The views expressed in this presentation are the views of the author and do not necessarily reflect the

views or policies of the Asian

Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent.
ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of
their use. Terminology used may not necessarily be consistent with ADB official terms.

Financing SMEs
Sharing Ideas for Effective Policies
Capacity Building and Training Workshop

Presentation by Mr.Parag Patki

Ex- CEO SMERA Ratings Ltd

(formerly known as SME Rating Agency of India Ltd)

Jakarta, Indonesia
15-16 October, 2014

Topics Covered
Genesis of SME Rating Agency in India
Lenders Challenges
SME Expectations
What is Credit Rating
What is Financial Asymmetry
About SMERA Ratings Ltd ( SME Rating Agency)
Rating Process/Parameters and its Rationale
Benefits of SME Credit Ratings
Key Success Factors

Genesis of Dedicated SME Credit Rating Agency in

India
Year 2006-07
SMEs are the backbone of Indian Economy with high Employment/Export/GDP contribution
55% of Indias population in the age bracket of 22-30 years-employment challenge
High potential of SME sector to absorb millions of job seekers vs Agri & Corp sector
Only 11% could access finance from formal sources; rest from informal or own funds
Very high interest rates( 17-22%) due to risk perception and historical NPA baggage
Year on year reduction in credit disbursement to SME sector vis a vis Agriculture &
Corporate sector
Average loan ticket size was just US$ 2,000 to 80% of micro/small sector units
Prevention of social unrest/ capital formation/ controlling inflation/financial literacy/ low
income to high income country
Lending institutions reluctance as well as inability to assess SME credit applications.
Limited avenues to lend, earn better spreads & diversify risks-High Corporate
lending/sectoral & regional centric/concentric risk etc.
SME Sector was undergoing benign neglect for a decade beginning 1990s; till Indian Govt. decided to act
in creation of supportive Ecosystem to tackle the neglect by creation of enabling institutions

Decreased Financial Lending to SMEs

Commercial bank credit to SMEs, as a percentage of net bank credit,
has declined sharply since the late 1990s
Access to adequate, timely financing on competitive terms has been a
major deterrent to growth and competitiveness of SME
20

Ratio of
Credit to
SSIs to Net
Bank Credit
for Banks

15
10
5
0

1995

1996

1997

1998

1999

2000

2001

Source: Central Bank

2002

2003

2004

Credit Penetration
Relevance of Information
Credit/GDP

Data source: World Bank

Switzerland

United States

United Kingdom

Chile

UAE

Croatia

India

Bangladesh

Indonesia

Without
Infrastructure

Singapore

With Infrastructure

South Korea

1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0

The State of Information

High

10

Country
Infrastructure

9
8

Finland

7
6
5
4
3
2
1

India

Low

Information Availability

10

High

Value of Information "Rule of Thumb

One Dollar of Information

Generates $ 1,000 of
Credit

Ratio: 1:1,000
7

Information Asymmetry

Information Asymmetry - Defined

A situation in which one party in a transaction (borrower) has more or
superior information compared to another (lender)

Low
symmetry

Small
enterprises

Medium
enterprises

Large
corporate

High
symmetry

Micro
enterprises

Larger the organisation, lesser is the asymmetry or greater is the symmetry

Asymmetry

contd

Irregularity -

Supply of Information

Lop-sided-

Un-Reliability

Information Asymmetry & MSMEs

Inadequate Information

E.g. Timeliness, completeness and accuracy of filings/financial statements

Filing Quality

Questionable accounting practices (more than one balance sheet issues)

Issues of Scale

Management constraints, Financial infrastructure etc

Mindset

Managed financials to pay lesser taxes/ lack of Vision/Governance/Investing in

business etc.

Exposing banks to the perils of lending in a competitive albeit less informative

environment (absence of separate credit scoring/rating models for MSME assessment)

Asymmetry Cause and Effects

Causes
Borrowers

Has more information than the lender

Reluctant to share the information
Lack of awareness and ability to project right information
Paucity and timeliness of info on sector/geography
Consultants role in opaqueness/questionable practices

Impact
Borrower

Inadequacy/Refusal of Credit
Higher Cost of Borrowing

Impact
Banker

Higher NPA
Lack of risk based pricing
Higher cost of lending

Impact
System

Inadequate credit flow to a key sector of the economy

Deterioration in banking systems asset quality

Challenges Faced by Lenders

Numerous
Limited
skill sets

SMEs Spread
Geographically
sectorally

High Mortality/
Default/
Vanishing cos/
NPAs

to assess
SME Appl.

Safe Lending/
Parking money
(Corp Sector
Govt Bonds)

Information
Asymmetry

Lending
Institutions/
Financiers

Lack of
Disclosure/
Dependence on
consultants

Slow
Recovery
of NPA/Bad
Debts
High audit/
regulatory
scrutiny on
decisions
gone bad

Financial /

Commercial

illiteracy

Lenders Perception of SMEs

It is estimated that only about 5% of the worlds 500 million
low-income entrepreneurs have access to financial services.
The Asian Banker (2013)

Absence of reliable information

Weak accounting & unreliable financial statements
Lack of sufficient market credibility
Poor historical performance & high transaction cost
High Risk Perception

SME Expectations

Information Asymmetry

Can External CRAs Bridge the

Information Gap
and
Facilitate Informed Decision Making ??

SME Credit Ratings

Building Information Bridge

Structured Information
Financier

Proper definition of
SMEs
Creation of Credit Rating Model
and Default History for SMEs

Support from the Central Banking &

Banking Sector crucial
Fee Subsidy from the Govt. to make the Credit
rating fee affordable for SMEs

SME
BORROWER

Is SME Rating a Solution?

SME Rating Agencies (SMERA) - Institutions specialised in

providing Risk Opinion in this space

Posses Information across sectors, clusters, geographies and

rating categories

SMERA has build Proprietary Models and Expertise

evaluating MSME entities

Informed Credit Decisions Enabled By

Detailed Analysis of Units:
Ability to Generate Cash Flows
employee strength

Business Information, Customer and supplier analysis,

Ability to Manage Cash Flows Facility details, historic financial analysis

Key Managers and Generators of Cash Flows Business relationships, management

evaluation, group company analysis etc.

Detailed Analysis Enabled thru:

Trained and Experienced Personnel and Analysts Rating committee approach
Established Models Benchmarking and cross industry and geography comparison

Detailed Management Interaction Site Visits, Management discussion and meeting

Informed Decisions
SMEs Evaluated on Various Risks
Sector
Risk

Slowing economy hits different sectors differently, some MSMEs are hit
less than the others

Dependency
Risk

Dependency on another player Auto component players being hit on

account of labour unrest in a large automobile player

Cluster
Risk

Management
Risk
Financial
Risk

Impact of a regulation on an entire cluster A regulatory ban on dyeing

units in particular clusters( court ruling for prevention of pollution)
Clarity and vision, professionalism, second line of management, ability
to weather economic cycles
Ratio analysis, Cash flow analysis, Leverage analysis etc.

What is Credit Rating?

Rating determines the ability or/and intention of the SME unit to meet his
financial & commercial obligation in a given period of time
Rating process simplifies analysis of information on a SME unit to arrive
at an alpha numeric suffix ( SME 1, SME 2 or BBB,BB etc)
Rating process assess the discipline, integrity & commitment level of
management towards the unit
Enables financial literacy due to process of rating
Enables creation of good credit culture and responsible units

Assess 3 Cs

Character
Capacity
Capital

Developing SMEs
Creation of Ecosystem

Ecosystem to Encourage Funding to SMEs in India

SME Stock

Collateral
Registry

IT and other
infrastructure
Development

Exchange

Encouraging

Credit
Guarantee
Trust Fund

Credit
Bureaus

SME funding

Govt.
Favourable
Regulations

Development
SME Credit
Rating Agency

Programs

PIONEER IN SME RATINGS

IN INDIA

SMERA RATINGS LTD

Est: Sept 2005

Key Milestones
SMERA Ratings Ltd

September 2005:
SMERA commenced
operation by offering
SME Ratings

2005

2006
Received technical
assistance under the
World
Bank/Department for
International
Development (DFID)

SIDBI Received
award from
Association of
Development
Financing
Institutions in Asia
for setting up
SMERA

2007

April 2008:
New Products &
Services launched

2008

2009

Recognized by International
Finance Corporation (IFC) as
an important institution to
address deficiencies in
financial infrastructure at G20
meet

March 2011:
Registered with SEC
for Corporate &
Infrastructure
Ratings

2010

2011

March 2011:
Completed 500 corp.
Ratings

2012

September 2012:
Accreditation from
Central Bank for
Bank Loan Ratings
( BASEL II)
Mar 2012:
Completed 15000
SME Ratings

2013

2014

Jan 2014:
Completed 25000
SME Ratings

Small Industries Development Bank of India

Set up in April 1990 under an Act of Parliament, SIDBI is the Principal Financial Institution for Promotion,
Financing and Development of Small Scale Industries and to Coordinate the functions of Institutions Serving the
Micro & Small Industries

SIDBI Nominated As Nodal/ Operating Agency for Government Schemes

National Equity Fund
Integrated Infrastructural Development Scheme
Technology Development & Modernisation Fund Scheme
Technology Up gradation Fund Scheme for Textiles and Jute Industries
Risk Capital for Small Industries
Credit Guarantee Fund Scheme for Small Industries (through separate Trust)
Credit Linked Capital Subsidy Scheme
Cumulative assistance USD 6 billion to the Indian SME sector since inception!

Dun & Bradstreet Information Services India

Technical Partner

A USA based credible information agency: founded in 1865 with current database of 150
million business entities globally
Has compiled detailed reports on over 75,000 Indian entities since its inception
Over 20,000 active ratings in D&B India database
Has data base on 146,000 entities with P&L and B/S in SME Space
Receives over 75,000 rating requests on cross border entities annually
A predominant agency in the SME sector
Well known in the financial sector-domestic as well as Internationally
High on credibility within fortune1000 Cos. globally who are OEMs & service providers in
India

Challenges..
In-ability to understand the information requirement
Lack of seriousness in complying with rigor of rating procedure
One point contact and flow of information within the enterprise
Lack of appreciation of the changes in the regulatory environment
Excessive dependence on the consultant/ audit firms
Ambiguity in the Financials provided Viz : 2 or more Balance Sheets for the same year, Non tally of
schedules with Balance Sheet.
Lack of proper documentation Viz: non availability of historical information on capacity details,
commencement of production, incorporation date etc.

In-ability to understand the information requirement

Lack of seriousness in complying with rigor of rating procedure
One point contact and flow of information within the enterprise
Lack of appreciation of the changes in the regulatory environment
Excessive dependence on the consultant/ audit firms

External vs Internal Rating

Banks Internal Risk Rating

Models
Mostly financial parameters
Industry benchmarking nil or
limited

Enterprise Rating by SMERA

Rating beyond financials
Robust industry
benchmarking and also linked
to size

Mostly generalization of MSMEs

across geographic boundaries

Consideration to parameters
specific to a geographic
location

Banks are involved as financiers

Ratings are neutral, unprejudiced & credible

Backward Looking

Forward Looking

Benefits of SME Ratings

Target creditworthy SMEs and other

customers for future promotions
Increase Approval Rates

Increased
Credit
Sanctions

Risk
Management

Consistency

Ensure unbiased and objective

treatment of each applicant
Apply Consistent, Objective
Decisions across the
organization based on ratings

Reduce bad debts

Reduce Exposure to High
Risk Accounts

Speed

Efficiency

In Depth Analysis for Borderline SME credit

accounts
Increase Volume of Accounts Evaluated With Same
Staff

Quickly Grant
Approvals/Declines
Less Efforts in Data
Collection

SME Credit Assessment

Assistance from Credit Ratings

Immediate
Approval
Credit
Ratings from
SME Rating
Agency
SME
Application
Lenders

Application
Processing

High Scores
Low Exposure
Targeted Markets

Internal Bank
Model

Business
Decision
Rules

Gray
Area
Middle Scores
Review Criteria

Outside
Information

Decline or
Seek More
Guarantees
Very Low Scores
Knockout Criteria

Detailed
Review

Benefits of SME Ratings

Assessed Data Available Readily from A 3rd Party-Unbiased/Credible Source
Small & Medium

Credit Grantors/

Enterprises

Lenders

Higher standard of living

Faster and easier access

to credit

Enables risk mapping of

exposures/portfolio/sector
etc.

Improve credit culture

and financial discipline

Reduces SME high risk

perception among lenders

Higher % of capital
formation and
investments

Access to alternate source

of finance

Economy

Employment generation

Healthy basket of
imports
Diversified source of
financing
Development of better
investment climate
Enables healthy vendor
base for large
manufacturers

Reduced cost of
borrowing for applicants
with demonstrated credit
performance-over 2-3
years
Preferential treatment
from
lenders/insurers/guarante
e funds/ Pvt Equity etc.
Build credibility with
business value chain

Risk based pricing

Increased market
penetration
Operating efficiencies
Shift to information based
banking

Periodic risk review of

clients
Ability to monitor Credit
granting officers
Diverse portfolio of
accounts/ better risk
mgmt.

Regulators

Provides effective credit

risk monitoring mechanism
Facilitates credit
expansion with reduced
risk
Reduces NPLs and
default probability levels in
economy
Monitor delinquent lending
institutions unable to fulfil
priority sector obligation
Diversify banking risks
Creation of structured
information on the sector

Key Success Factors

Government & Central Bank support to frame basic regulations for acceptance of SME Ratings by banking sector
Enabling legislation to bring clarity on SME definition/ Priority lending norms/ Information sharing by Credit Bureau/
Collateral Registry/ Banking/Govt. data on sectors with SME Rating agencies
Govt./SME/Finance Ministry support in creating Rating subsidy budget for SMEs
Identifying efficient Nodal agency to manage disbursement of the rating subsidy
Idenfity diversified shareholding- Development Financial Institution/Leading lenders/ Technical collaborators-private
body for becoming part of the dedicated rating agency
Seek 8-10 year Technical & Financial support from Multilateral institutions in creation of A SME Rating Agency
Set up A professional Credit Rating Agency for SMEs on Public/Private Partnership model for building trust/efficiency
& profitable growth
Hire Professional personnel to manage the rating agency & provide complete autonomy in day to day management
Setup a Professional Board representing various stake holders and experts to ensure orderly growth of the Agency
Register the Rating Agency with the local regulators to gain credibility and acceptability

Thank You
paragpatki61@Gmail.com