Opportunities abound for SME Lending, but continuous tracking of sectors critical to managing risks
An “11% compound annual growth rate (CAGR) in lending to micro, small and medium enterprises (MSME) in India, over the next two fiscals, way faster than the ~7% growth anticipated in bank credit to India Inc.” is being forecasted by CRISIL Research.
That compares with a 13% CAGR seen in the past five fiscals ending 2017, with non-banking finance companies (NBFCs) recording a 4-fold increase in their credit book. Consequently, the cumulative market share of non-banks in MSME financing rose to ~18% in fiscal 2017 from 8% five years ago.
Currently, the MSME lending market size is estimated at Rs 14 lakh crore.
While competition has intensified and asset quality has weakened, the overall opportunity remains compelling, given the huge under-penetration of formal finance in the segment. Moreover, structural changes such as the Goods and Services Tax (GST) will increase transparency in MSME financials.
Over the next 2 fiscals, too, Crisil expects NBFCs to outperform banks with a sharper focus on small-ticket loans, adoption of technology and data analytics, and focus on smaller towns and cities.
“Competition in MSME lending has intensified, putting pressure on yields,” said Prasad Koparkar, Senior Director, CRISIL Research. “For example, in loan against property, net interest margins have compressed 75 basis points (bps) in the past 2 years. Financiers have been trying to protect their return on assets by focusing on smaller loans, where yields are higher, and on unsecured loans. For non-banks, unsecured loans account for 20% of the MSME portfolio as of March 2017.”
Asset quality in the segment worsened due to demand-side pressures and liquidity issues after demonetisation. Over the course of fiscal 2017, gross non-performing assets (GNPAs) across lenders increased by 70-100 bps. With GST compounding the challenges for MSMEs, especially the unorganised lot, the overall asset quality picture will likely deteriorate before getting better.
The competitiveness of MSMEs hereon would be determined by the extent of tax avoidance, their position in the value chain, labour cost arbitrage, product offering, local market knowledge and proximity to the customer.
Given the rapidly changing business milieu and variation in business prospects across sectors and geographies, financiers need to have a structured decision-making approach and monitor any changes in key factors altering business prospects on an ongoing basis.
“The business potential for MSME units from the same industry but in different clusters can vary significantly,” said Ajay Srinivasan, Director, CRISIL Research. “For instance, prospects of machine tool manufacturers in Ludhiana, which are mainly into conventional tools, are distinctly inferior to those in Bengaluru that manufacture higher-margin CNC machine tools. Changes in the external environment, including commodity prices and government policy, also have an impact. For example, the sudden increase in the price of crude oil over the past month has cranked up the input cost for chemical and plastics manufacturers. To boot, GST has changed raw material procurement patterns for some segments of the chemical sector.”