Credit Guaranteed

J&K Bank Chairman Dr Haseeb A Drabu talked about the prospects and problems of Credit Guarantee Fund Scheme at a seminar on the issue in Srinagar last week. Excerpts.

Dr Haseeb A Drabu
Dr Haseeb A Drabu

The reason why we are holding this joint session with SIDBI and Credit Guarantee Fund Trust for Micro & Small Enterprises (CGTMSE) is to ensure that there is customer empowerment or client empowerment. One of the biggest challenges that we find today in J&K is that even as we are willing as an institution to lend, the terms of lending as required by us are not as we want them to be.

One of the reasons for that is non availability of empowered customers. We do not have empowered clients who would demand a certain amount of quality of service from us or a certain amount of ownership of what we are trying to do.

It has always been a unidirectional relationship wherein they accept whatever we want to give to them. Of course, we will change and we are already onto changing ourselves. I am sure many people sitting here would know the fact that we have changed. A simple fact that I now keep saying, to ramp up credit from Rs.1200 Crore to Rs.12000 crores is not a mean job. But on what terms is this credit available?

Is it the most desirable way to do it. In order to change the paradigm of lending in the state, I strongly believe, an enlightened customer and an enlightened client is the basic requirement. One has to understand that J&K Bank today has a monopoly in J&K. It is not by choice or by conviction. It is by force of circumstances that we have to be the largest lenders. Out of the total credit portfolio of Rs.15000 Crores, Rs.12000 crores is with J&K Bank. Monopolists tend to have a very poor customer service. In a competitive environment I would have, perhaps, gone out of my way to do business with you. But when one is in a monopolistic situation then the whole business ethics change.

In order to prevent us from being so, we need customers with a certain level of enlightenment; we need people who demand services from us. We need people who actually want us to do things in a better way. By saying so, I am not absolving myself of any responsibility for bettering our business processes. We surely are doing as much as we can and I am confident that most of you would agree to that. But for raising the bar what is required is active participation of our stakeholders. It is towards that end we are today conducting this workshop and I would expect that at the end of the day we would disseminate more awareness among clients and assure a better credit delivery system.

The basic issue facing us is the credit flow to the MSME segment.  It is now an acknowledged fact that credit flow to MSMEs is low not only in the state but also nationally, and even internationally. It is, as such, not a unique problem in J&K alone. Nowhere in the world do MSMEs get the required level of credit. Why is this so? The reason for this, nationally as well as internationally, is that SMEs have to compete with corporates for finance. If a bank has the option to lend to a listed company why would it lend to an SME? Lending to corporate is less risky and more remunerative. Banks are commercial organizations at the end of the day and are into the business of doing business and not charity.

Another reason for low credit flow to MSMEs is that there is complete asymmetry of information. Information on SME businesses is not only unavailable it is also expensive to get.

Talk of a listed company and all you need to do is go to its website and get the balance sheet. You will get all the information you may need. A lot of information is disseminated today on a quarterly basis. True there are Enrons and Satyams but those are exceptions to the rule. In the case of SMEs it is the opposite. Asymmetry of information is true by rule and that is another determent to lending.

Third issue is that SMEs by and large tend to be under-collateralized. So there is an issue of security, because, if the bank is not able to understand the business model or the income flows, then the bank would seek a higher level of collateral as a comfort. If even that is not present, lending to SMEs becomes an issue.

And finally what really deters a bank from lending to SME is the high transaction cost. The transaction cost is related to the size of the loan and also to the behaviour of the loanee. It is well known that SME accounts need to be more intensively monitored which increases the transaction for the bank. All this ends up in assigning a higher risk weightage to the SMEs. That’s where from the need for a credit guarantee emerges.

The point simply being that if the risk in the system is high then there is a need for some third party guarantee. This is a broad kind of position which is, however, not relevant in J&K especially in relation to J&K Bank. And that is the point I want to make today.

Most of the reasons that I enumerated for low flow of credit to the SME’s are not relevant to J&K and to J&K Bank. First of all we are not an economy where you have a corporate economic system. We are not a corporate driven economy but an enterprise led one. As such, we do not need an industrial policy because we do not have an “industry” in J&K. What we need is ‘Small Enterprise’ policy. A small enterprise policy for a state will be more relevant than having an industrial policy of the kind that we have had for the last 50 years.

The way in which our economy is structured is very different because the essential core for the economy is not industry or corporates, it is the small enterprise. As a consequence of this SMEs don’t compete for funds with large corporates. Also and more importantly, SMEs in J&K, unlike the world over, are producers and not sub-contractors. So lending to them is not in the form of surrogate lending to corporates but to actual producers.

A crafts person, an artisan, and a carpet weaver, a shawl person is the SME and he is in the end a producer of a good which is sold in the market. Regarding asymmetry of information with respect to SMEs, I do not think J&K bank in J&K suffers from asymmetry of information because we know everybody here and everybody knows us. The credit history is institutionalized in the minds of J&K Bank Managers and that is a tremendous asset and a positive for us.

This is what I have been arguing for sometime now. We must have confidence in our clients and in the people we lend to. The essence of the issue is moving from collateral based lending to confidence based lending. Can we do that?

As far as SMEs are concerned, we have, in the last four to five years, moved from an asset based lending to a business based lending. That we are no longer into asset based lending is evident from the fact that our fruit loans are linked to size, type and productivity by orchard; or in the case of carpets by size and type.

Finally, apart from confidence another determining factor is that SMEs in J&K have a committed lender in J&K Bank. I think that is a factor that takes a large chunk away from the issue of non-delivery of credit to SMEs.

There are, though, still some constraints. I find the organizational structure of SMEs a big constraint. The organizational structure within an SME does not give me confidence as a lender. It is more a family affair, a typical “mom and pop” show. This needs to be changed.

Second major constraint is growth- or the lack of it. Our SMEs are not growing up the value chain. None of our enterprises graduate from micro enterprises to SME’s and then to Medium Scale Enterprises. What stops us from growing up the chain? Why is it that, for the last 70 years, not a single listed company has come up from J&K?

This brings me to the most important point. The lending in J&K for the SMEs is low because there is no growth lending happening. There is only start-up lending happening every time. Look at our credit portfolio. Somebody wants to set up an enterprise and the bank finances it. The enterprise should then, normally, grow from a Rs.50 Lac enterprise to Rs.5 Crore enterprise over 10 years.

We don’t see that happening. Why should it be difficult to move to the next step on the growth ladder? Because for every step taken, comes a larger amount of finance. It is all about leveraging of finance. Instead of that, what happens is this: one, nobody is willing to put in his own margin. It is all bank’s money that is used. Two, Resources are not leveraged. For example a Rs.1,000 resource base could be leveraged to raise Rs. One Lakh. This leveraging is not happening for two reasons.

One SMEs are not debt leveraging and second, there is no alternative source of finance. Equity is yet to become a part of our business lexicon. We, at J&K bank, tried to introduce venture capital approach for financing CA stores. We found no takers. Leveraging of finance is a serious issue for SMEs and they need to do something about it. You need to think about it because we are very open and willing to work that out. I cannot leverage finance for you, you have to leverage finance for yourself which again rolls up to the point of organizational structure.

SMEs need to have an organizational structure that allows you to do three things: Technology, Marketing and Finance.

On technology front, most of you are aware that J&K Bank has tried to intervene through technology upgradation fund. Being a banking institution we can not help you in marketing. That is something which is imponderable for us. This is something that remains firmly in the ambit of the SMEs themselves or perhaps the state government. Third of course, is the finance where the bank has a role to play. The bottomline is credit does not flow to SMES because the risk is high. The nature of the risk is but different.

First of all I do not face a credit risk; I face a situational risk. The fact that I have Rs.12,000 Crore invested in J&K means that I have now aligned myself totally with you. I have no problem with any of you individually or collectively but I have a problem with the environment. I have a problem with the situation so unlike any other bank or financial institution that talks of credit risk, operational risk and so on so forth. I am really talking of a situational risk. I am not making a comment on the politics of the situation. I am making a comment on the business of it. I have had problems and I have seen problems. Projects have been delayed.

Situational risk in some way ties up with the credit risk because when the situation gets bad the credit turns bad. And that brings us back to the necessity of Credit Guarantee. No matter whether our own little problems are different from those faced nationally, the fact is that credit guarantee does have a role to play in environments which face situational risk.

But let me share with you something else. To tell you honestly and I say this will all humility, I do not believe in Credit Guarantee Schemes. I do not think it is good for us as a system or for me as bank or for the borrowers. This is my fundamental position as an economist if not as a banker.

Because in many ways, a credit guarantee is a form of subvention or a subsidy. It has two moral hazards. One it weakens the will of the borrower to repay. Two, supervision and selection can also become a bit reckless. Three, There are many operational problems. It involves lengthy procedures and the success rate is not very high.

Where do we stand then? I see the Credit Guarantee Scheme as a transition, an opportunity for the bank to learn about SME problems and financing under conditions of reduced risk so that by the time the Bank actually gets into more into SME lending, the more it is certain about what it is doing. This is a transition phase where, one, I will know you better and two, you will build a credit history for yourself.

These are the two things that are required. Once that happens, we should move to non-gurarantee, non-crutch lending because it is profitable lending and in an environment like ours there is no other option but to lend to SMEs.

To reiterate, credit guarantee is not an end in itself. You should see it as a transition for 3 to 5 years, to build a credit history for yourself. The bank should use it as an opportunity to understand the sector more.

The final point I want to make I want act as an intermediary even in the transition period. I want to take on the responsibility of doing this but at the same time build a market for guarantee loans. So that I can contract the liability and then pass that forward with a guarantee. For instance, I would like to build a portfolio of Rs. 100 crores with the guarantee of CGMS and then give it to RRBs. That would amount to taking the liability on myself but create a market for guarantee loans.


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