SMEinsight 1

VOLUME 2

A recent study conducted by CRISIL on the funding patterns of small and medium enterprises
(SMEs) in India reveals that there is scope for banks to increase their lending to SMEs by
Incremental SME Rs.500 billion. Against the acceptable banking practice of financing 75 per cent of an SME's
funding: A Rs.500 incremental working capital requirement, on an average, only around 60 per cent was funded
between 2006-07 (refers to financial year, April 1 to March 31) and 2008-09. The SMEs met the
billion business bulk of their residual funding needs from their own funds. CRISIL's study of the SMEs' working
opportunity for capital funding patterns also debunks the long-held perception that these enterprises are
overleveraged. Moreover, the study indicates that bank branches in the urban areas have
India's banks greater scope than their counterparts in the semi-urban and rural areas to increase funding
support to SMEs; the headroom for lending to the small SMEs is greater than that to the larger
SMEs.

The above mentioned study is based on a large sample of enterprises rated by CRISIL under
Analytical contact: NSIC’s performance and credit rating scheme for micro and small enterprises. CRISIL, in
Ramraj Pai association with Ministry of MSME, Government of India, has assigned more than 13000 ratings
Director - CRISIL Ratings under this scheme in the last five years.
Tel: +91-22-3342 3036
Email: rpai@crisil.com
Analysis by composition of balance sheet

As part of its study, CRISIL first analysed changes in the composition of SME balance sheets
over the past two years. Table 1 indicates the component-wise changes in balance sheet during
the period.
Table 1 – Component-wise increase in balance sheet size ∆

∆ Liabilities Percent ∆ Assets Percent

Tangible net worth 4 Fixed assets 26

Internal accruals 38 Current assets 74
Unsecured loans from promoters 8
Total promoters' funds 50
Long term borrowing from banks 4
Working capital borrowing from banks 25
Current liabilities 21

Total external sources 50

The table reveals that for all SMEs considered as part of this study, growth in current assets
contributed 74 per cent to the growth in balance sheet. Augmentation in fixed assets
contributed the remaining 26 per cent to growth in SME balance sheets. In terms of funding,
the increase in asset base was funded by enhanced bank borrowings (25 per cent), and
stretched creditors (21 per cent) with the bulk of residual funding coming in from
promoters/internal accruals.

1
Of the 15,000 and more SMEs that CRISIL has rated so far, a large sample of more than 2000 SMEs rated in
2009 was considered for this study. The sample ensured adequate representation by region, industry sector, and
other parameters. A detailed profiling of the sample SMEs is provided in Annexure 1.

'∆' represents the contribution of growth in the related asset to growth in total assets; if, for instance, ∆ current
assets is 74, it indicates that growth in current assets contributed 74 per cent to growth in assets (over the
previous year)
 As per accepted banking practice, banks are permitted to fund up to 75 per cent of the incremental working capital requirements (increase
in current assets less increase in current liabilities) of borrowers. As Table 1 indicates, banks can fund 75 per cent of increase in current
assets (74 per cent) less increase in current liabilities (21 per cent); in other words, while banks can fund up to 40 per cent of SMEs'
incremental working capital requirements, the actual funding provided by banks was only 25 percent. This reveals a significant incremental
funding opportunity of 15 per cent of SMEs' incremental working capital requirements.

Another way of estimating the size of this opportunity is to evaluate its proportion over the existing stock of banking sector advances to
2
SMEs. CRISIL's analysis indicates that the size of this opportunity may be as large as Rs.500 billion, which is about a fifth of advances to the
SME sector. This not only reflects the size of the opportunity, but also underscores the impact it can have on the SME sector as a whole.

The rest of this article will attempt to understand the dynamics of this large funding opportunity in greater detail. For the purpose of further
analysis and ease of reference, the difference between the actual bank funding and the maximum permissible levels as explained above,
has been defined as the incremental funding opportunity (IFO) in this article.

Analysis by scale of operations

The smaller the SME's scale of operations, the greater the IFO. As
Chart 1 indicates, SMEs with low turnover (less than Rs.50 million)
have a much larger IFO than those with larger turnover, indicating that
the opportunity in financing smaller enterprises is much larger than that
of financing larger enterprises. Increased support will help boost
growth of the smaller SMEs and enhance the effectiveness of various
government initiatives to support the SMEs.

Analysis by geography
SMEs in urban areas have significantly higher IFO as compared to those in semi urban and rural areas. Banks appear to have better
utilised the opportunity for funding the SMEs in the semi-urban and rural areas. Funding opportunities for banks are still strong in the
urban areas, where the IFO is 17 per cent; in the semi-urban and rural areas, the IFO is much lower at 13 per cent. This is surprising,
given the general perception that SMEs in the urban areas have greater access to bank funding than those in the semi-urban and rural
areas, where banking penetration is lower. The reason for this urban-rural divide in bank funding for SMEs may be that urban banks
spread their funds over a wider basket of large, medium, and small companies the urban areas, whereas in the semi-urban or rural
areas, the key customers are restricted mainly to SMEs.

A state-wise analysis (refer to Table 2) reveals that SMEs in states such as Gujarat, Delhi, and West Bengal have the highest IFOs.
These states have the highest potential for incremental SME funding. In comparison, SMEs in states such as Tamil Nadu,
Rajasthan, and Punjab have low IFOs, and appear to be better funded.

Table 2 – Geographic distribution of IFO

Analysis of the funding patterns based on other parameters do not reveal any prominent trend. Banks have opportunity to increase
funding support to SMEs across industry sectors and there are no specific sector-related trends with respect to IFOs. Also, most SMEs
in CRISIL's study have long track records, which rules out the possibility that working capital financing was adversely affected by
concerns on management pedigree or quality.

2
It was observed in SMEs evaluated under this study, that the IFO represented 30 per cent of the existing stock of working capital debt. With working capital
advances to SMEs estimated at Rs.175 billion in 2009, the additional funding possibility could be Rs.500 billion.
Funding mismatch not a temporary phenomenon

The aforementioned trends, as revealed by CRISIL's study, however, raise certain questions. Was this large funding mismatch a
temporary phenomenon? More importantly, was it a result of the SMEs' efforts to reduce gearing during the period of the study? To
answer these questions, CRISIL analysed the data for the period between 2006-07 and 2007-08 as well. The analysis revealed similar
trends—the funding mismatch is certainly no temporary phenomenon, and has existed for the past three years. The financing pattern for
the SMEs' incremental working capital requirements in 2007-08 (over the previous year) was similar to that in 2008-09. Moreover,
deleveraging by SMEs is unlikely to have caused the funding mismatch—SME balance sheets have remained moderately geared
between 2006-07 and 2008-09.

CRISIL believes that the SME sector will continue to be one of the engines of growth for the country's economy, and present a significant
business opportunity for banks. The banks will derive commercial benefits from lending to SMEs. In addition, access to bank funds will
help the SME sector grow and prosper, and, in the process, favourably impact industrial output, and employment and wealth creation.

Annexure 1

Detailed profile of SMEs evaluated as a part of this study

Rating Distribution: NSIC-CRISIL Rating Rating Distribution: SME Rating

Nature of Business Operation Constitution of Enterprises

Net sales: 2008-09 Track record of enterprises

Geographical Distribution Industry wise Distribution

Disclaimer

CRISIL has taken due care and caution in preparing this report. Information has been obtained by CRISIL from sources which it considers
reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors
in transmission and especially states that it has no financial liability whatsoever to the subscribers/ users/ transmitters/ distributors of this report.
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