Needed urgently: A credit rating system for SMEs
By Kavi Arora
Published: 23rd Sep 2012 10:05:39 AM
India’s small and medium enterprises segment has been growing. Having played an important role in the economy, the sector deserves special focus from the policy-makers. In today’s dynamic environment, increasing focus is being laid on inclusive growth, making the role of the SME sector vital in India’s socio economic development.
In our ecosystem, there are several hurdles to growth faced by entrepreneurs; some real and some perceived. These are to do with regulatory set-up, political risk and interference, and ineffective legal and enforcement infrastructure, lack of organized information sources, and access to capital, to name a few.
Prevailing information asymmetry within the SME sector impedes supply of adequate quantum of finance. The banking and financial service institutions are unable to take decisions due to lack of structured and analyzed information on the SMEs. In such a scenario, a credit rating for the SMEs will build the formal channels’ confidence in lending to these enterprises.
A professional credit rating agency assesses the financial viability of SMEs and looks into all related growth aspects such as providing invaluable insight into sales, operational and financial architecture to minimize risk. The ratings not only help in mitigating the business risk but also enhance loan acceptability of SMEs sector with lenders.
The third party assessment of an SME enables four key benefits; firstly, a good rating can help gain faster and cheaper credit. The agencies that provide rating for SMEs, such as Crisil Ratings, SME Rating Agency of India (SMERA), ICRA, Credit Analysis and Research (CARE), Onica and Fitch, have tie ups with several banks to offer preferential interest rates based on ratings.
Second, better opportunities are available to rated SMEs as the independent risk evaluation by an unbiased third party lends credibility to them and opens doors while dealing with MNCs and corporates. Third, it provides tools for improvement by highlighting the strengths and weaknesses enabling opportunities for self-correction. And last, the government seems to favour rated SMEs which, in light of the new budget requirements of ministries and CPSEs to buy at least 20 per cent of actuals from SME, may lead to huge benefits for the sector.
However, a rating system for SMEs gets deterred as there is a fear among some enterprises that their value will go down if they get a low rating, making fund-raising difficult. It is also believed that many SMEs get themselves rated only when they are pushed by lenders/banks. In addition to these perceived fears, for many smaller SMEs, the cost of having organized finances is perceived to be too high. They can access unorganized sector finance without having to go through the rating process. This despite the fact that research globally has proven that it is better to possess low ratings than to stay non-rated.
This is mainly due to the fact that the underwriting process of most financial institutions involves a detailed look at the business cash-flows and understanding the customer’s need to tailor a financial solution for him. If an SME has been rated, his organized finances, external validation of the business, capital structure, discipline in cash-flow management and better governance will greatly leverage his application. Also, the ratings can be reviewed yearly which provide the SMEs the opportunity to grow their strengths and take corrective measures on their weaknesses.
The writer is Managing Director & CEO, Religare Finvest