The Indian MSME sector is the backbone of the national economic structure and has unremittingly acted as the bulwark for the Indian economy, providing it resilience to ward off global economic shocks and adversities. With around 48.8 million units throughout the geographical expanse of the country, MSMEs contribute around 7% of the manufacturing GDP and 31% of the GDP from service activities as well as 37% of India s manufacturing output and 40% of the overall exports.

1. MSME Financing - Key Issues and Solutions
Analysis by Resurgent India Ltd.
June 2016

2. Table of Contents
 Introduction
o Overview of MSME Sector in India
o Contribution of MSME to the Economy
o Key Challenges and Hindrances faced by MSMEs
o Government Initiatives
 MSME Amendment Bill – 2015
 Current status of Rehabilitation policy framework for sick MSME Units
 Ease of Doing Business – An MSME perspective
o Understanding Ease of Doing Business in India
o Statewise comparison and Policies
o Impact on MSMEs
 CGTMSE Scheme
o Overview
o Benefits of CGTMSE
o Drawbacks and Future requirements
 Financing MSMEs in India
o Demand and Supply Gap
o Collateral Free Loans
o Receivable Financing
o Cash flow Management
 Recommendations and Suggestions

4. SUBHASH DESAI
MINISTER
INDUSTRIES
GoVERNMENT OF MAHARASHTRA
Mantralaya, Mumbai400 032
www.maharashtra.gov.in
Date
30/05/2016
MESSAGE
I am happy to learn that The Associated Chambers of
Commerce and Industry of India ( ASSOCHAM) is organizing
a seminar "Financial Clinic for MSMEs - Facilitating
Businesses for Sustainability" on 23rd June, 2016 in Mumbai.
Government of Maharashtra is committed to work
towards the uplifment ofMSME sector across all the segments
of Industrial domain. In order to improve the performance of
Small & Medium Enterpriese and to enable them to have
unrestrained access to finance, the state government is
facilitating various schemes and initiatives for the growth of
MSME sector.
I am hopeful that ASSOCHAM shall continue working
efficiently towards this .direction to ensure the growth III
MSME sector.
Iwishtheseminaragreatsucces~,;fr
( Subhash Desai)
Chamber 402, (Main) Mantralaya, Mumbai400032, Tel. No. : (022) 2202 5250, 2202536

6. Message
The Indian MSME sector is the backbone of the national economic structure
and has unremittingly acted as the bulwark for the Indian economy,
providing it resilience to ward off global economic shocks and adversities.
With around 48.8 million units throughout the geographical expanse of the
country, MSMEs contribute around 7% of the manufacturing GDP and 31% of
the GDP from service activities as well as 37% of India s manufacturing
output and 40% of the overall exports. They have been able to provide
employment to around 111.4 million persons during FY14, recording a CAGR
of 4.8% in employment generation since FY07. The sector contributes around
46% of the overall exports from India and has consistently maintained a
growth rate of over 10%. The highest growth in recent time was recorded during 2011-12 (18.5%)
whereas during year 2012-13 and 2013-14 growth rate was around 14.3% and 12.4%, respectively.
MSMEs are predominant across the sectors of retail, apparel manufacturing, food products & beverages
as well as hotels and restaurants. They are also well spread out across the geography including rural
areas. About 55.3% of the MSMEs are based out of rural areas, which indicates the deployment of
significant rural workforce in the MSME sector and is an exhibit to the importance of these enterprises
in promoting sustainable and inclusive development as well as generating large scale employment,
especially in the rural areas.
MSMEs become a part of the industrial ecosystem and act as ancillary units for large enterprises, to
support the system growth. Flexibility in operations, lower capital requirement, use of local resources,
access to low cost workforce, strong customer relationships, etc. are some of the factors that provide a
global competitive edge to Indian MSMEs.
In spite of their significance, these enterprises face an assortment of challenges and constraints. Some
of these include poor access to finance, shortage of skilled manpower, technological obsolescence,
regulatory issues, lack of access to infrastructure and logistics facilities, inadequate linkages to domestic
and international markets, lack of skilled manpower, etc. The government of India, directly and through
its various affiliated bodies, operates several schemes for infusing vigour and vitality in the Indian MSME
sector. Looking ahead, the challenge lies in building the next generation of SMEs that will collectively
function as the powerhouse of the economy. To achieve this, the governments and industry must make
many collaborative efforts to create conducive eco-systems for MSMEs
Jyoti Prakash Gadia
Managing Director
Resurgent India Limited

7. MESSAGE
I am delighted that the Associated Chambers of Commerce and Industry
of India (ASSOCHAM) is organizing the series of summits on
“Financial Clinic for MSMEs – Facilitating Businesses for
Sustainability” in Mumbai, Bengaluru, Kolkata and Hyderabad.
There is urgent requirement to provide support to the SME sector in
form of financial assistance from financial institutions including banks.
To give a brief overview of the alternate options of financing and their
benefits, ASSOCHAM has come out with a study in collaboration with
Resurgent India Pvt. Ltd. which carries a holistic view of the current
scenario of MSME financing.
I congratulate my colleagues Mr. U.K. Joshi, Director, Mr. Sumitra
Nandan Srivastava and Mohd. Zumair for this remarkable initiative. I
would also extend my profound thanks to all other stakeholders and
partners for their support to make this conclave a grand success.
I wish the Seminar a great success. I am sure this study will give rich
insight and adequate knowledge to all the stakeholders.
(D.S. Rawat)

8. Overview of MSME Sector in India
Micro, Small and Medium Enterprises (MSME) sector is a significant contributor to the
economic growth of the country. It not only acts as the backbone of manufacturing,
agriculture & engineering and services, but also is among the top employment generating
sectors. Being complementary to large industries, it contributes enormously to the
country’s GDP besides fostering the entrepreneurial spirit. Today, the sector produces a
wide range of products, from simple consumer goods to high-precision, sophisticated
finished products; demonstrating high growth potential and stake in manufacturing and
value supply chain.
The sector is characterized by low investment requirement, operational flexibility and
location wise mobility. This enables providing employment at lower capital cost and also
helps in correcting regional imbalances through industrialization of rural and backward
areas, towards an efficient and inclusive growth model.
Micro, Small and Medium Enterprises (MSME) contribute nearly 8 percent of the country’s
GDP, 45 percent of the manufacturing output and 40 percent of the exports. They provide
the largest share of employment after agriculture. They are the nurseries for
entrepreneurship and innovation. They are widely dispersed across the country and
produce a diverse range of products and services to meet the needs of the local markets,
the global market and the national and international value chains.
The Ministry of Micro, Small and Medium Enterprises has a number of programmes to help
and assist entrepreneurs and small businesses. If you are planning to set up business, you
may contact National Institute for Entrepreneurship and Small Business Development
(NIESBUD), National Institute for Micro, Small and Medium Enterprises (NI-MSME), Indian
Institute of Entrepreneurship (IIE) or the Development Commissioner (DCMSME) for
details about their programmes. If you are an existing entrepreneur and would like to
improve your competitiveness, you may contact DC, MSME who can be of assistance in
various ways. If you are wanting to set up a village industry or want to know more about
Khadi or Coir Products, you may contact KVIC or Coir Board. Ministry of MSME encourages
and honors innovation and enterprise. The State Governments, Industry Associations,
Banks and other stakeholders through their numerous field offices and technical
institutions act as catalysts to help the ‘engines of growth’ throughout the country.

9. Classification of MSMEs by location (%)
Key highlights of the MSME Sector:
 MSMEs account for about 45% of India’s manufacturing output
 MSMEs accounts for about 40% of India’s total exports
 The sector is projected to employ about 111.4 million people in more than 48
million units spread across the country
 MSMEs manufacture more than 6,000 products ranging from traditional to high tech
items
MSMEs CONTRIBUTION TO ECONOMY
MSMEs have contributed significantly to the Indian economy, with more than 48 million
units employing more than 111.4 million persons. Further, productivity of the MSME sector
has been improving significantly with fixed investments and employment growing
consistently over the past few years. This is a direct indication of the efforts focused on this
sector to integrate the workforce with technological enhancements to increase production.

10. Employment Generation
MSME sector in India creates largest employment opportunities, next only to Agriculture. It
has been estimated that a lakh rupee invested in fixed assets in the sector results in
generating employment for four persons. Some of the interesting observations related to
employment in MSMEs are related to generation of employment according to the industry.
For instance, food products industry ranked first, followed by non-metallic mineral
products and metal products. Additionally, Chemicals & chemical products, Machinery
parts except Electrical parts, Wood products, Basic Metal Industries, Paper products &
printing, Hosiery & garments, Repair services and Rubber & plastic products also
contributed to generate employment.
Employment Generation by MSMEs (millions)
Production
MSMEs play a crucial role in the growth of the country by accounting for 40 per cent of the
gross manufacturing output. As per estimation, a lakh rupee of investment in fixed assets in
the sector produces 4.62 lakh worth of goods or services with an approximate value
addition of ten percentage points. The space has registered impressive growth over the
past few years and the growth rate recorded during the various plan periods have been
very impressive. Further, the transition period of the process of economic reforms was also
affected for some period by adverse factors such as foreign exchange constraints, credit
squeeze, demand recession, high interest rates, shortage of raw material etc. Further, when
the performance of this sector is compared with the growth in the manufacturing and the
industry sector as a whole, it instils confidence in the resilience of MSMEs.

11. MSME units and fixed investments
Export Contribution
MSMEs play a major role in India's export performance by accounting for 45-50 per cent of
total exports. The surprising fact is that non-traditional products account for more than 95 per
cent of the MSME exports. The exports from the segment have registered enormous growth
during the last decade. Further, the growth in the segment has been mostly fuelled by the
performance of garment, leather and gems and jewellery units.
Opportunities
MSMEs has performed outstandingly well and enabled the country to attain a wide
measure of industrial growth and diversification. By its nature of being less capital
intensive and more labor intensive, the sector has made significant contributions to
employment generation and also to rural industrialization. This sector is ideally suited to
build on the strengths of traditional skills and knowledge, by infusion of technologies,
capital and innovative marketing practices.

12. The opportunities of growth in the MSME sector are extensive due to the following
attributes, which makes it a more attractive investment option:
Less Capital Intensive
Extensive Promotion & Support by Government
Reservation for Exclusive Manufacture by small scale sector
Project Profiles
Funding - Finance & Subsidies
Machinery Procurement
Raw Material Procurement
Manpower Training
Technical & Managerial skills
Tooling & Testing support
Reservation for Exclusive Purchase by Government
Export Promotion
Growth in demand in the domestic market size due to overall economic growth
Increasing Export Potential for Indian products

13. Key Challenges and Hindrances faced by MSMEs

14. Key Government Schemes and Initiatives launched to support MSMEs
An overview of government support listed below:
Incubation Support Schemes –
 Technology Incubation and Development of Entrepreneurs (TIDE) Scheme –
The scheme aims to support institutes of higher learning to strengthen their
Technology Incubation Centers so as to nurture technology MSMEs, especially start-
up companies. Key initiatives undertaken by the Host institute includes mentoring,
infrastructure and financial support, entrepreneurial training, IPR facilitation,
initiate contact with AIs/VCs, etc. Host institute/TIDE center receives financial
support from government up to INR 155 lakhs. These funds can be used for
improvement in infrastructure - up to INR 30 lakhs and for providing financial
support to the incubating companies – INR 125 Lakhs (@ INR 25 lakhs per
company).
 Support for Entrepreneurial and Management Development of SMEs through
Incubators-
The Scheme aims to provide early stage funding for nurturing innovative business
ideas in select fields including electronics and software. Under this scheme, financial
assistance is provided for setting up of business incubators. The objective of the
scheme is to promote development of knowledge based innovative start-ups and
improve the competitiveness and survival ability of the MSMEs. Under this scheme,
Business Incubators (BIs) are to be set up under Technology (Host) Institutions
which are normally the Indian Institutes of Technology (IITs), National Institutes of
Technology (NITs), engineering Colleges, Technology Development Centers, etc.
Each BI is expected to support incubation of 10 new ideas/units. Each BI is given
financial assistance between INR 4 lakh to INR 8 lakh per idea/unit subject to an
overall cap of INR 62.5 lakh per incubator. The Scheme is implemented in a Public
Private Partnership (PPP) mode with private participation ranging b/w 15 % to 25
%. This scheme has been successful as more than 80 ideas have already been
commercialized under the scheme, with a majority being in the IT space.
 Technology Development Board –
GOI set up TDB to provide financial assistance to the industrial concerns and other
agencies undertaking development and commercial application of indigenous

15. technology or adapting imported technology for wider domestic application. TDB a)
provides financial assistance to research and development institutions b) pprovides
financial assistance to Venture Capital Funds for assisting technology MSMEs c) provides grants
to Technology Business Incubators in IITs/Labs/ Institutions for giving loans/equity support to
small technology start-ups d) provides loans and grants to Labs/Institutions/ Indian Companies
to co-develop and commercialize technologies of national importance.
 Business Development & Promotion / Marketing Support Schemes–
Since most SMEs do not have easy access to capital and have to invest a larger
amount of their funds in production activities, they do not have any surplus funds
left for marketing activities.
Moreover, even with availability of funds, the importance of marketing is not
recognized by majority of them. Thus, the government provides special schemes
wherein SMEs are specially provided assistance solely for their marketing activities.
Some of the schemes provided by the Government are listed below-
 Scheme to Promote International Cooperation –
This scheme offers assistance to MSMEs for exploring new areas of technology
infusion/up gradation and identifying new markets through Joint ventures and
foreign collaborations.
Financial assistance up to 95% of airfare and space rent is provided to
entrepreneurs to participate in international exhibitions, trade fairs and buyerseller
meets in foreign countries and India.
 Marketing Assistance Scheme
It offers assistance to MSMEs for undertaking marketing promotion activities. Under
the scheme, MSMEs can avail financial assistance for organizing exhibitions, trade
fairs, buyer-seller meets and other marketing promotion events.
 MSME Market Development Assistance Scheme
It offers financial assistance to MSMEs for using Global Standards in bar coding. The
scheme also provides funding to MSMEs for participation in the international
exhibitions / fairs, producing publicity material and sector specific studies and for
contesting antidumping cases.
 Information Assistance-
Ministry of MSME launched ‘Udyami helpline’ in 2010. This call center acts as a
single-point facility for a wide spectrum of information and accessibility to banks

16. and other MSME-related organizations. It also gives information on a wide range of
subjects, including guidance on setting up a unit, access loans from banks, project
profiles and about various MSME schemes.
Manufacturing Support Schemes–
 Lean Manufacturing Competitiveness for MSMEs
It aspires to enhance the manufacturing competitiveness of MSMEs through the
application of various Lean Manufacturing (LM) techniques. Under this scheme,
manufacturing MSMEs can receive financial assistance up to 80% of the cost from
the GOI on the implementation of lean manufacturing techniques.
 Enabling Manufacturing Sector to be Competitive through Quality
Management Standards and Quality Technology Tools –
This scheme seeks to encourage MSMEs to understand and adopt latest Quality
Management Standards (QMS) and Quality Technology Tools (QTT) in the
manufacturing process.
MSME Amendment Bill, 2015
The Ministry of Micro, Small and Medium Enterprises Development (Amendment) Bill,
2015 envisages to (i) enhance the existing limit for investment in plant and machinery
considering changes in price index and cost of inputs consistent with the emerging role of
the MSMEs in various Global Value Chains, (ii) include medium enterprises apart from
small enterprises in section 7(9) to enable the aforesaid category of enterprises to avail the
benefits and become competitive, and (iii) empower the Central Government to revise the
existing limit for investment, by notification, considering the inflation and dynamic market
situation.
As per Micro, Small and Medium Enterprises Development (Amendment) Bill, 2015, the
investment limit prescribed for Micro, Small and Medium Enterprises (MSMEs) in the
country, is proposed as under:

17. Manufacturing enterprises:
i. Micro enterprise: Investment in plant and machinery does not exceed fifty lakh
rupees
ii. Small enterprise: Investment in plant and machinery is more than fifty lakh rupees
but does not exceed ten crore rupees.
iii. Medium enterprise: Investment in plant and machinery is more than ten crore
rupees but does not exceed thirty crore rupees.
Service enterprises:
i. Micro enterprise: Investment in equipments does not exceed twenty lakh rupees.
ii. Small enterprise: Investment in equipments is more than twenty lakh rupees but
does not exceed five crore rupees.
iii. Medium enterprise: Investment in equipments is more than five crore rupees but
does not exceed fifteen crore rupees.
Rehabilitation Policy Framework for Sick MSME Units
The Reserve Bank of India has come up with a revised framework for revival and
rehabilitation of Micro, Small and Medium Enterprises so that incipient sickness can be
detected by banks in the units and a corrective action plan can be set in motion for them.
The revised framework, which supersedes RBI’s earlier guidelines on rehabilitation of sick
micro and small enterprises, is applicable to MSMEs having loan limits up to ₹25 crore,
including accounts under consortium or multiple banking arrangement.
Corrective action plan (CAP) may include rectification. The RBI said before a MSME turns
into a non-performing asset, banks should identify incipient stress in the account by
creating three sub-categories under the special mention account (SMA). Under the SMA-0
sub-category, principal or interest payment is not overdue for more than 30 days but
account showing signs of incipient stress; SMA-1 (principal or interest payment is overdue
between 31-60 days); and SMA-2 (principal or interest payment is overdue between 61-90
days).
On the basis of these early warning signals, the branch maintaining the account should
consider forwarding the stressed accounts with aggregate loan limits above ₹10 lakh to the
Committee (for Stressed Micro, Small and Medium Enterprises) within five working days
for a suitable corrective action plan (CAP). Forwarding the account to the Committee for
CAP will be mandatory in cases of accounts reported as SMA-2.
As regards accounts with aggregate loan limits up to ₹10 lakh identified as SMA-2, the
account should be mandatorily examined for CAP by the branch itself under the authority

18. of the branch manager / such other official as decided by the bank in terms of their Board
approved policy. However, the cases, where the branch manager / designated official have
decided the option of recovery under CAP instead of rectification or restructuring, should
be referred to the Committee for their concurrence.
Any MSME borrower may voluntarily initiate proceedings under this revised framework, if
the enterprise reasonably apprehends failure of its business or its inability or likely
inability to pay debts or there is erosion in the net worth due to accumulated losses to the
extent of 50 per cent of its net worth during the previous accounting year, by making an
application to the branch or directly to the Committee. When such a request is received by
the lender, the account with aggregate loan limits above ₹10 lakh should be referred to the
Committee. The Committee should convene its meeting at the earliest but not later than
five working days from the receipt of the application, to examine the account for a suitable
CAP.
The accounts with aggregate loan limit up to ₹10 lakh may be dealt with by the branch
manager / designated official for a suitable CAP. The RBI said the Board approved policy to
operationalize the framework may be put in place by the banks not later than June 30,
2016.
EASE OF DOING BUSINESS –India
India is one of the fastest growing economies in the world. The high potential of the Indian
market driven by an emerging middle class, cost competitiveness and a huge pool of talent
makes it one of the most attractive investment destinations. Yet, according to the World
Bank’s ‘Doing Business 2014’ report, India is ranked 134 out of 189 countries in the overall
ease of doing business. This places India lower than the other BRICS (Brazil, Russia, India,
China and South Africa) members and highlights its relatively poor performance among
other South Asian countries.

19. In the World Bank survey, India ranks lowly on most of the determinants of investment
attractiveness — especially starting a business, enforcing contracts, dealing with
construction permits and paying taxes. Problems in securing land, inadequate
infrastructure, power shortages, stringent labour laws, tax regulation, lack of governance
and transparency and approval processes are critical issues in the country that need to be
addressed.

20. An MSME Perspective
The manifest capacity of Micro, Small and Medium Enterprises (MSMEs) around the world
for driving economic growth and development at regional, national and global levels
cannot be overemphasized. As India gears up to retrace the high growth path, the MSME
sector assumes a pivotal role in driving the growth engine. The MSME sector in India
continues to demonstrate remarkable resilience in the face of adverse global and domestic
economic circumstances.
The sector has sustained an annual growth rate of over 10% for the past few years. With its
agility and dynamism, the sector has shown admirable innovativeness and adaptability to
survive economic shocks, even of the gravest nature. The significance of MSMEs is
attributable to their caliber for employment generation, low capital and technology
requirement, promotion of industrial development in rural areas, use of traditional or
inherited skill, use of local resources, mobilization of resources and exportability of
products. According to the estimates of the Ministry of MSME, Government of India, the
sector generates around 100 million jobs through over 46 million units situated throughout
the geographical expanse of the country.
With 38% contribution to the nation’s GDP and 40% and 45% share of the overall exports
and manufacturing output, respectively, it is easy to comprehend the importance of the role
they play in social and economic restructuring of India. Besides the wide range of services
provided by the sector, the sector is engaged in the manufacturing of over 6,000 products
ranging from traditional to hi-tech items.
The Government has recently taken some concrete steps to address the issues faced on
each of the parameters so as to improve the ‘ease of doing businesses’ in the country. The
Government is targeting to move to the top 50 in the ‘Ease of Doing Business’ rankings.
Role of Make in India initiative towards “Ease of doing Business”- FOCUS OF MSME’s
The ‘Make in India’ initiative, launched by the honorable Prime Minister in September
2014, aims to facilitate investment, foster innovation, provide employment, enhance skill
development and build manufacturing infrastructure in the country. The real objective of
this strategy is to ease the investment caps and controls to open up India’s industrial
sectors to global participation. This initiative also applies to MSMEs and relates to the
various relevant departments which have been entrusted with the task of simplifying the

21. rules for MSMEs. The ‘Make in India’ initiative invites global firms to set up manufacturing
units in the country.
This is expected to give a solid boost to the MSMEs especially in sectors such as
automobiles, aviation, defense manufacturing, construction, chemicals and food processing
among others.
The effort is to get global companies to manufacture goods for the Indian market as well as
export them to third countries. India must become a manufacturing powerhouse in order
to gainfully employ its demographic dividend. Its natural advantages like a big labor pool
and a large domestic market are available enablers. In addition, China’s competitive
advantage in terms of cost is fast eroding, being only marginally better than other
developed countries. India has the opportunity to take some share of global manufacturing
away from China. This would be possible only if the prevalent process inefficiencies are
addressed through—improved infrastructure, ease of doing business, rationalized tax
policies, reform labor laws, and enhanced skills, ease of land acquisition,implement Goods
and Services Tax (GST) and fast track approvals.
The "Make in India" initiative, will act as a first reference point for guiding foreign investors
on all aspects of regulatory and policy issues, as also assist them in obtaining regulatory
clearances. The Centre has already allowed 100% Foreign Direct Investment (FDI) under
the automatic route in construction, operation and maintenance in rail infrastructure
projects and increased FDI in defense from 26 to 49 per cent.

22. State-wise Analysis
The figures indicate the degree of implementation of the 98-point plan of business reforms. The
report goes on to categorize states in four groups based on the results.
Leaders: No states achieved this status. The ‘leaders’ group signifies states which have an overall
implementation of 75 percent and above.
Aspiring Leaders: Seven states are in this group. The ‘aspiring leaders’ group is for states that had
an overall implementation of 50-75 percent.
Acceleration required: Nine states are in this group. This group is for states with 25-50 percent
overall implementation.
Jump start needed: Sixteen states were placed in this group. This is for states with an overall
implementation of 0-25 percent.

24. Impact on MSMEs
Flow of credit to the MSME sector is of paramount necessity for increasing export and
provisions have been made for collateral free loan for an amount of up to Rs 1 crore.
The changed scenario is totally different from the one in which the Indian MSMEs operated
until the early 1990s, where certain products were reserved for manufacturing by SSIs and
market competition was mostly inter-se. While the challenges of change are obvious, it is
now possible for even small firms to acquire a strong competitive position by creating and
offering products and services of superior value to the customers concerning price, quality,
distinctiveness, and so on. However, this competitive advantage requires better
management and performance of the value chain of the enterprise. The changing structure
of the production-distribution system shifts the focus of productivity improvement from
looking exclusively at the organisation’s internal processes to examining the extended
value chain, supply chain and networks of the organisation. The Government programmes
have also to be re-oriented accordingly.
Enhancing Credit to MSME’s: Recognizing the crucial role of bank finance for the MSMEs,
the PM’s Task Force on MSMEs recommended specific and monitorable targets for credit
disbursement by Scheduled Commercial Banks in the Micro and Small Enterprises sector.
Other Measures: In the context of ‘Ease of Doing Business’ and ‘Expanding Business’
phases of a manufacturing enterprise, it is useful to recall some important initiatives of the
government in recent years. Some of the recent initiatives include MSMED Act, 2006;
National Manufacturing Competiveness Programme; and Public Procurement Policy, 2012.

25. CREDIT GUARANTEE FUND TRUST FOR MICRO AND SMALL ENTERPRISES
MSMEs face numerous challenges in accessing capital requirements for their business due
to their inability to provide collateral /third party guarantees, a relatively high interest rate
on the credit facility and intense competition due to globalization.
To overcome a few of these hurdles in the growth of MSE sector, the Credit Guarantee Fund
Trust for Micro and Small Enterprises was set up by the Ministry of MSME, Government of
India and SIDBI (Small Industries Development Bank of India). It was started in the year
2000 and came into force on August 1, 2000. The key objectives of the scheme are: To
provide collateral free loans to small businesses, to give more importance to the viability
and sustainability of the project rather than its ability to provide collaterals / third party
guarantees, and to give composite credit to the borrowers so that the borrowers obtain
both term loan and working capital facilities from a single agency.
This scheme ensures that no eligible proposal is deprived of guarantee cover.
Entrepreneurs having viable business plans are encouraged to make use of this scheme.
Thus, it facilitates the flow of credit to MSE sector and is a major step towards financial
inclusion. Since its inception in 2000, CGTMSE has been quite successful in its purpose and
has increased its outreach considerably. A total of 16,89,492 accounts have been accorded
guarantee approval for Rs. 84,026 Crore as of February 2015. There are more than 100
Money Lending Institutions (under this scheme. More than 10 Lacs units have availed the
services of CGTMSE. Thus, since inception it has been playing a major role in boosting MSE
sector. However, CGTMSE hasn’t been as successful as expected. Though, there has been a
steady growth in guarantee cover, the total coverage is still low.

26. CGTMSE has created awareness among various stakeholders such as banks, MSE
associations, entrepreneurs, etc. of credit guarantee scheme through all possible means. It
has adopted various approaches such as conducting workshops / seminars, meetings,
exhibitions, promotion through online media, posters, electronic and print advertisements
to reach out to beneficiaries of its guarantee scheme.
The main objective is that the lender should give importance to project viability and secure
the credit facility purely on the primary security of the assets financed. The other objective
is that the lender availing guarantee facility should endeavor to give composite credit to the
borrowers so that the borrowers obtain both term loan and working capital facilities from
a single agency. The Credit Guarantee scheme (CGS) seeks to reassure the lender that, in
the event of a MSE unit, which availed collateral free credit facilities, fails to discharge its
liabilities to the lender, the Guarantee Trust would make good the loss incurred by the
lender up to 75 / 80/ 85 per cent of the credit facility.
Fallbacks and challenges:
There are a few shortcomings in the scheme such as, a majority of the budding
entrepreneurs have no knowledge that such a scheme exists. Surprisingly, most of the bank
managers are also not aware of the scheme. Even if they do,
they are not providing required information to the customers regarding the scheme. It
takes a long time for the loans to be sanctioned. The banks these days have targets under
the MSME sector and are very aggressive in lending. Perhaps some extra delegated powers
could hasten up the process of loan sanction. Trade is not covered under CGTMSE scheme.
Loan for only manufacturing and services is available.
The scheme provides for collateral free loan of only up to Rs 100 lakh. Perhaps the
government could think of increasing this limit. Presently, micro, small and medium
enterprises have capital investment (plant and machinery) ceiling of Rs 25 lakh, Rs 5 crore
and Rs 10 crore in manufacturing; and Rs 10 lakh, Rs 2 crore and Rs 5 crore respectively in
service sector. This needs to be revisited as the limits were fixed around 8 years ago. On the
part of the government, they need to visit educational institutes, especially B-schools and
conduct Seminars to popularize this scheme.

27. FINANCING MSME’S IN INDIA
Finance is life blood of any enterprise. But Indian MSMEs have always suffered the
deficiency of this life blood, despite India having one of the most extensive banking
networks in the world.
The present domestic 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. The cost of credit in the Indian
MSME sector is higher than its international peers.
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 Government is taking proactive measures to ensure better access to credit. Bank
lending to the sector will grow at a rate of 20 per cent on a year-on-year (y-o-y) basis, along
with 10 per cent annual growth in number of micro enterprise accounts, with 60 per cent
of the share of MSME credit directed towards micro enterprises. These and various other
measures ensure that credit flow to the sector, especially micro and small enterprises, is
adequate.
In spite of these measures banks are reluctant to lend to MSMEs due to their higher risk
profile owing to zero collateral or their limited years of operations. Indian firms raised
about 47 per cent of their total funding from internal sources, 19 per cent from banks and
financial institutions (FIs), and 5 per cent from capital markets. The remaining 29 per cent
came from alternative sources.
When it comes to MSME, only 15 per cent of funding came from internal sources, 25 per
cent from banks and FIs, and 10 per cent from capital markets. Around 50 per cent of
the funding has been sourced through alternative funding sources including friends and
family, trade credit etc.
These alternative sources are far more expensive and are dependent on prevailing market
conditions and are rarely a guaranteed source. This clearly implies that MSMEs face a
demand and supply gap.

28. MSME Financing: Demand and Supply Gap
The present situation does not offer enough opportunities for the MSMEs to raise low cost
funds. However, the Government is taking proactive measures to guarantee better access to
credit. Despite this, banks are reluctant to lend to MSMEs as a result of high risk profile of
the segment.
The present domestic 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. The cost of credit in the Indian
MSME sector is higher than its international peers.
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 Government is
taking proactive measures to ensure better access to credit. Bank lending to the sector will
grow at a rate of 20 per cent on a year-on-year (y-o-y) basis, along with 10 per cent annual
growth in number ofmicro enterprise accounts, with 60 per cent of the share of MSME
credit directed towards micro enterprises. These and various other measures ensure that
credit flow to the sector, especially micro and small enterprises, is adequate.
Indian firms raised about 47 per cent of their total funding from internal sources, 19 per
cent from banks and financial institutions (FIs), and 5 per cent from capital markets. The
remaining 29 per cent came from alternative sources.
When it comes to MSME, only 15 per cent of funding came from internal sources, 25 per
cent from banks and FIs, and10 per cent from capital markets. Around 50 per cent of the
funding has been sourced through alternative funding sources including friends and family,
trade credit etc. These alternative sources are far more expensive and are dependent on
prevailing market conditions and are rarelya guaranteed source. This clearly implies that
MSMEs face very high interest cost due to the lack of availability of adequate credit.
The reasons that are keeping banks away from financing MSMEs are the high transaction
cost and NPA. These factors have made commercial banks to perceive that lending to MSME
sector is non profitable lending. One of the reasons attributed for low profits by public
sector banks is lending to priority sector at lower rates of interest. But as per the studies in
other countries, lending to this sector is a lucrative banking activity.

29. Finance Demand
MSMEs have a very high demand for finance, large part of which is not met, particularly,
debt, to finance their growth. There is a total financial requirement of Rs. 32, 50,000 crore
(US$ 650 billion) in the MSME sector, which comprises Rs. 26, 00,000 crore (US$520
billion) of debt demand and Rs. 6, 50,000 crore (US$ 130 Billion) of equity demand.
However, the viable and addressable debt demand is estimated to be Rs. 9, 90,000 crore
(US$ 198 billion), which is 38 percent of the total debt demand. This excludes (a) sick
enterprises, (b) new enterprises (those with less than a year in operation), (c) enterprises
rejected by financial institutions, and (d) micro enterprises that receive finance from the
informal sector.
The viable and addressable equity demand is estimated to be Rs. 67,000 crore (US$ 13.4
billion), that does not include (a) entrepreneurs’ equity contribution to enterprises
estimated at Rs. 4,60,000 crore (US$ 92billion), and (b) equity demand from micro and
small enterprises that are structured as proprietorships or partnerships. Proprietorships
and partnership are unable to absorb equity from external sources although equity demand
from these firms is estimated to be about Rs. 1,23,000 crore (US$ 24.6 billion).
Formal sources of funding are able to serve only around 25 per cent of total MSME debt
financing. Of overall funding requirement in the sector, only 78 per cent, that is around Rs.
25, 50,000 crore (US$ 510 billion) is either financed by the promoter or from informal
sources. Further, formal sources account for only 22 per cent or Rs. 7, 00,000 crore (US$
140 billion) of the total MSME debt financing.
Additionally, Banks contribute for more than 85 per cent of debt supply to the MSME
sector, with Scheduled Commercial Banks lending Rs. 5,90,000 crore (US$ 118 billion).
Non-Banking Finance Companies (NBFCs) and smaller banks such as Regional Rural Banks
(RRBs), UrbanCooperative Banks (UCBs) and government financial institutions (including
State Financial Corporation and State Industrial Development Corporations) constitute the
balance of the formal MSME debt flow. Within the informal financial sector non-
institutional sources of funding include family, friends, and family businesses while
institutional sources consist of money lenders and chit funds.

30. Finance Gap
Even though funding for MSMEs has witnessed a surge, there is still a significant
institutional finance gap of Rs. 20, 90,000 crore. Excluding the debt finance that accounts
for 62 per cent of overall financing demand and the equity demand, there still exists a
demand-supply gap of Rs. 3,57,000 crore which can be funded by formal financial
institutions in the near term.
This is the demand-supply gap for approximately 11.3 million enterprises. While a large
number of these already receive some form of formal finance, they are significantly
underserved with only 40-70 per cent of their demand currently being met.
However, if Government intervenes and implements proper policies and support to the
MSME sector, a considerable part of the currently excluded demand can be made
financially viable for the formal financial sector.
Micro and small enterprises together account for 97 percent of the viable debt gap and can
be addressed by financial institutions in the near term. Available data and primary
interviews indicate that medium enterprises in India are relatively self-financed.
The equity gap in the sector is a combined result of demand-side challenges such as the
legal structures of enterprises, as well as supply-side gaps, such as a lack of investment
funds focused on MSMEs. The equity requirements for the MSME sector are majorly
concentrated in the growth-stage.

31. Gap – By Geography and Segment
When the MSME sector in India is closely observed, it signifies that the entities spread
across the Low-Income States (LIS) have 32.6 per cent of India’s total MSMEs, the viable
debt gap is disproportionately high at Rs. 1,93,000 crore (US$ 38.6billion), which is 66 per
cent of the country’s total. On the other hand, only 3 per cent MSMEs based in the North-
Eastern States accounts for a viable debt gap of Rs. 9,000 crore, whereas the rest of India
accounts for the remaining 65 per cent of MSMEs, with a viable and addressable debt
supply gap of Rs. 90,000 crore (US$ 18 billion) or 31 percent.
Segment-wise, there is more service sector MSMEs in India than manufacturing units.
Service sector MSMEs constitute for 71 per cent of total entities, whereas manufacturing
sector accounts for mere 29 per cent.
However, manufacturing enterprises are more capital intensive with longer working
capital cycles and consequently have higher working capital requirements. Therefore,
nearly 60 per cent of MSME demand for finance arises from the manufacturing sector.

32. Financing options available to MSMEs
Scheduled Commercial Banks
Conventionally, banks have been the largest source of finance for SMEs. Amongst
commercial Banks, Public Banks have a better access to MSMEs and take the lead in lending
to the sector, as compared to private and foreign Banks. Public sector Banks have been the
front-runners in providing financial support to the MSMEs which can approach them for
loans under various schemes. Public sector banks also have considerable empirical
knowledge of the MSME sector, and with the increased use of core banking technology,
they are able to analyze historical data on MSMEs to develop targeted products and better
risk management techniques.
However, Banks have also aimed at limiting their exposure due to high risk perception and
high transaction costs. Credit is usually extended against collateral equivalent to 100% of
the loan amount. Majority of the MSMEs, especially those in the early / start-up stage do
not have sufficient assets to offer as collateral for lending, thereby making the banking
system inaccessible to them.
Further, Banks appraise loan proposals based on the financial ratios of the MSME. As
majority of the MSMEs do not follow proper accounting processes, the task of generating
clean financial statements becomes quite difficult.
SMEs are part of the priority sector lending for banks along with agriculture, rural markets
and microfinance. As per RBI guidelines, priority sector lending should be 40% of the total
credit lending of banks. However, there are no sub-targets within the priority sector
lending requirements. This has limited the quantum of credit which banks have extended
to MSMEs.
Non-Banking Finance Companies
NBFCs have also been a significant source of MSME debt. Large share of the funding is for
purchase of asset / plant & machinery. Major share of the loan portfolio comprises of
business related to transport, engineering, vendor supply chains and retail trade. According
to Frost & Sullivan, the MSME Small Loan Credit Market for NBFCs in India stood at INR
7,200 crores in FY 2012 and is expected to grow to INR 38,400 crores by FY 2020 at a
compounded growth rate of 23 %.

33. Small Banks
Small banks such as RRBs, UCBs and government financial institutions such as SFCs, SIDCs
enjoy significant branch outreach, and have been able to leverage their local presence to
get better knowledge and understanding of MSME financial needs. Small Banks have also
exhibited the potential to serve a much larger MSME customer base than they are currently
serving. It was felt that the risk-averse lending practices of banks were hindering credit
disbursal to the MSME sector. In order to counter this, the RBI allowed collateral-free
lending up to a limit of INR 5 lakh for all enterprises covered under the definition of the
MSMED Act 2006.
Further, in an effort to minimize the impact of default on loans, the GOI and SIDBI launched
the Credit Guarantee Trust for MSMEs. The CGTMSE aims to comfort the financier that in
the event of MSME default (which availed collateral-free credit facilities), the Guarantee
Trust will make good the loss by up to 75 to 85% of the credit availed.
Equity funding
Venture capital provides financial assistance primarily by way of equity or equity-linked
capital investment. Typically, MSMEs which are involved in commercializing innovations
and high-end technologies need access to the VC fund. These firms need finance during the
initial stages of conceptualizing their product offerings (seed phase) and during
development and marketing phase. Besides infusing capital, VCs also bring expertise,
superior advice and other skills that help the MSME to develop marketable products.
They also seek to provide overall guidance and mentoring support to MSMEs so as to
enable them to realize their growth potential and gain competitive edge in both domestic
and global markets. Typically, the VC provides assistance to the entrepreneur in recruiting
key personnel, providing contacts in international markets, introductions to strategic
partners, etc. Their main aim is to earn higher returns on their investments.
In addition to that, they also take active part in the management of the company and
provide expertise / involve in the board decisions of the firm. Furthermore, VC funding
improves the credibility of the MSME and increases the chances of receiving Bank finance.

34. SME exchange
GOI and regulators have initiated several measures to address the low level of MSME
financing through the capital markets. In March 2012, post issuance of SEBI guidelines,
both BSE and NSE have set up institutional trading platforms in the SME segment to allow
MSMEs to list and raise equity capital through venture funds, private equity and wealthy
individuals, without initial public offerings.
The listing process in this platform can be completed within a month and this also involves
lower costs compared to regular IPO route. Besides offering a suitable platform to raise
capital, it also provides easier entry and exit options for investors. It also offers better
visibility and wider investor base while offering tax benefits to long term investors. The
platform offers relaxed compliance and cost effective listing to SMEs.
Since this facility involves minimum regulatory procedures to be followed, it has already
encouraged a host of MSMEs to tap the BSE’s SME platform. A total of 70 companies with a
collective market capitalization of Rs.8,200 crore now trade on these platforms. There
companies are from various sectors like trading, manufacturing, steel, textile and finance
spread across the geography of India. (CHECK THE FIGURES. I THINK THEY ARE HIGHER)
Export lines of credit
This financing option supports export oriented segments such as leather, gems and jewelry,
etc. EXIM Bank has launched several initiatives for the benefit of such exporters - Export
lines of credit to overseas financial institutions, regional development banks and foreign
governments and their agencies and buyers credits (BC) to foreign corporates.
Line of credits serve as a market-entry mechanism to Indian exporters and provide a safe
mode of non-recourse financing option to Indian exporters. LOCs and BCs are particularly
relevant for Indian MSME exporters as the payment risk is borne by Exim Bank without the
need for insurance from Export Credit Guarantee Corporation.
Microfinance
Leading national financial institutions like the SIDBI, the NABARD and the Rashtriya Mahila
Kosh (RMK) have played a significant role in making micro-credit an important movement.
These groups also adopt a variety of approaches. However, most of these organizations
tend to operate within a limited geographical range.

35. Electronic bill factoring exchange
In a recent move, RBI permitted the setting up of an exchange-based trading platform
(Trade Receivables Discounting System) to facilitate financing of bills /invoices raised by
MSMEs to corporate buyers including government departments and PSUs. This initiative
was taken to make the MSMEs capable of converting their trade receivables into liquid
funds.
Despite the many policies and measures to provide financial assistance to the MSMEs, they
continue to face difficulties in raising timely and adequate credit at reasonable cost. This
has led to the emergence of alternative sources of financing, some of which have been
detailed below.
Factoring
Under this mode of finance, the MSME sells or assigns its accounts receivables to a finance
company (a factor) at a discount to meet its immediate funding requirement. This method
of financing evolved so as to minimize the adverse effect of delayed payments by large scale
customers on the operations of MSMEs. Factors buy the right to collect on invoices raised
against any sales by the MSME and releases 80-90% of the invoice value to the firm. The
Indian factoring market is still at a nascent stage. There are approximately 10 factoring
companies in India, and the oldest among them are Canbank factors and SBI Global Factors.
Supply chain finance
Supply chain finance is fast emerging as another route to facilitate MSMEs access to
enhanced working capital from bank and non-bank sources. This mode of financing enables
MSMEs, which are suppliers to large OEMs to receive short-term credit against the volume
supplied during the payment receivable period.

36. Receivable Financing
It is the devised scheme by SIDBI to mitigate the receivables problem of suppliers
belonging to Micro, Small and Medium Enterprises (MSMEs) and improve their cash flow /
liquidity.
The scheme helps the MSMEs in
 Quicker realization of receivables.
 Discounting at competitive rates.
 Efficient Cash Management.
How does it work?
SIDBI helps mitigate the problem of delayed payments to MSMEs in respect of their credit
sales to large purchaser companies by offering them finance against bills of exchange /
Invoices arising out of such sales.
What is the Scope of Coverage?
The scheme covers discounting of bills of exchange/invoices arising out of sale of
indigenous components / parts / sub-assemblies /accessories /intermediates by an MSME
unit. Services provided by an enterprise in the services sector (eligible service provider) to
a Purchaser Company are also covered.
Description of Transactions under the Scheme
Limits are sanctioned to well-performing Large Corporates / Purchaser Companies with
sound financials for covering their purchases of components / sub-assemblies / parts /
accessories and services obtained from MSMEs and MSME sellers for early realization of
dues from large Corporates by discounting the bills

37. i. MSME suppliers draw Bills of Exchange on Purchaser companies against supplies
made/ services provided by them and the Bills of Exchange are accepted by the
Purchaser companies.
ii. Whereverbill of exchange is not furnished by the large Corporates, based on
acceptance on the Invoices and proof of delivery challan/ Goods Received Note,
discounting is done as per agreed terms between the Corporates and SIDBI.
iii. On a selective basis, in respect of large Corporates, with good repayment track
record with SIDBI, a platform has been created with NSE viz. NTREES where, E-
discounting is allowed.
iv. These Bills/ Invoices are discounted by SIDBI within the sanctioned limit and
payment effected (after deducting the applicable discount / retaining the retention
margin) directly by way of RTGS / NEFT to the working capital account of the MSME
supplier/ service provider.
v. On the due date, the Purchaser makes payment to SIDBI either through RTGS or by
cheque.
vi. The limits are reviewed / renewed every year.
Cash flow Management
According to a World Bank Group report released in January 2014, 35 percent or one in
three MSMEs receive payment only after 90 days or more. While larger corporations can
alleviate the adverse effects of delayed payment, managing cash flows is a struggle for
MSMEs due to the nature of their businesses. The consequence of delayed payments is that
at any given point in time, 15-20 percent of an MSME's cash flow remains locked up - or not
liquid - which in turn affects their business.
Manufacturers face the biggest difficulty. They need to invest in raw materials,
manufacture goods, and sell them to customers. Manufacturers, who have already invested
substantially in buying raw materials for production, end up with a huge cash crunch due
to the 90-120-day cycle for cash receivables and subsequent delays by their customers.
Also, they are hampered by weak bargaining power as they juggle between corporate
buyers and a highly networked raw material supplier base.
In the services sector similarly, small firms that have limited cash and cater to large
corporate entities do not get funds before 45-60 days, despite billing on a monthly cycle.
This limits the ability of small business owners to add value, seek new clients and upgrade
technologies. While the cash flow situation is bleak for MSMEs at present, the recent
announcement by Union Minister for MSMEs Shri Kalraj Mishra about the constitution
of Micro and Small Enterprises Facilitation Councils (MSEFCs) to enable quick adjudication
and disposal of delayed payment cases is a welcome move.

38. Recommendations Suggestions on MSME Credit & Finance
1. The corpus under the Credit Guarantee Fund Trust for Micro and Small
Enterprises (CGTMSE) can be increased to benefit higher number of MSMEs by
offering them collateral free credit.
2. RBI-registered ‘AAA’ and ‘AA+’ rated NBFCs should be made eligible for
becoming Member Lending Institution of CGTMSE, subject to availability of
additional corpus of CGTMSE.
3. SIDBI to play a pivotal role in developing and promoting specialized instruments
that augment the access to credit for the MSMEs. Additionally, special exercises
should be undertaken for meeting the credit gap in the MSME sector. In this
regard, modifications in the existing CGSTMSE scheme can be debated to ensure
a wider coverage, Banks can be directed to make fuller use of CGTMSE
dispensation and collaboration can be sought with other relevant institutions in
the state government and Development Institutes of Ministry of MSME so as to
reach out to needy MSME units with credit offers.
4. RBI should firmly enforce its guidelines to Banks for not seeking collateral up to
a loan of INR 100 lakhs. This will reduce the tendency to seek security, which is a
foremost deterrent to fostering entrepreneurship.
5. Banks to simplify loan application forms and establish a common Scoring Model
for loan up to INR 25 lakh.
6. The banks should issue directives to further enhance the awareness of CGS
amongst its branch level functionaries in different parts of the country for
securing greater coverage of MSME loans under CGS.
7. Banks should educate and clearly specify there requirements for assessing a loan
proposal, i.e. what information they require from MSMEs, what essentially they
look for while assessing a loan proposal and how they will be convinced.

39. 8. Banks should create separate cells to provide consultancy to MSMEs to impart
learning on data / information management so that their performance can be
analyzed easily and thus expediting the loan sanctioning process.
9. Bank to establish robust credit evaluation systems and invest in training and
development of loan officers. Additionally, proper credit evaluation systems /
frameworks should be developed so as to ensure that valid due diligence checks
are done with no scope for personal biases in assessment of loan proposals from
MSMEs.
10. State level Public Procurement Policy must be launched.
11. A monitoring mechanism should be put in place to monitor the effective
implementation of the Public Procurement Policy.
12. The District Industry Centers should ensure the provision of continuous power
supply to MSMEs to facilitate smooth operation.
13. Incubation Centers should be developed to assist MSMEs with marketing
operations and acquisition of knowledge and technical know-how.
14. Sector Specific industrial zones must be developed in various locations with 50%
space allocated to MSME with world class infrastructure & connectivity & other
facilities like banks, insurance etc.
15. A Bankruptcy Code must be developed specifically for MSMEs to facilitate
compliances with respect to banking requirements, statutory dues, etc. and to
make the ecit of MSMEs speedy and easy.
16. A single window nodal agency may be set up to address all approvals and
clearances to MSMEs in a time-bound manner.
17. MSMEs should be allowed a special dispensation from various compliances
related to taxation, labour laws, etc. for an initial period of 3 years to remove
hurdles in their growth.
18. In order to encourage technology upgradation in MSMEs, the cost incurred for
technology upgradation, including acquiring new technologies and that for
protection of IPR, shall be excluded from the monetary limit of respective
sectors, once in 10 years.

40. Contemporary MSMEs
Financial Needs and Solutions
Mr. U. K. Joshi
Director, ASSOCHAM
Introduction
Indian economy is dominated by a vibrant set of enterprises, which are prestigiously known as
MSMEs for their scale of operations. Only 1.5 million MSMEs are in registered segment while
the remaining 24.5 million that constitute 94% of the units are in unregistered segment. The role
of MSMEs in economic and social development of country is widely acknowledged. They are
nurseries for entrepreneurship, often driven by individual creativity and innovation contributing
significantly towards country’s GDP, manufacturing output exports and employment generation.
Finance – The Essential Need
Bank lending is the most common source of external finance for many MSMEs and
entrepreneurs, which are often heavily reliant on straight debt to fulfill their start-up, cash flow
and investment needs. While it is commonly used by small businesses, however, traditional bank
finance poses challenges to SMEs and may be ill-suited at specific stages in the firm life cycle.
There are limitations of traditional debt financing for responding to the different financing needs
that SMEs encounter along their life cycle, and for sustaining the most dynamic enterprises. In
particular, debt financing appears to be ill-suited for newer, innovative and fast growing
companies, with a higher risk-return profile. The “financing gap” that affects these businesses is
often a “growth capital gap”. Substantial amounts of funds might be needed to finance projects
with high growth prospects, while the associated profit patterns are often difficult to forecast.
The financing constraints can be especially severe in the case of start-ups or small businesses
that rely on intangibles in their business model, as these are highly firm-specific and difficult to
use as collateral in traditional debt relations. Yet, for most enterprises, there are few alternatives
to traditional debt. This represents an important challenge for policy makers pursuing sustainable
recovery and long-term growth, since these companies are often at the forefront in job creation,
the application of new technologies and the development of new business models. While
alternatives to traditional debt finance are particularly important for start-ups, high-growth and
innovative SMEs, the development of alternative financing techniques may be relevant to the
broader population of SMEs and micro-enterprises. Capital gaps exist also for companies
seeking to effect important transitions in their activities, such as ownership and control changes,
as well as for SMEs seeking to de-leverage and improve their capital structures. The thin
capitalisation and excessive “leverage” (excessive reliance on debt financing compared to
equity) impose costs, as loans to companies that already have considerable amounts of debt tend
to have higher interest rates, and increase the risk of financial distress and bankruptcy.

41. The long-standing need to strengthen capital structures and to decrease dependence on borrowing
has become more urgent, as many firms were obliged to increase leverage in order to survive the
recent economic and financial crisis. Indeed, the problem of SME over-leveraging may have
been exacerbated by policy responses to the crisis, which tended to focus on mechanisms that
enabled firms to increase their debt (e.g. direct lending, loan guarantees). At the same time,
banks in many countries have been contracting their balance sheets in order to meet more
rigorous prudential rules. While bank financing will continue to be crucial for the SME sector,
there is a broad concern that credit constraints will simply become “the new normal” for SMEs
and entrepreneurs. It is therefore necessary to broaden the range of financing instruments
available to SMEs and entrepreneurs, in order to enable them to continue to play their role in
investment, growth, innovation and employment.
Alternative Financing Instruments
Asset-based finance
Asset-based finance, which includes asset-based lending, factoring, purchase-order finance,
warehouse receipts and leasing, differs from traditional debt finance, as a firm obtains funding
based on the value of specific assets, rather than on its own credit standing. Working capital
and term loans are thus secured by assets such as trade accounts receivable, inventory,
machinery, equipment and real estate. The key advantage of asset-based finance is that firms
can access cash faster and under more flexible terms than they could have obtained from a
conventional bank loan, regardless of their balance sheet position and future cash flow
prospects. Furthermore, with asset-based finance, firms that lack credit history, face
temporarily shortfalls or losses, or that need to accelerate cash flow to seize growth
opportunities, can access working capital in a relatively short time. In addition, asset-based
financiers do not generally require any personal guarantee from the entrepreneur, nor that
s/he give up equity. On the other hand, the costs incurred and/or the complexity of procedures
may be substantially higher that those associated with conventional bank loans, including asset
appraisal, auditing, monitoring and up-front legal costs, which may reduce the firm’s levels of
profits. Also, funding limits are often lower than in the case of traditional debt.
Across OECD countries, and increasingly also in emerging economies, asset-based finance is
widely used by SMEs, for their working capital needs, to support domestic and international
trade, and, partly, for investment purposes. In Europe especially, the prevalence of these
instruments for SMEs is on par with conventional bank lending, and the specific financial
segment has grown steadily over the last decade, in spite of repercussions of the global financial
crisis on the supply side. Through asset-based finance, firms obtain funding based on the value
of specific assets, including accounts receivables, inventory, machinery, equipment and real
estate, rather than on their own credit standing. In this way, it can serve the needs of young and
small firms that have difficulties in accessing traditional lending. Asset-based lending, which
provides more flexible terms than collateralised traditional lending, has also been expanding in

42. recent years, in countries with sophisticated and efficient legal systems and advanced financial
expertise and services.
While asset-based finance is a widely used tool in the SME financing landscape, alternative
forms of debt have had only limited usage by the SME sector, even within the larger size
segment which would be suited for structured finance and could benefit from accessing capital
markets, to invest and seize growth opportunities. In fact, alternative debt differs from traditional
lending in that investors in the capital market, rather than banks, provide the financing for SMEs.
To foster the development of a corporate bond market for SMEs, mainly mid-caps, policy
makers have especially targeted transparency and protection rules for investors, to favour greater
participation and liquidity. Recent programmes have also encouraged the creation of SME
trading venues and the participation by unlisted and smaller companies. In some countries,
public entities participate with private investors to funds that target the SME bond market, with
the aim of stimulating its development.
Alternative external financing techniques for SMEs and entrepreneurs
Trade Credit
Trade credit is also an important source of finance for many SMEs and start-ups, which can
substitute or supplement short-term bank lending. This mainly consists of the extension of
traditional credit instruments and credit-mitigation tools, such as loans and guarantees, to sustain
import and export activities. Guarantees can take the form of letters of credit (L/C), which
represent a bank obligation to pay, thereby reducing an export's payment risk on an
importer/buyer.
Hybrid Instrument
The market for hybrid instruments, which combine debt and equity features into a single
financing vehicle, has developed unevenly in OECD countries, but has recently attracted interest
of policy makers across the board. These techniques represent an appealing form of finance for
firms that are approaching a turning point in their life cycle, when the risks and opportunities of
the business are increasing, a capital injection is needed, but they have limited or no access to
debt financing or equity, or the owners do not want the dilution of control that would accompany
equity finance. This can be the case of young high-growth companies, established firms with
emerging growth opportunities, companies undergoing transitions or restructuring, as well as

43. companies seeking to strengthen their capital structures. At the same time, these techniques are
not well-suited for many SMEs, as they require a well-established and stable earning power and
market position, and demand a certain level of financial skills. In recent years, with the support
of public programmes, it has become increasingly possible to offer hybrid tools to SMEs with
lower credit ratings and smaller funding needs than what would be the practice in private capital
markets. Governments and international organisations mainly intervene through: i) participation
in the commercial market with investment funds that award mandates to private investments
specialists; ii) direct public financing to SMEs under programmes managed by public financial
institutions; iii) guarantees to private institutions that offer SMEs the financial facility and; iv)
funding of private investment companies at highly attractive terms.
Equity Finance
Equity finance is key for companies that seek long-term corporate investment, to sustain
innovation, value creation and growth. Equity financing is especially relevant for companies that
have a high risk-return profile, such as new, innovative and high growth firms. Seed and early
stage equity finance can boost firm creation and development, whereas other equity instruments,
such as specialised platforms for SME public listing, can provide financial resources for growth-
oriented and innovative SMEs.
Factoring
Factoring is a supplier short-term financing mechanism, whereby a firm (‘seller’) receives cash
from a specialised institution (‘factor’), in exchange for its accounts receivable, which result
from the sales of goods or provision of services to customers (‘buyers’). In other terms, the factor
buys the right to collect a firm’s invoices from its customers, by paying the firm the face value of
these invoices, less a discount. The factor then proceeds to collect payment from the firm’s
customers at the due date of the invoices. The difference between the face value of invoices and
the amount advanced by the factor constitute the “reserve account”. This is paid to the seller
when the receivables are paid to the factor, less interest and service fees. Typically, the interest
ranges from 1.5% to 3% over base rate and service fees range from 0.2% to 0.5% of the turnover.
Factoring is thus a transactions funding technology, based on ‘hard’ data, similar to asset-based
lending, as the financing depends on the value of an underlying asset, rather than on the
creditworthiness of the firm. However, it is different from asset-based lending in the following
aspects: i) it involves exclusively the financing of accounts receivable, rather than a broader
range of assets; ii) the underlying asset is sold to the factor at a discount, rather than
collateralised; iii) it is a bundle of three financial services, i.e. a financing component, a credit
component, and a collections component, as in most cases the borrower outsources to the factor
its credit and collection activities.

44. Conclusion
Broadening the finance options available and accessible to SMEs is a key challenge for policy
makers in the quest for fostering their development and sustaining the most dynamic enterprises,
in a credit constrained environment. It also represents a long-term challenge to improving the
SMEs’ capital structure and investment capacity, and reducing their over-reliance – and
vulnerability – to the traditional lending channels.

45. About Resurgent India Ltd
DEBT I EQUITY I ADVISORY
Resurgent India is a full service investment bank providing customized solutions in the areas of debt,
equity and merchant banking. We offer independent advice on capital raising, mergers and acquisition,
business and financial restructuring, valuation, business planning and achieving operational excellence to
our clients.
Our strength lies in our outstanding team, sector expertise, superior execution capabilities and a strong
professional network. We have served clients across key industry sectors including Infrastructure &
Energy, Consumer Products & Services, Real Estate, Metals & Industrial Products, Healthcare &
Pharmaceuticals, Telecom, Media and Technology.
In the short period since our inception, we have grown to a 100 people team with a pan-India presence
through our offices in New Delhi, Kolkata, Mumbai, and Bangalore. Resurgent is part of the Golden
Group, which includes GINESYS (an emerging software solutions company specializing in the retail
industry) and Saraf & Chandra (a full service accounting firm, specializing in taxation, auditing,
management consultancy and outsourcing).
www.resurgentindia.com
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