Nothing much to cheer about new rating system for MSMEs

Harini Subramani

Raising finance is probably the biggest challenge for a small enterprise. Thus, a recent announcement by the Small Industries Development Bank of India (SIDBI) brought MSMEs fresh hope.

SIDBI, the principal financing institution for small business, says it will work with credit rating agencies to develop rating products for MSMEs in the loans syndication space. In other words, rating agencies along with SIDBI will rate loan proposals to help banks assess each proposal better while deciding on funding a small enterprise. SIDBI plans to start this on a test basis in some specific SME clusters and depending on its success, will expand the scope to other geographies.

If you're a small enterprise looking for funding, don't cheer just yet. First, let's examine SIDBI's new proposal.

How The Rating Works

Ordinarily, institutions like CRISIL, ICRA and five other credit rating agencies registered with the Securities and Exchange Board of India (SEBI) rate products like bonds, commercial papers and structured finance instruments that a company is planning to float. In this case, the company pays the credit rating agency to get its product rated.
 
Theoretically, it is a splendid idea to rate loans or other products and provide banks with additional information that may enable credit disbursement. Although this move appears straightforward, it is ridden with challenges.

Conflict Of Interest

The main challenge to SIDBI's new proposal is the potential conflict of interest in the payment method, which could very likely influence these ratings. The issue has been debated in the past, but the problem remains. Since rating agencies rely on fees earned from rating assignments given by their clients, it is very likely that the agency may not be objective in its assement.

To work around this, market watchdog SEBI has established guidelines for credit rating agencies to follow and the latter have uploaded a document on their respective websites explaining how they propose to avoid this challenge. But that still does not clear them of potential bias.

Burden Of Fees

Each credit rating agency has a different rate card, although the range of fees is not wide. For example, at CRISIL, the rating fee is based on the turnover of the company while at CARE, the fee is computed on a percentage basis with minimum caps on the product and the amount the enterprise seeks to issue and raise, respectively.
 
For a micro enterprise, the fee works out to around Rs 40,000. For small and medium enterprises, it is even higher. It is no secret that every enterprise engaged in this sector is looking to cut costs.

Given the current definition of an MSME, it would not be wrong to assume that this money would be hard to cough up for a micro enterprise and would put a reasonable amount of burden on several small and medium enterprises.

To be fair, let us not overlook the subsidies given by the government for these ratings. In coordination with the National Small Industries Corporation, rating agencies provide subsidies on the fee. Accordingly, 75 per cent of the fee is paid by the government while 25 per cent is paid by the enterprise.
 
While agreeing that the fees might place a burden on MSMEs, especially micro enterprises, a senior manager with SIDBI claimed there would be no conflict of interest. It is not possible for large credit agencies to be influenced by small SMEs, he argues. Endorsing the new move by SIDBI, he said, "Banks are finding it difficult at this point in time. We are looking to develop complete proposals in the loan syndication module. We are trying to put together a value chain."
 
Is There Anything New About The Rating System?

Probe deeper and you will find that, conflict of interest apart, there is another problem with SIDBI's new ratings proposal. There are a total of seven rating agencies in India, of which the SME Rating Agency of India Ltd (SMERA) is dedicated solely to SME ratings. SMERA, co-promoted by SIDBI, was set up 8 years ago for this purpose while the other ratings agencies too can provide ratings for SMEs.
 
Beyond the marketing speak, the SIDBI official admitted that there was nothing new per se in what S Muhnot, Chairman and Managing Director of SIDBI, proposed recently. So why is SIDBI not building on its existing platform? Are these not adequate enough?

Credit disbursement with the existing machinery lacks sufficient focus. Will these new ratings really lead to increased credit disbursements? Most large banks have dedicated SME teams which may have deeper insights and relationships with their clients to gauge an SME's true creditworthiness.
 
SIDBI should probably coordinate with public sector banks and other SME financing agencies to draw on this learning. The SIDBI chief needs to follow up his announcement with some pretty weighty clarifications.

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