By
Prof. Abhijit Bhattacharya (Dean - Globsyn Business School, Ahmedabad and Director, Asian Institute of Family Business)
With the introduction of Basel-II norms stipulating that funding of firms by banks must be linked to ratings by independent agencies, banks can now justifiably claim to have a well-researched rule of thumb for initial filtering of SME loan-seekers. Now, many bankers can even insist that those small enterprises that do not necessarily come under the purview of Basel-II must also get their ratings. Considering the fact that credit accessibility is the sore point of the SME sector, the impact of compulsory rating on credit deserves careful scrutiny.
For SMEs, mostly operating under hard budget constraints, credit rating imposes additional costs and hence must bring tangible benefits to the firms. Logically, a high credit score improves the chances of securing external finance and also boost the confidence of the entrepreneur since a high score essentially confirms the soundness of the firm’s internal systems and processes. In addition, a good score helps building reputation among buyers, suppliers and other stakeholders and thus enhances the firm’s brand value.
The apparent benefits to the bankers for having credit scores of SMEs are quite obvious. Information about a firm’s reputation for honouring or dishonouring its borrowing commitments conveyed through the credit score provides additional input for decision making. Considering that bankers are seldom rewarded for profitable investment decisions and often punished for bad decisions, a credit score from a reputed external entity confirming the capacity of the borrower to meet obligations can always act as a safeguard for a banker.
Though Basel-II can potentially assist the banks to increase their financial and operational risks-mitigating ability by providing better information on the SME, there is also a real danger that it may end up reducing credit flow to SMEs.
A good rating by itself does not ensure investment, because rating is not a recommendation to invest. Actual investment decision depends upon the combination of various factors including credit history, pricing, innovation, market volatility, etc., and both the creditor and the borrower must come to an agreement regarding structuring, monitoring or enforcing the exchange. It is quite possible that even after securing a high score (say, AAA) a borrower still may not be able to access cheap credit. The situation can be much worse for firms with low credit rating, particularly for those firms whose low score is not always a reflection of their actual potential.
Many of these firms come with their innovative projects with associated high uncertainties and ambiguities. A low credit rating can instantly goad an average risk-averse banker to look at the entrepreneur with a much higher level of suspicion from the very beginning and thus impose very difficult hurdle criteria.
As we are moving into an era of high uncertainty caused by rapid growth of disruptive innovations, often introduced by small firms without any credible credit history, increased difficulties for SMEs to avail credit can certainly undermine India’s efforts to achieve sustainable competitive advantage. To avoid such a situation, bankers’ tolerance for ambiguity and their ability to support innovative projects with high uncertainty will be critically important.
Besides the possibility of an adverse impact of Basel-II on SME credit flow, the system is also unfair to the SME sector. SMEs are now forced to get rated and provide their credit scores to the banks for further processing of their credit applications, whereas they are not provided with any independent rating or information about the expertise and performance of their prospective bankers.
If banks and SMEs are partners in the business then both must have enough information to make informed decisions about the choice of their partners. Entrepreneurs must be provided with independent rating of individual branches of banks, and even better, of individual credit appraisal officers. Ratings by reputed rating agencies reflecting the abilities, expertise and performance of individual branches of banks will allow the entrepreneurs to make the right selections of their bankers.
With relationship lending becoming the most preferred choice of lending to SMEs the world over, proper selection of the bank and its branch is quite vital for any cash-strapped entrepreneur. Once the entrepreneur, on the basis of independent rating, identifies an appropriate branch of a particular bank for his project finance, he can start making investments in time and money to establish high bandwidth interaction (such as personal or face-to-face interactions, invitations to special events, sites, etc) for creating a meaningful relationship with the potential banker.
Relationship developed through high bandwidth interactions, as opposed to low-bandwidth communications (such as e-mail, fax and letters) will ultimately create a high level of confidence and trust between both the parties. Therefore, the system must initially provide reliable data to the entrepreneurs on performance of individual bank branches and their appraisal officers, similar to the credit information available to the bakers on the firms and/or entrepreneurs.
A rating of the branches will also bring more competitiveness and innovations to the grass-root level operations of banks. If a branch manages to get high rating then the prestige and clout of the branch as well as its officers automatically get enhanced in the neighbourhood and relevant industry circles. This can then bring healthy competition not only among the branches within a bank but also among disbursing officers within a branch. Everyone will be automatically incentivised to locate innovative projects with high growth potential.
With the passage of time banks will gain more experience and generate more data to identify and measure various factors that go into the making of a successful credit appraisal officer capable of assessing innovative projects and tolerate associated risks. This data will help to design appropriate training programmes for the bank employees to develop specific human resources required to meet the challenges of credit delivery in an innovation-led economy.
Source: The Economic Times
The article is the Most read Economic Times Article
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