INTRODUCTION

Small and Medium Enterprises (SMEs) have played a significant role world over in the
economic development of various countries. India, certainly, is no exception. Over a period of
time, it has been proved that SMEs are dynamic, innovative and most importantly, the
employer of first resort to millions of people in the country.
SMEs in India have recorded a sustained growth during last five decades and today, SMEs
have substantial share in industrial production, export and employment. The sector contributes
40 % of the gross value added in manufacturing, around 35 % to direct exports, provide
employment to around 28 million people in the country and is a breeding ground for
entrepreneurship. Keeping in view its importance, the promotion and development of SMEs has
been an important plank in our policy for industrial development and a well- structured
programmed of support has been pursued in successive five-year plans for the promotion and
development of SMEs in the country. India embarked on the path of opening up its economy and
integrating it with the global economy in 1991. The liberalization of economy, while offering
tremendous opportunities for the growth and development of Indian industry including SMEs,
has also thrown up new challenges in terms of fierce competition both in domestic and
international markets. The very rules which provide increased access for our products in the
global market, also put domestic industry under increased competition from other countries,
not only in exports but also in the domestic market. In today’s world, technology, competitive
strength together with benchmarking with the best international standards and practices have
become the drivers of change and accelerated growth. Access on a global basis to modern
technology, capital resources and markets have become the most critical determinants of
international competitiveness. This underscores the need for SMEs to be internationally
competitive in terms of quality, delivery, after-sales service, price, etc. The need of the hour for
Indian SMEs is to upgrade their technology, quality and adopt modern management techniques
to keep pace with the changes that are taking place in the global market. Investment would be a
prerequisite in these areas to bring about transformation. The availability of adequate credit at
affordable cost, thus, becomes critical for Indian SMEs. There exist a well-developed network
of financial institutions at national and state level to channelize credit to SMEs. SIDBI is the
national level principal financial institution for promotion, financing and development of
SMEs. It provides direct assistance to the SSI sector through several schemes like direct
discounting, project finance, assistance for technological up gradation and modernisation,
marketing, finance, resource support to institutions engaged in developing SSIs, venture
capital, factoring services, etc. It also provides indirect assistance comprising refinance, bills
re-discounting (equipment) and against
Inland supply of bills through an organized network of 910 Primary Lending Institutions (PLIs)
including banks and SFCs with more than 65,000 outlets throughout the country. In order to
enhance the flow of credit to the sector, various initiatives have been taken by the Government of
India/Reserve Bank of India from time to time, viz. enhancement of loan limit under
Composite Loan Scheme, increase in project cost limit under National Equity Fund (NEF)
Scheme, launching of Credit Guarantee Fund Trust for Small Industries, extension of
concessional assistance under Technology Development and Modernization Fund Scheme,
introduction of special schemes for modernization of units under Technology Up gradation Fund
Scheme for textiles and jute industries, Tannery Modernization Scheme and Credit Linked
Capital Subsidy Scheme for Technology Up gradation. Further, to give focused attention to the
needs of SSIs, public sector banks have so far opened 391 specialized SSI branches. Last year,
the Government of India has announced that the credit to SMEs would be doubled in the next
five years. Various policy directives and schemes have been announced from time to time
to help improve the credit flow to the sector. The credit rating system for SMEs has recently
been introduced to ensure availability of adequate and timely credit at low cost.
Dedicated agencies for credit rating to SSI sector have been created with a provision of
subsidized credit rating charges. The concept and practice of cluster financing has been brought
into practice. Besides, the RBI has recently allowed banks to appoint business correspondents for
collecting deposits and delivering credits. This could concept and practice of cluster financing
has been brought into practice. Besides, the RBI has recently allowed banks to appoint business
correspondents for collecting deposits and delivering credits. This could decline from 17.5 % in
1998 to 8.5 % in 2006. Lack of credit at reasonable rate has hindered the growth of SMEs in the
past. According to the third All India Census of Small Scale Industries, there are around
11.85 million small scale units in India, out of which, only 1.63 million are registered and rest
are unregistered. Only 14.26 % of the units in registered sector and 3.09 % in unregistered sector
have access to institutional finance. The coverage of institutional finance, thus, is far from
satisfactory. It is no wonder that according to a survey conducted by SSI Ministry in 2003-
04, 48 % of the respondents cited shortage of working capital as at the key reason for
sickness in the industry. Non-availability of acceptable collateral is the major problem at the time
of starting a venture. The problems get further compounded in case of young and women
entrepreneurs. Even though the Government along with SIDBI has set up a Credit Guarantee
Fund Trust for Small Industries (CGTSI), to encourage banks to extend financial assistance to
SMEs without collateral, the banks still seem to be hesitant to extend credit to SMEs. Similarly,
despite a scheme for technology and quality up gradation with a subsidy component, the
disbursement under the scheme is certainly below expectations.
It is clear from the above, that despite the best intentions of the Government to expand the credit
to SMEs, the results are far from satisfactory. It calls for an urgent need to have a relook on
the policy measures for the promotion of SMEs and iron out the problems hindering the growth
of credit to this sector. Following points could be considered:
 First, a very important issue to understand is the composition of Indian SMEs and
their financing needs. As per third All India SSI Survey, out of 11.85 million SSI units
in India, more than 99 % units falls in the category of tiny, i.e. investments in plant
and machinery of these units is less\ than Rs. 25 lakh. Even in this tiny sector, majority of
them would be very small and would include cottage industries and artisans. Only a
few lakhs would actually form what can be termed here as modern SSI sector having
investments in plant and machinery in the range of Rs. 25 lakh to Rs. 1 crore. The
financing needs of these modern SSIs along with medium enterprises, say with an
investment in plant and machinery less than Rs. 10 crore, are, most of the time, quite
different than that of tiny enterprises. These big units among the SSI sector would often
require funds mainly for diversification and expansion of the business and technology up
gradation that needs to be dealt with separately. The schemes like credit ratings are most
relevant to this sector. On the other hand, micro financing would be a very effective
tool for financing smallest of small enterprises providing coverage to a large
number of small units and also reducing the risk of banks. Further, there is a need
of reorientation of government functionaries to this vast range of SMEs. It will be in the
best interest of the sector if government officials are properly designated to take care
of certain set of SSIs and the relevant schemes.
 Second, one will have to realistically assess the positions of banks and other financial
institutions in this regard. They have the concerns about the NPAs and the growing
incidences of sickness in SSIs. Obviously, financing of SMEs should be a profitable
venture for banks so that they can extend credit to SMEs. As the large enterprises
have access to alternative sources of financing, like capital markets\ and often the
rate of interest is very low in case of large enterprises, banks have also started looking at
SMEs as a potential thrust area. However, this needs to be further strengthened by
the right mix of promotional policies reducing the risk of banks while financing the
SMEs. Banks, on their part, would do well by providing adequate publicity to various
promotional schemes so that a large number of units could get benefited.
 Third, it is often observed that there is a lack of understanding of the government policy
directives and guidelines and schemes of the RBI and the SIDBI on the part of field level
functionaries of financial institutions. The officials need to be sensitized regarding the
needs of the SMEs through proper training.
 Fourth, a number of private banks are venturing in the field of SME financing with
innovative schemes. Besides, cluster financing and innovative financing schemes like
factoring are emerging as powerful tools for extending credit to SMEs. Credit rating
is also gaining prominence. However, again there is a lack of understanding of these
schemes on the part of banks and other financial institutions as well as SME
entrepreneurs. It, therefore, becomes extremely important to engage SMEs and
financial institutions and apex SME developmental agency in a constructive dialogue
to ensure better understanding of policies and schemes. SME associations should come
forward in this regard and organize programmes in which all the stakeholders could
be invited and the schemes could be popularized.
 Fifth, the SME associations and NGOs should come forward and accept more respon-
sibilities. Their role should not be limited to only lobbying for their members. The
associations and NGOs can play a crucial role in micro financing. They could also
provide specialized services to the SMEs in preparation of project documents and
help in procedural aspects and could also help banks in assessing the risk for financing
a venture.
  Sixth, a few changes and improvements in the policies could help infuse credit to this
sector. Equity participation ceiling of large companies in small scale sector should be
raised from 24 % to 49 %. It would certainly motivate large enterprises to invest in
small enterprises and thereby expansion of these units. Similarly, technology up
gradation fund of SIDBI needs to be strengthened. The scope of credit linked capital
subsidy scheme should be enhanced to cover a wide spectrum of products, sub-sectors
and technologies.
 Seventh, over the period, it has been observed that small units that are linked to large
corporate as suppliers, service providers, etc. are usually successful. It is relatively easier
for the banks and financial institutions to finance various requirements including working
capital, technology up gradation, etc. of these units. Promotions of clusters linked to large
units, thus, could help expansion of credits to small units. Finally, it has been observed
that one of the major reasons for delays in sanction and disbursal of loans is the
lengthy documentation and legal procedures involved in the process. While the large
industries can afford to hire specialists for the job, the small scale entrepreneurs are often
ill-equipped to handle this job on their own. It will greatly help SMEs if facilitation
services are provided by various promotional agencies like SISIs, DICs, SIDCs,
industry associations, banks, etc. The evaluation of various applications should also
take place in a time bound manner and a stand should be taken within a stipulated
time period. In case the application is rejected, the bank must apprise the applicant of
the reasons for not granting the loan. For the benefit of SMEs, which through improved
efficiency have managed to reduce the stock, the banks should give consideration to
other factors for computing the maximum permissible bank finance.

2. SME FINANCE

The exact information on how small firms are financed in their early stages is
limited because the majority of SMEs is financed outside the public domain,
through informal sources. It is clear, however, that small businesses use
different types of finance compared to large firms, mainly because small
businesses do not have access to capital markets and owner-managers
themselves are the single most important providers of start-up finance. The
sources SMEs really use depend upon different factors:

- the stage of business development where initial start-up capital is sought

from internal sources, from the entrepreneur's own pocket, and later on
sources of external funding become more important;
- the extent and source of funds depend upon the size of business, with larger
ventures seeking external sources
- the industrial sector in which a SME operates (some production firms are
based on tangible assets – land, buildings, equipment
- SMEs, like female-owned face larger barriers in the access to capital, at least
in some countries.

3. DEVELOPMENT OF SME FINANCE IN INDIA

To cure the overall disease of lack of appropriate growth of Indian SMEs –

Small and Medium Enterprises, India needs several small pills such as adequate
credit delivery to SMEs, better risk management, technological up gradation of
Banks esp. Public Sector Banks, attitudinal change in Bankers and so on. Among
them, the major problem of inadequate financing to SMEs needs an urgent
attention. Having said this, it is pertinent to mention that Small Industrial
Development Bank of India has achieved landmark results in the domain of
small and medium enterprise financing and fulfilling their credit requirements
time to time in various forms such as long term project finance, working capital
finance, bill discounting etc. However considering the level of appetite for
credit facilities of Indian small and medium enterprises, private and public
sector banks in India need to work out an unique and innovative model of
financing to this vital sector (SME) of Indian Economy.

In today’s changing world, retail trading, SME financing, rural credit and
overseas operations are the major growth drivers for Indian banking industry.
The scene has changed since the adoption of financial sector restructuring
programme in 1991. The reform in the financial sector in India along with the
overall second generation economic reforms in Indian economy has transformed
the landscape of banking industry and financial institutions. GDP growth in the
10 years after reforms averaged around 6 %.

With the introduction of the reforms especially in financial sector and

successful implementation of them resulted into the marked improvement in the
financial health of the commercial banks measured in terms of capital adequacy,
profitability, asset quality and provisioning for the doubtful losses. Now, the
rules of the game have completely changed. Consolidation has become the new
mantra for survival. Due to the growing influence of globalization on the Indian
banking industry, the author is of the opinion that the financial sector would be
opened up for greater international competition under WTO. Opening up of the
financial sector from 2005, under WTO, would see a number of global banks
taking large stakes and control over banking entities in the country. They are
expected to bring with them capital, technology, and management skills which
would increase the competitive spirit in the system leading to greater efficiency.
Government policies to allow greater FDI in banking industry and the move to
amend Banking regulations Act to remove the existing 10 per cent cap on voting
rights of shareholders are pointer to these developments.

The pressure on banks to gear up to meet stringent prudential capital adequacy

norms under Basel II and the various Free Trade Agreements (FTAs) that India
is entering into with other countries, such as Singapore, will also impact on
globalization of Indian banking.

However, the flow need not be one way. Some of the Indian banks may also
emerge as global players. As globalization opens up opportunities for Indian
corporate entities to expand their overseas operations, banks in India wanting to
increase their international presence could naturally be expected to follow these
corporate entities and other trade flows out of India.

Alongside, the growing pressure on capital structure of banks is expected to

trigger a phase of consolidation in the banking industry. In the past mergers
were initiated by regulators to protect the interest of depositors of weak banks.
In recent years, there have been a number of market-led mergers between private
banks. This process is expected to gain momentum in the coming years. A
merger between two public sector banks or between a public sector bank and a
private bank could be the next logical development. Consolidation could also
take place through strategic alliances or partnerships covering specific areas of
business such as credit cards, insurance, SMEs financing etc.

Secondly, risk management has become the key to success in which adoption
of the state-of-the-art technology and latest rating and management skills
turn out to be the significant aid for better risk management. The ability to
gauge the risks and take appropriate position will be the key to successful
financing in the emerging Indian banking scenario. Risk-takers will survive,
effective risk mangers will prosper and risk-averse are likely to perish.

In this context, Indian banks have to ensure:

1. Risk management has to trickle down from the corporate office to

branches. They should be made more accountable and responsible towards
their duties.

2. As audit and supervision shifts to a risk-based approach rather than

transaction oriented, the risk awareness levels of line functionaries also
will have to increase.

3. There is a growing need for banks to deal with issues relating to

`reputational risk' to maintain a high degree of public confidence for
raising capital and other resources.

In this process, the technological advancement of Indian banks would create a

soothing climate to manage their risk in a better way. In the years to come,
technological developments would render flow of information and data faster,
leading to prompt appraisal and decision-making. This would enable banks to
make credit management more effective, besides leading to an appreciable
reduction in transaction cost.

In order to reduce investment costs in technology, banks are likely to resort

sharing of facilities such as ATM networks. Banks and financial institutions will
join together to share facilities in the areas of payment and settlement, back-
office processing, data warehousing, and so on – majorly for cost effectiveness
and secondary motto would be to provide everything under one head.

The advent of new technologies could see the emergence of new players doing
financial intermediation. For example, we could see utility service providers
offering, say, bill payment services or supermarkets or retailers doing basic
lending operations. So for better profit margin, with the help of technological
innovation, consolidation and innovation in corporate lending, the conventional
definition of banking might undergo changes.

Considering such developments in the banking industry of India, it seems that

the next decade will be an era of consolidation and integration. In such a
scenario, the expected integration of various intermediaries in the financial
system would require a strong regulatory framework. It would also require a
number of legislative changes to enable the banking system to remain
contemporary and competitive. There would be an increased need for self-
regulation among Indian banks since development of best international standard
practices could evolve better through this rather than based on mandatory
regulatory prescriptions. For instance, to enlist the confidence of the global
investors and international market players, the banks will have to initiate
adopting the best global practices of financial accounting and reporting. It is
expected that banks should migrate to global accounting standards smoothly
rather than waiting for the regulatory circulars and guidelines, although it would
mean greater disclosure and tighter norms.

Last and the most important development in the Indian banking industry is its
change of focus in corporate lending on account of above mentioned changes
and challenges. In the sheltered days of corporate lending by banks, when
customers could be freely charged, banks concerned themselves with only
`revenue' which was equal to cost plus profit. Post-reforms- after 1991, when
the cost of services became nearly equal across banks and cost-control was a key
to higher profits, the focus of financial institutions especially banks shifted to
`profit', which was equal to revenue minus cost. This was an alternative measure
of revenue stream which every bank thought of due to effects of external
environment on their workings. And in the future, as domestic and
international competition hots up, financial institutions including banks
may have to shift their focus to `cost' which will be determined by revenue
minus profit.

In other words, cost-control in tandem with efficient use of resources and

increase in productivity will determine the winners and laggards in the future.
The economic theory of ‘survival of the fittest’ works everywhere it seems
through this example.
The ray of hope is Small and Medium Enterprises (SMEs) 1 which is an
emerging, inevitable and profitable target market for the financers’ i.e. financial
institutions and banks. However, that need not mean banks and financial
institutions will back-up the social banking. Rather than being seen as directed
and philanthropic-like financing, such lending should have been now more
business driven.

On the contrary, the authors believe that all the sources or market of revenues
have not been vanished yet. The SMEs sector is considered to be an untapped
market for financial institutions in India. We just need to combat certain
obstacles. The hurdles which need to be removed are:-

1. Minimization of probabilities of skewed returns from SMEs by

better risk management

2. Eradicate inconsistency in the knowledge of SMEs business. For

example, entrepreneurs may possess more information about the
 nature and characteristics of their products and processes than
potential financiers.

3. Absence of managerial and technical expertise of intermediaries

whose role is to evaluate and monitor companies

4. Lack of international infrastructure and expertise in SME financing.