Financing Micro, Small, and Medium Enterprises: An Overview of Today's Landscape

INTRODUCTION

The Reserve Bank of India (“RBI”) in the exercise of its powers conferred under Section 21 and Section 35A of the Banking Regulation Act, 1949 has issued a Master Direction bearing no. FIDD.MSME & NFS.12/06.02.31/2017-18 dated July 24, 2017 (updated as on December 28, 2023) (“Master Direction”)ⁱ for the purpose of providing instructions and guidelines to banks on lending to the Micro, Small and Medium Enterprises (“MSME”) Sector.

The following are the key highlights of the Master Direction:

1. Classification of MSME
   
   An enterprise shall be deemed to be micro if the investment in plant and machinery or equipment does not exceed INR 1,00,00,000 (Rupees One Crore Only) and turnover does not exceed INR 5,00,00,000 (Rupees Five Crore Only). However, for being classified as a small enterprise, the investment in plant and machinery or equipment shall not exceed INR 10,00,00,000 (Rupees Ten Crore Only) and turnover shall not exceed INR 50,00,00,000 (Rupees Fifty Crore Only). Furthermore, if the investment in plant and machinery or equipment does not exceed INR 50,00,00,000 (Rupees Fifty Crore Only) and turnover does not exceed INR 250,00,00,000 (Rupees Two Hundred Fifty Crore Only), the enterprise shall be deemed to be mediumⁱⁱ.
   
   All MSMEs are required to obtain udyam registration certificate which shall also enable the bank to determine the classification for any priority sector lending. The retail and wholesale trade are included as MSME only for priority sector lending and are allowed to be registered on udyam registration portal.
   
   The certificate issued to informal micro enterprises on udyam assist portal shall be treated at par with udyam registration certificate for availing priority sector lending benefits and such enterprises shall be deemed to be micro in nature.



2. Targets or sub-targets for lending to MSME Sector
   
   The banks are required to adhere to the master direction on priority sector lending- targets and classification dated September 4, 2020,ⁱⁱⁱ for the purpose of lending to priority sector MSME. It is also supposed to achieve 20% (twenty percent) year-on-year growth in credit to micro and small enterprises (“MSE”), 10% (ten percent) annual growth in number of micro enterprise accounts and 60% (sixty percent) of total lending to MSE sector as of the corresponding quarter of the previous year to micro enterprises.
   



3. Acknowledgement of loan applications, Collateral Security and Composite Loan
   
   The loan applications submitted either manually or online by the MSME borrowers are required to be mandatorily acknowledged by the banks through a serial number and acknowledgement receipt. Furthermore, a system of central registration of loan applications, online submission of loan application and e-tracking of MSE loan applications should be put in place by the banks.
   
   No collateral security is to be accepted by banks in case, loans up to INR 10,00,000 (Rupees Ten Lakh Only) is extended to units in the MSE sector. Collateral-free loans up to INR 10,00,000 (Rupees Ten Lakh Only) can however be extended to all units financed under the Prime Minister Employment Generation Programme. Further, banks may increase the limit to dispense with collateral requirement for loans up to INR 25,00,000 (Rupees Twenty-Five Lakh Only) based on the good track record and financial position of the MSE units, and with the approval of the appropriate authority. Banks shall also encourage their branches to avail central guarantee scheme cover for evaluation of the field staff.
   
   Banks can also sanction a composite loan limit of INR 1,00,00,000 (Rupees One Crore Only) to enable the MSE entrepreneurs to avail their working capital and term loan requirements through single window.


4. General Credit Card Facility
   
   Banks eligible to issue credit cards^iv may issue general credit cards to individuals or entities sanctioned working capital facilities for non-farm entrepreneurial activities which are eligible for classification under the priority sector guidelines. The terms and conditions of such credit facilities shall be as per the bank’s policies and within the overall framework of RBI. The guidelines on collateral free lending for micro and small units and instructions on reporting general credit card data shall be applicable to banks.


5. Flow of credit to MSE
   
   Banks are required to incorporate the following provisions in order to facilitate timely and adequate availability of credit to viable MSE borrowers during need of funds in unforeseen circumstances:
   
   
   1. To extend standby credit facilities for term loans and to provide additional working capital for meeting any emergent needs of MSE units.
   
   
   2. Mid-term review of regular working capital limits, where changes in demand pattern of MSE borrowers require increasing the existing credit limits of the MSMEs, every year based on the actual sales of the previous year.
   
   
   3. Timelines for credit decisions.
   
   


6. Debt Restructuring Mechanism and Revival and Rehabilitation of MSMEs
   
   Debt restructuring of MSME should be as per the guidelines provided under the Master Circular-Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances^v. The banks are additionally required to comply with the following:
   
   
   1. Implementation of loan policies governing extension of credit facilities, restructuring and rehabilitation policy for revival of potentially viable sick units/enterprises^vi and non-discretionary one-time settlement scheme for recovery of non-performing loans for MSE sector, with the board of director’s approval, and
   
   
   2. provide wide publicity to such one-time settlement scheme by placing it on the bank’s website and other modes of dissemination. Reasonable time may be given to the borrowers to submit the application and make payment of dues for extending the scheme’s benefits to eligible borrowers.
   
   
   3. Implementation of the recommendations with respect to timely and adequate flow of credit to MSE sector.
   
   
   The revival and rehabilitation of MSME units having loan limit up to INR 25,00,00,000 (Rupees Twenty-Five Crore Only) would be undertaken as per the framework for revival and rehabilitation of MSME dated March 17, 2016^vii. The essential features of such framework are as follows:
   
   
   1. Banks or creditors should identify incipient stress in the account by creating three sub-categories under the special mention category prior to turning the loan account of the MSME into a non-performing asset.
   
   
   2. Any MSME borrower may voluntarily initiate proceedings under the framework, and committee approach shall be adopted for deciding corrective action plan.
   
   
   3. Timelines for taking various decisions under the framework has been fixed.
   
   
7. Monitoring the credit growth to MSE Sector
   
   Based on the suggestions of the Indian Banking Association led sub-committee, banks are required to strengthen the existing system of monitoring credit growth to the MSE sector and implement a system driven comprehensive performance management information system at every supervisory level, which should be evaluated critically on regular basis. The banks are also supposed to implement a e-tracking system for MSE loan applications and monitor the disposal process in banks. The branch-wise, region-wise, etc. positions shall also be displayed by the bank on their website^viii.


8. Institutional Arrangements
   
   
   1. Specialised MSME branches and Empowered Committee
      
      At least 1 (one) specialised branch shall be opened by the public sector banks in each district. Further, in order to encourage the MSME sector, banks are eligible to categorise their general banking branches having 60% (sixty percent) or more of their advances to MSME sector as MSME branches. The banks shall also ensure specialised MSME branches with preponderance of small enterprises to enable the entrepreneurs to have easy access to bank credit and to enable the bank personnel to have the necessary experience.
      
      Empowered committees on MSMEs are also constituted at the RBI’s regional offices to review the progress in MSME financing including revival and rehabilitation of stressed micro, small and medium units periodically. These committees would also coordinate with other banks and financial institutions to ensure smooth flow of credit to the MSME sector.
      
   
   
   2. Banking Codes and Standard Board of India (“BCSBI”) and Financial Literacy
      
      ‘Code of Bank's Commitment to Micro and Small Enterprises’ has been developed by BCSBI along with Indian Bank’s Association and RBI in order to set the banking practices while dealing with MSEs. It emphasizes on transparency and disclosure of complete information to the customer before selling a product or service.
      
      Further, banks shall comply with the RBI’s directives on financial literacy and consultancy support to the MSME sector^ix for setting up special cells at their branches, or vertically integrate the same in financial literacy centre set up by them. The financial literacy centres shall also conduct target specific financial literacy camps, where one of the target groups is small entrepreneurs^x.
      
   
   
   3. Cluster Approach and Delayed Payment
      
      The State Level Banker’s Committee (“SLBC”) shall incorporate in their annual credit plans, the credit requirement in the clusters as identified by the MSME ministry. It shall also extend banking services in such clusters which have come up and identified by SLBC or DCC members. Further, banking services shall be extended to recognised MSE clusters by adopting a 4-C approach which indicates customer focus, cost control, cross sell and contain risk. Such approach would help in dealing with recognised groups, for making available appropriate information for risk assessment and for monitoring by the lending institutions^xi. These clusters can be identified on the basis of trade record, competitiveness, growth prospects, etc. Banks shall also open more MSE focused branches at different MSE clusters which can act as counselling centres for the MSE.
      
      The provisions pertaining to Interest on Delayed Payment to Small Scale and Ancillary Industrial Undertakings Act, 1998 under the MSME Development Act, 2006 have been strengthened to provide:
      
      
      
      1. Payment to the supplier shall be made on or before the date agreed upon between the buyer and the supplier in writing, or in case of no agreement, before the appointed day. The period agreed upon between the supplier and the buyer shall not exceed 45 (forty-five) days from the date of acceptance or deemed acceptance.
      
      
      2. In the event of failure to pay the amount, the buyer shall be liable to pay compound interest with monthly rests to the supplier on the amount from the appointed day, or on the date agreed on at three times of the bank rate. The buyer shall also be liable to pay interest in the same manner, for any goods supplied or services rendered by the supplier.
      
      
      3. If any dispute arises on the amount due, the same shall be referred to the micro and small enterprises facilitation council, as constituted by the respective State Government.
      
      
      4. Banks are required to fix sub-limits within the overall working capital limits to the large borrowers in order to meet the payment obligations on purchases from MSMEs.
      
      
      
      

The Master Direction provides a comprehensive guideline on the procedures and compliances to be followed while lending money to the MSME sector. It has been updated time and again to meet the contemporary requirements and changing demands. The recent changes to the Master Direction introduce significant alterations wherein, online registration and procurement of udyam registration certificate has been mandated with banks, aligning their priority sector lending. It also reaffirms the ministry of MSME’s authority in various matters pertaining to classification, cluster approach, etc. These developments reflect the RBI’s proactive stance in nurturing a conducive environment for the expansion of the MSME sector.