with a maximum guarantee cap of
Rs 62.50 lakh / Rs 65 lakh. The extent of guarantee cover is 85 per cent for micro enterprises for
credit up to Rs 5 lakh.
For micro and small enterprises owned by women the guarantee cover is 80 per cent and the
same the case for credits and loans in North Eastern Region. If a business owner or entrepreneur
defaults than the trust settles the amount up to 75 to 80 per cent of the credit facility extended by
lending institution.
As per the CGTMSE, the eligible credit facilities should be immediately covered.
As per a latest RBI direction, collateral free loans up to Rs 5 lakh sanctioned to MSE units must
be provided by all the banks to both manufacturing as well as service enterprises. This direction
came after there was dillydallying on part of the banking sector on the issue of extending
collateral free loans.
The institutions eligible for credit guarantees are:
All Scheduled Commercial Banks (either PSU, Private or Foreign Banks), select Regional Rural
Banks, or such of those institutions as may be directed by GOI can avail of guarantee cover in
respect of their eligible credit facilities under the Scheme. Small Industries Development Bank of
India (SIDBI), National Small Industries Corporation Ltd (NSIC) and North Eastern
79 | P a g e

Development Finance Corporation Ltd (NEDFI) have been included as eligible institutions

The businesses eligible for Credit Guarantee facility:

New and existing Micro and Small Enterprises engaged in manufacturing or service activity
excluding 'Retail Trade'. As of now, all activities that come under service sector as per RBI's
guidelines on 'Lending to Priority Sector' and MSMED Act, 2006 except retail trade are eligible
for coverage under the scheme.

80 | P a g e