Budget 2019: When the Finance Minister Nirmala Sitharaman presents the Union Budget on 5 July, one of her primary concerns will be unemployment and the need to spur job creation in the economy. This is a daunting challenge and will necessarily involve a series of measures across multiple industries. However, with many competing claims and interests vying for attention, there is one stumbling block where her immediate attention is required, and that is the continuing challenge faced by MSMEs in accessing credit. While the macro parameters such as GDP growth, fiscal and current account deficits, capital formation etc. have been on everyone’s radar, improved access to institutional credit for micro-entrepreneurs is less eye-catching but nevertheless a critical component of the roadmap to higher growth and employment.

While India continues to improve its ranking in the worldwide Ease of Business Index, our policymakers seem focused more on the cost of the loan rather than increasing its reach. Mudra loans, interest subvention and other such initiatives are good ideas but without reach their impact is minimal. Cost matters, yes, but access to credit is critical, because it helps business survive and thrive.

The recent RBI committee report on MSMEs mentions that the real challenge faced by the institutional lenders in extending credit to micro-entrepreneurs is credit underwriting. Most often, MSME borrowers do not have the right documents for underwriters to assess creditworthiness. Consequently, institutions find it difficult to extend credit to this segment. The traditional underwriting process is still largely template based and so when the required information is not backed by evidence, credit officers choose to play safe and decline the loan.

Take the example of a hardworking single mother who runs a tea stall and who wishes to expand her business by selling snacks to customers along with tea. Here is the situation she is in: she needs a loan, but then she can’t shut down her stall to make multiple visits to the local banks. She cuts short her lunch break to approach the nearby bank branch for a loan. Her application does not move forward because she lacks documented proof of the regular income she earns. She has never filed tax returns, nor does she have an audited statement of her business income. The ownership of the tea-stall is not hers, and she does not have even a credit score, among the many such requirements for availing institutional credit.

When she approaches a bank for a loan, she runs into a system which regards as a non-entity anyone who may have a regular income but no salary slip or bank account statement, no credit history, and no documented collateral (e.g. land ownership). Even the most well- intentioned banker would hesitate to entertain a case like this.

On the other hand, there are gold loan companies, whose products are effectively short-tenured microloans and who are best placed to evolve such a credit underwriting mechanism. Unfortunately, regulatory restrictions put in place from the fear that they may over lend and cause financial instability, have effectively tied their hands behind their backs. Today, the RBI stipulates that gold loans be restricted to a maximum of 75 per cent of the value of the gold. Interestingly, this kind of blanket cap on loan to value (LTV) applies to no other microloans. Indeed, policy shackles of this sort take away the incentive to innovate because lenders know that in the event of default they can recover their dues by auctioning the gold pledged.

Perhaps a more straightforward approach would be to allow the gold loan companies to increase the loan amount based on the observed repayment history of the borrower. Say, a customer is given a loan equal to the value of their jewellery (i.e. at 100 per cent LTV). If they default, the lender would likely lose some money from unrealised interest or fall in gold price etc. but not too much. This would still be an acceptable risk compared to unsecured credit.

A facility to extend loans over the collateral value will incentivise creditors to devise methods for better credit underwriting. It will shift a broader cross-section of society into the ambit of institutional credit and help the economy achieve real financial inclusion, an objective dear to everyone. This budget is, therefore, an opportunity for the newly appointed finance minister to think out-of-the-box and infuse innovation into credit underwriting with the mechanism of gold-backed loans that allow institutions to take on additional risk without peril to the broader financial system. The government would be well advised to encourage stakeholders to work on such a risk underwriting mechanism which promises to extend institutional credit to micro-entrepreneurs.

(VP Nandakumar is MD & CEO of Manappuram Finance Limited)

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