credit rating for small & medium enterprises

8/2/2019 Credit Rating for Small & Medium Enterprises

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1. Definitions of Micro,

Small & MediumEnterprises

What is Micro, Small & Medium Enterprises?

There is no universal definition of small and medium enterprises. In somecountries, there are certain objective standards, which classify the units as

micro, small or medium enterprises depending on the number of employees.In some other countries, annual turnover of the company determines the sizeof an enterprise. The concept of size is also a relative phenomenon withreference to the local economies, since a large company in a small countrycould possibly be considered as a small company in a larger country.

However, in accordance with the provision of Micro, Small & MediumEnterprises Development (MSMED) Act, 2006 the Micro, Small and MediumEnterprises (MSME) are classified in two Classes:

(a) Manufacturing Enterprises- The enterprises engaged in the

manufacture or production of goods pertaining to any industry specified in thefirst schedule to the industries (Development and regulation) Act, 1951). TheManufacturing Enterprise is defined in terms of investment in Plant &Machinery.

(b) Service Enterprises: The enterprises engaged in providing or renderingof services and are defined in terms of investment in equipment.

The limit for investment in plant and machinery / equipment for manufacturing/ service enterprises, as notified, vide S.O. 1642(E) dtd.29-09-2006 are asunder:

Manufacturing Sector

Enterprises Investment in plant & machinery

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Micro Enterprises Does not exceed twenty five lakh rupees

Small EnterprisesMore than twenty five lakh rupees but does notexceed five crore rupees

Medium EnterprisesMore than five crore rupees but does not exceed tencrore rupees

Service Sector

Enterprises Investment in equipments

Micro Enterprises Does not exceed ten lakh rupees:

Small Enterprises More than ten lakh rupees but does not exceed twocrore rupees

Medium EnterprisesMore than two crore rupees but does not exceed fivecore rupees

It is often said that there is no fixed definition for SME. Some banks like

United Bank of India defines SME as

A Small Scale Industrial Unit is an undertaking in which investment in plantand machinery (original cost), does not exceed Rs. 1.00 crore, except inrespect of certain specified items under Hosiery, Hand Tools, Drugs andPharmaceuticals, Stationery items and Sports Goods, where this investmentlimit has been enhanced to Rs. 5.00 crore. A comprehensive legislation whichwould enable paradigm shift from Small Scale Industries to Small and MediumEnterprises is under consideration of Parliament. Pending enactment of theabove legislation, current SSI/Tiny Industries definition may continue. Unitswith investment in plant and machinery, in excess of SSI limit and upto Rs.10.00 crore and the annual sales turn over should not exceed Rs. 100.00crore, may be treated as Medium Enterprises (ME).

AXIS BANK defines SME as

Units with a turnover upto Rs. 125 crores or those with aggregatecredit/capital market exposure with our bank upto Rs. 25 crores or grossinvestment in plant and machinery [original cost excluding land and building

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and the items specified by the Ministry of Small Scale Industries vide itsnotification no. S.O. 1722 (E) dated October 5, 2006] upto Rs.15 crores. Anaccount should satisfy all the three conditions in order to be classified as anSME account.

[NOTE: The terms Small Scale Industry (SSI) and Small & Medium Enterprises(SME) may be used alternatively in the report since technically there is nohardcore difference in both the terms]

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2. Overview of Economy

and SME

SME's contribution to national GDP is projected to go up by a minimum of 5per cent and touch 22 per cent share of India's GDP by 2012, since over 55 percent ofSMEs are aggressively upgrading themselves technologically to reducetheir input costs and increase production and exports.

Currently, SMEs' share in national GDP is measured around 17 per cent as inthe last couple of years, the small scale part of small and medium enterpriseshave been facing not only recession but credit crunch and variety ofregulations from Centre, states and local governments.

The scenario has started changing after enactment of Micro, Small andMedium Enterprises Development Act (MSME) 2006, the fruits of which willstart flowing in near future as the sector now has been relaxed and liberalizedto a large extent.

The assessment incorporated in a paper named 'SMEs Tomorrow's Blue

Chips' reveals that SMEs that had been growing at 35 per cent over the lasttwo years will register a 40 per cent growth rate which will be technologicallydriven and contribute to manufacturing outputs to an extent of 46 per cent.Their present manufacturing contribution is around 40-42 per cent.

SMEs' share to national exports currently is estimated at around 38 per cent,which will surge to over 44 per cent in next five years.

The main reason of SMEs doing exceedingly well in next 4-5 years would bebecause over 55 per cent of SMEs would have absorbed technologicalupgradation to their units.

Currently, this sector accounts for 95 per cent of industrial units and itscontributing about 40 per cent on the value addition in the manufacturingsector. More than 32 lakh are spread over the country producing about 7500items and providing employment to more than 400 lakh persons.

The main constraint which the SME still face is the credit problem. This sectoris still neglected by banks and financial institutions, mostly in the private

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sector domain. Four key issues with regards to MSME Finance and CreditPolicies:

a. Perceived poor quality of service.b. High cost of credit to MSME sector in comparison to their larger

counterparts.c. Lack of transparency (in fixing charges, credit rating process, disposal ofloan application, etc.)

d. Deficiency of domain knowledge (products or services) among branchmanagers which enhance their risk perception.

FUTURE PROSPECTS

Indian SMEs are highly optimistic in their view that the year 2010 will be betterin terms of overall business activity and profitability of their industry.

As the recession-hit year comes to a close, most of SMEs in India believe thatmarket conditions will improve in 2010, resulting in increased revenues andgrowth. Around 56 per cent of Indian SMEs are highly optimistic in their viewthat the coming year 2010 will be better in terms of overall business activityand profitability of their industry.

In addition, 92 per cent of SMEs believe that revenues will increase in 2010and the revenue growth will be around 6-15 per cent. Also, nearly 58 per centbelieve that 2010 will be better for the performance and profitability of theirown businesses.

Despite the recession, the outlook for 2010 amongst SMEs in India is veryoptimistic as companies are looking forward to reviving and growing theirbusinesses. 50 per cent of SMEs were affected by the recession but more than90 per cent seem to be confident of improving their revenues. This proves theresilience of Indian SMEs.Most SMEs have benefited from the dawn of globalization that has given themaccess to wider markets, improved business processes, better managerialcapabilities and greater competitiveness.

For instance, 73 per cent of SMEs in the engineering goods industry and 71per cent of SMEs in the food processing industry believe opportunities toenhance scope of business and efficiencies in technology and operations arethe key advantages that have accrued to SMEs due to globalization. The US isthe leading country with which most Indian SMEs do export business followedby Germany, UK, Singapore, UAE and Saudi Arabia.

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However, most industries including major SME clusters experienced seriousfall in number of customers, order quantities and values coupled withincreasing difficulties in managing international customers and increasedcompetition from other low cost producing nations since the economic crisisset in late last year.

With a mix of strategies and tools like aggressive focus on searching newersources of supply, exploring newer markets, dedicated marketing, costcutting, multitasking and staff training, the Indian SME sector was able towithstand the crisis period. Most SMEs explored newer markets and adoptedcost-cutting measures. while SMEs in the electronics and computers industry(78 per cent) and other industry adopted efficient sourcing.

SMEs are the backbone of the Indian industry, with a consistent contribution of45 per cent to India's total manufacturing output and 6 per cent to the GDPover the last five years. With a total SME base of around 14 million, India is a

very important market for us and we have grown our member basesubstantially over the past few years. However, in order to serve the IndianSMEs better, it is realised that it is important to understand issues affectingtheir business growth and specific challenges faced particularly after therecession.

3. Growth and Performance

of SME

In the recent past, small companies have performed better than their largercounterpart. Between 2001-06, net companies with net turnover of Rs. 1 crore 50 crore had a higher growth rate of 701% as compared to 169% for largecompanies with turnover of over Rs. 1,000 crore. The total SSI production,which had reached the all time high of Rs. 1, 89,200 crores in 1989-90,dropped dramatically in the next 10 years and only in 2001-02 the level ofproduction was surpassed. But after 2002, the production has risen at a fasterrate. Since 2000, there is a continuous growth in number of units, production,& employment & in exports. The average annual growth in the number of unitswas around 4.1%.

Statistics of SMEs in IndiaYear No. of

units(million

Production

(Billion

Employment

(Million

Export(Billion

Rs.)

Comparative growth ofSME & Industrial Sector

%

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Nos.) Rs.) Nos.)(at

currentprices)

SME SectorIndustrial

Sector

1996-97

8.621684.10 20.60 392.70 11.29 6.00

1997-

98 8.97

1891.80 21.30 444.42 9.19 6.70

1998-99

9.342129.01 22.10 489.79 7.84 4.10

1999-00

9.722342.05 22.91 542.00 7.09 6.70

2000-01

10.102612.89 23.90 599.78 8.04 5.00

2001-02

10.502822.70 24.90 697.97 6.06 2.70

2002-03

10.953119.93 26.01 712.44 7.68 5.70

2003-04 11.39 3577.73 27.13 860.13 8.59 6.90

2004-05

11.864297.96 28.25 1244.17 10.88 8.40

2005-06

12.344978.42 29.49 N/A 12.32 8.10

2006-07

12.735243.09 31.25 N/A N/A N/A

2007-08

13.255604.46 33.25 N/A N/A N/A

Source: Ministry of Small Scale Industries, Govt. of India

Today, some of the SMEs are acquiring companies abroad as part of theglobalization process. Mostly, these units are ancillaries and are exportoriented. The SME sector have transformed to the need of large localmanufacturers and suppliers to global manufacturers like Auto Industry.Today some SMEs are investing in R&D in order to compete globally.Outsourcing from multi-national companies has played a vital role in theemergence of Indian SMEs as world leaders in specified products. Theadvantages in labour-intensive manufacturing units, lower transportcosts and lose labour policies of the small scale sector have led to majoroutsourcing in manufacturing and services.

Presently, SMEs in textile sector have shown an average growth rate of 32%for the past two years. The auto component sector grew at an average35% over the past two years. The retail business in India has become anarea of immense opportunity. In the retail sector, the SMEs will act as asupply source for the big retailers like Reliance Retail, Big Bazaar, etc.

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CONTRIBUTION OF SMEs IN THE GROSS DOMESTIC PRODUCT (GDP)

YEARContribution of SME (%) at 1999-2000 prices in

Total IndustrialProduction

Gross Domestic Product

1999-00 39.74 5.862000-01 39.71 6.042001-02 39.12 5.772002-03 38.89 5.912003-04 38.74 5.792004-05 38.62 5.842005-06 38.56 5.832006-07 38.57 5.94

EMPLOYMENT IN SME SECTOR

CHARTS SHOWING OTHER STATISTICS OF THESECTOR

a)

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b)

4. Government Initiativestowards Financing to SME

sector

In recognition of the contribution and vast potential of the sector in theeconomy as well as its inherent infirmities, provision of adequate credit to this

sector has continued to be an element of banking policy, even thougheconomic and financial policies themselves have undergone significanttransformation, particularly after the initiation of structural reforms in 1991.

Bank credit to SSIs has increased from Rs.168 billion in March 1991 toRs.583 billion in March 2004 in respect of public sector banks. The Indianprivate sector banks and foreign banks have an additional outstanding SMEportfolio of more than Rs.100 billion.

In the policy context, the Government of India introduced acomprehensive policy package for SMEs, which included fiscal, credit,

infrastructural and technological measures. An exclusive Ministry dedicated toSSIs was created by the Government in 1999 to provide more focusedattention to the sector.

There exists a well structured institutional set up both in the public andprivate sectors to cater to the credit needs of SMEs. The Small IndustriesDevelopment Bank of India (SIDBI) was set up in April 1990, as the principalfinancial institution for financing and development of SSIs and coordination of

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institutions engaged in similar activities. A fair code of practices has beenadopted by the Bank in its day-to-day operations while functioning as an apexfinancial institution for the sector.

A network of State Financial Corporations, National Small Industries

Corporation, State Small Industries Corporations, Commercial Banks, Co-operative Banks, Regional Rural Banks provide financial assistance to smallscale units. Small Industries Development Bank of India/NABARD providesrefinance to the industrial loans advanced by these institutions to small scalesector.

Various steps taken by the GoI / RBI to enhance the flow of credit toSMEs in the recent past include:

(i) increase in the loan limit of composite loan scheme for SSIs uptoRs.5 million

(ii) providing loans to SSIs within the interest rate band of 2 percentabove and below the respective bank's PLR

(iii) setting up of Technology Bureau for Small Enterprises to addressthe technology related needs of SSIs and proposal to convert TBSEinto a full-fledged Technology Bank

(iv) opening of specialized SSI branches throughout the country,presently numbering 417

(v) introduction of Laghu Udyami Credit Card for SME borrowers withsatisfactory track record

(vi) identification of 60 clusters for focused development by includingtheir credit requirements in the respective State Credit Plans

(vii) setting up of a Credit Guarantee Fund Trust for Small Industries.

In order to boost investment in SSI sector, the benefits of exemptions ofcapital gains arising from the transfer of long term capital assets are allowed,if such capital gains are invested in the bonds issued by SIDBI.

Public Sector Banks will be advised to fix their own targets for fundingSMEs in order to achieve a minimum 20% y-o-y growth in credit to SMEs. Theobjective is to double the flow of credit from Rs. 67,600 crore in 2004-05 to Rs.

135,200 crore to the SME sector by 2009-10, i.e. within a period of 5 years.

Public Sector Banks will be advised to follow a transparent rating systemwith cost of credit being linked to the credit rating of the enterprise.

SIDBI in association with Credit Information Bureau (India) Ltd. (CIBIL)will expedite setting up a credit rating agency.

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SIDBI in association with Indian Banks' Association (IBA) would collectand pool common data on risk in each identified cluster and develop an IT-enabled application, appraisal and monitoring system for small (including tiny)enterprises. This would help reduce transaction cost as well as improve creditflow to small (including tiny) enterprises in the clusters.

The National Small Industries Corporation (NSIC) has also introduced aCredit Rating Scheme for encouraging SSI units to get themselves credit ratedby reputed credit rating agencies. Public Sector Banks will be advised toconsider these ratings appropriately and as per availability, and structure theirrates suitably.

SIDBI has developed a Credit Appraisal & Rating Tool (CART) as well as aRisk Assessment Model (RAM) and a comprehensive rating model for riskassessment of credit proposals for SMEs. Public sector banks will beadvised to take advantage of these models as appropriate and reduce

their transaction costs.

Government policies have, thus, aimed at the simultaneous development ofall segments of small industry, viz. the village, cottage and modernenterprises. Public Sector Banks have been advised to operationalise morespecialised SSI branches at centres where there is a potential for financinga more number of SSI borrowers. Thus the policy frame and thepromotional measures are intended to enable the small scale unitswithstand competition from the large scale enterprises.

THE ROLE OF BANKS IN THE DEVELOPMENT OF SMEs INTHE DOWNTURN

In recent months, the economy has faced a major slowdown triggered by theglobal recessionary trends with a larger than expected impact, particularly for theMSME sector and export-oriented units. The typical problems faced by this sectordue to the downturn include falling exports and sliding domestic orders, piling upof inventory, stretched credit/ carry period of receivables, low or negative cash

accruals resulting in shortage of working capital and inability to service term loans,delays in implementation of modernisation/expansion programmes etc. This sectoralso faces huge idle capacities in some pockets due to the continuous slide indemand, particularly the export intensive units. Some of the major industriesaffected are Textiles, Auto ancillaries, Iron & Steel, Gems & Jewellery, Cement,Handicrafts etc.

The Government of India, RBI and Banks have announced a series of relief

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measures to encourage flow of credit to this sector. The Government hasannounced two relief packages so far, since the economic downturn started;covering measures like reduction in excise duties for select items and specialrefinance facility of an additional Rs. 7000 crores to SIDBI for lending to the MSMEsector and 2% interest rate subvention for exporters upto 31st March 2009 in pre

and post shipment credit for labour intensive exports, increased Guarantee coverupto Rs. 1 crore with a guarantee cover of 50%, additional allocation of Rs. 1400crores under TUFS (Technology Upgradation Fund Scheme), etc.

RBI, apart from measures like reduction in CRR, SLR, Repo rates and ReverseRepo rates since October 2008 which have increased liquidity in the system andhelped reduce interest rates, has also announced other support measures whichwill impact the MSMEs significantly. These include extension of the period of pre-shipment and post-shipment credit for exports, expansion of the refinance facilityfor exports, adjustment of provisioning norms for all types of standard assetsbarring some exceptions, reduction of risk weights on bank's exposure to certain

sectors and expansion of the lendable resources available to the SIDBI, etc. TheRBI has also allowed special regulatory treatment for assets which are standard on1st September 2008 and taken up for restructuring upto 31st March 2009 even ifthese have turned non-performing in the mean time.

Similarly, the Banks have also taken steps to strengthen and improve their creditdelivery mechanism to sustain the growth momentum. To help MSMEs they tookmeasures like increase in working capital both fund and non-fund based, liberalmargin, inventory and receivable norms wherever applicable have been initiated.Suitable term loans are being granted to meet urgent requirement of fixed assets.Extended gestation periods for the projects under implementation are also being

built into the loan repayment programmes. Beside the above, the assets whichotherwise would have remained healthy, but for the downturn, are beingrestructured as per the latest RBI guidelines.

SBI on its part has already released a series of relief and concessionary measuresfor this sector and to bring the matter into focus, the Bank has released two newproducts "SME CARE" and "SME HELP" to ensure timely and need based creditflow to this sector. Under SME CARE, the MSME customers with fund based limitsupto Rs.10 crore can avail additional working capital upto 20% of the existing fundbased limits repayable in one year to enable them to finance the stretchedworking capital cycle. Similarly, under SME HELP, a five year loan is extended with

a liberal margin of 15% to finance any capital expenditure of the unit. Both theseloans are offered at a liberal rate of interest of 8% during the first year.

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5. BASIC PRINCIPLES OF

LENDING TO SMEs

Banks are in business to maximize value for its shareholders. Consequently,when a bank lends money, it attempts to lend money to those applicants thatare deemed as the best from the applicant pool. The process by which alender appraises the creditworthiness of the prospective borrower is calledcredit appraisal. This normally involves appraising the borrower's paymenthistory and establishing the quality and sustainability of his income. The

lender satisfies himself of the good intentions of the borrower only through aproper credit appraisal.

The bank assesses credit risk of any borrower based on the 5 "C's" of Credit:

1. Capacity:

Capacity to repay is the most significant of the five factors. The lender willhave to determine the sources of income that the applicant possesses torepay the loan. The main consideration will be cash flow generated fromthe business. The lender will also consider contingency sources of income

i.e., marketable securities, money market accounts and other assets thatcan be quickly liquidated into cash.

2. Capital:

Capital is the money that has been invested by the business owner intohis/her business. The amount of invested capital by the owner is indicativeof the owner's stake and confidence in the viability of his/her business.

3. Collateral:

Collateral is pledged assets to guarantee the security of a loan. Collateralis deemed as a second source of income in the event that the borrowercannot repay the loan. Assets that are typically accepted as collateral arefixed assets of a business i.e., equipment, plant and property. Bankstypically will file a UCC (Uniform Commercial Code) lien on collateralizedassets. Banks also consider working capital like accounts receivable andinventory, to be feasible sources of collateral. But, typically banks will

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usually discount the value of working capital (being that the market valueis neither fixed nor certain) at a certain percentage of estimated marketvalue.

4. Conditions:

Conditions focus on the intended purpose of the loan. How will theproceeds from the loan be utilized i.e. to purchase equipment, workingcapital? Will the use of the loan contribute to the future economic growthof the business? Also banks consider the local market and economicconditions both within your industry and other industries that affect yourbusiness e.g., your suppliers and customers

5. Character:

Character is the personal impression that a prospective borrower makes to

a potential lender or investor. This is the more subjective of the five creditfactors. A person's educational background, industrial experience andcredit history with other creditors will be considered.

6.INSTRUMENTS OF SME FINANCING

In spite of various initiatives taken by the Government, banks and FIs, SMEsface certain challenges, which are universal in nature. These problems relateto the issue of collaterals, cost of loans, delay in receivables, obsoletetechnology, marketing, etc. In order to address the above problems in theIndian context, some innovative instruments of financing have beenintroduced and institutional set up created. Some of the major initiativesinclude:

Credit Guarantee Fund Trust for Small Industries:Government of India, in association with SIDBI, has set up a CreditGuarantee Fund Trust for Small Industries (CGFTSI) to implement theguarantee scheme. The main objective of the Trust is to facilitate hassle

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free credit to SME Clusters and encourage banks to shift from securitybased lending to merit based lending. SME loans upto Rs.50 lakhs areeligible to be covered under the scheme and CGTSI has so far extendedguarantees to member lending institutions for around 18,000 units in thelast three years of its operations. The CGTSI contemplates to triple its

business in the current year, as compared to the previous year. Somenew guaranteeing techniques like mutual credit guarantee scheme on thelines of similar schemes in Italy and other European countries are alsobeing developed.

Risk Sharing Facility:While the CGTSI extends guarantee cover for the loans upto Rs.50Lakhs, there is a need for offering guarantees for loans extendedby banks beyond the above limit. Under a World Bank led Project onFinancing and Development of SMEs, a possibility of introducing a RiskSharing Facility for the SME sector is being examined, wherein the risk inlending by banks to SME Clusters could be shared on pari passu basisbetween the originating banks and the suggested entity. Of course, thefacility would be available at a cost. This mechanism, as and when inplace, would mitigate the credit risks of the banks and upscale SMEfinancing.

Venture Capital Funding:With regard to new sources of financing, many countries areconsidering liberalizing the rules regarding venture capitalinvestments. In India also, various measures have been taken in

this direction. SIDBI, along with some other institutions, has takena lead in promoting venture capital funding in the country. TheBank has contributed in setting up of 16 State level / Regional levelfunds; set up a National Fund or Software and IT Industry with a corpus ofRs.1 billion and recently launched a new SME Growth Fund of Rs.1 billioncorpus. This Fund would focus on units in pharma, biotech, lightengineering, software and other KBIs. The SME Growth Fund corpus iscontemplated to be enhanced to Rs.5 billion.

Micro Credit:

Realising the potential of micro finance in stimulating economicgrowth, SIDBI has laid emphasis on increasing the capacity of thesector to handle credit and growth in the disbursements of microfinance. SIDBI Foundation for Micro Credit, presently functioning as aDepartment of SIDBI, has sanctioned an aggregate financial assistance ofRs.710 million in FY2004. The cumulative number of beneficiaries assistedunder the programme in the last 4 years aggregated over 1 million,mostly women. The outstanding portfolio under the programme as at end-

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March 2004 is likely to be increased from a level of Rs.910 million to Rs.2billion by the end of this year.

Small and Medium Enterprises Fund:The most important amongst the sectoral initiatives taken by the

Government and SIDBI is launching of an SME Fund of Rs.100billion, with a view to giving impetus to the fund flow to the SMEsector. SIDBI has been advised to structure the Fund and itsoperations have commenced with effect from April 2004. Under theFund, assistance is being provided to SMEs at an interest rate of 200 basispoints below the Banks PLR. Direct assistance is being extended to SMEsthrough SIDBIs own offices at 9.5 percent rate of interest as also by wayof providing refinance to the primary lending institutions. Refinance toSFCs is available in the interest rate band of 7.5 percent to 8 percent. TheSME Fund provides for routing of assistance, besides SFCs, throughcommercial banks as well. The Fund, besides upscaling the flow ofassistance to SMEs, addresses the issue of cross sector parity in the costof loans.

Setting up of a Dedicated Credit Rating Agency for SMEs:In order to address the demand side issues of credit and provide comfortto the bank officials, initiatives have been taken to support themechanisms of information sharing and credit rating. With a view toproviding credit enhancement and comfort to the bank officials at thefield level in their taking bona fide credit decisions, SIDBI has decided tolaunch a dedicated credit rating agency for SMEs in association with

leading public sector banks. The Bank is in dialogue with select publicsector banks and credit rating agencies for this purpose and the proposedentity is likely to commence its operations during the current year.

Portfolio Purchase Scheme / Asset Securitisation:With a view to widening the scope of assistance to SMEs, theprocess of asset securitisation offers opportunities to purchase theSME portfolio from originators and channelise funds to the sector. Theportfolio so purchased can be either retained by the purchaser or sold tothe investors in the capital markets through structuring of suitableinstruments. SIDBI has recently been permitted by the Government ofIndia to undertake business through asset securitization.

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7. Credit Rating Agenciesand SMEs

To ensure a better future, the need of the hour is to address these issues priorto them turning too complex. The need for rating agencies was felt. There aremany rating agencies currently. Some of them are:

CRISIL CIBIL SMERA

ONICRA CARE ICRA

{ CRISIL (Credit Rating & Information Services of IndiaLimited), CIBIL (Credit Information Bureau India Ltd.), CARE(Credit Analysis & Research Limited), ICRA (Investmentinformation & Credit Rating Agency of India Limited) }

All the above rating agencies may not be into SME rating.Some of the above like CRISIL, SMERA, etc do rate small andmedium enterprises.

A Credit Rating on a company assigned by an independent

third party is a predictive indicator for risk assessment. It isdeveloped by using a combination of mathematicalmodeling, expert rules, skilled business analysts and anexperienced understanding of insolvency trends. The creditrating company will analyze all business failures, andcompare them with the normal population of activelytrading companies, to identify those events which are mostsignificant and predictive in nature, and which could affectthe status of the business.

SMERA, through its rating process and risk profiling of

clusters is attempting to pinpoint the possible risks thatmight be in store for SMEs. Setting up of SME Seva Kendraby SMERA is another step to further ameliorate theinformation asymmetry and enhance the reach andcapabilities of SMEs.

A study on the financial profiles of SMEs, carried out byCRISIL, comparing the financials of 32,000 SMEs with over

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2500 large corporates provides compelling evidence thatthere are a large number of creditworthy SMEs. For banks,the sector thus represents tremendous untapped businesspotential.

CRISIL study reveals that 50 per cent of SMEs have debt-equity ratios of less than 0.34, and interest coverage of over2.24 times. This is contrasted with large companies, wherethe respective debt-equity and interest coverage levels are0.73 and 2.63 times.

CRISIL believes that a reason for the low level ofindebtedness could be the non-availability of financing atattractive rates, due to a misplaced perception of high creditrisk in the SME sector. Moreover, there is wide variation infinancial profiles between the top half and the bottom

quartile of SMEs; therefore, financially strong SMEs canbenefit greatly by proving their superior creditworthinessthrough ratings. According to CRISIL, business success of somany SMEs, some of whom have gone on to make IPOs inrecent months, points to the potential of this sector. For alender, the capability to distinguish between strong andweak credits through credit ratings will be the key tosuccessful participation in this sectors growth.

The advantages, disadvantages and the reasons for creditratings for SMEs would be better understood with the help of

details covered about the working of different credit ratingagencies.

Let us now understand the working of two SME credit ratingagencies

SMERA (SME Rating Agency of India Ltd.) CRISIL (Credit Rating & Information Services of India

Limited)

ONICRA

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8. SME Rating Agencyof India Ltd.

(SMERA)

SME Rating Agency of India Limited (SMERA) is a jointinitiative by SIDBI (www.sidbi.in), Dun & BradstreetInformation Services India Private Limited (D&B)(www.dnb.co.in), and several leading banks in the country.SMERA is the country's first rating agency that focusesprimarily on the Indian SME segment. SMERA's primaryobjective is to provide ratings that are comprehensive,transparent and reliable. This would facilitate greater andeasier flow of credit from the banking sector to SMEs.

What is SME Rating?

SMERA Rating is an independent third-partycomprehensive assessment of the overall condition ofthe SME, conducted by SME Rating Agency of IndiaLimited

It takes into account the financial condition andseveral qualitative factors that have bearing on creditworthiness of the SME

SMERA Rating consists of 2 parts, a CompositeAppraisal/Condition indicator and a size indicator

SMERA Rating categorizes SMEs based on size, so asto enable fair evaluation of each SME amongst itspeers

An SME unit having SMERA Rating would enhance itsmarket standing amongst trading partners andprospective customers

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BENEFITS

1. Wide Recognition and Acceptance

With each bank having separate rating processes anddisclosure requirements for the purpose of disbursingloans, SMEs find themselves spending significant time,effort and money while approaching different banks forcredit.

As SMERA has adopted a comprehensive, transparentand reliable rating process, it would have a wideracceptance within the banking system of the country. Inaddition to this, SMERA would be supported by SIDBI anda large number of public and private sector banks in the

country Such wide acceptance would result in, SMERARatings becoming a key requirement in the loanapplication process. It will also simplify the process ofcredit requests and make the process more cost-effective.

2. MOU with Banks

SMERA has taken the initiative of entering into MOUs with14 Banks, viz., State Bank of India, Punjab National Bank,Syndicate Bank, Canara Bank, State Bank of Bikaner &Jaipur, Dena Bank, Corporation Bank, Union Bank of India,UCO Bank, CitiGroup, Bank of India, Vijaya Bank,Allahabad Bank and Bank of Baroda. Further a number ofbanks have announced favourable credit terms includingreduction in interest rates to units rated by SMERA.Andhra Bank, Bank of India & SIDBI has alreadyannounced reduction in interest rates for units rated bySMERA.

3. Favourable borrowing terms

Better ratings from SMERA have already startedbenefiting units by way of more favorable credit terms interms of interest rebates.

Lower collateral requirements

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Reduced Interest Rates

Simplified lending norms

4. Faster Access to Credit

SMERA Ratings facilitate banks/lending institutions inreducing the turnaround time in processing creditapplications, thereby providing SMEs access to timely &adequate credit.

5. Lower Rating Fees

The rating fees charged by SMERA are very competitive,and the rating fee is subsidised upto 75 % for eligible SSIunits. i.e. Units having a valid Small Scale IndustriesRegistration Certificate (Permanent / Provisional). Unitscan get rated as low as Rs 5618/- all taxes included.

6. D-U-N-S NO

Each unit availing of SMERA ratings is assigned a unique9 digit number DUNS NO. The Number is a unique nine-digit identification sequence, which provides unique

identifiers of single business entities, while used by theworld's most influential standards-setting organizations,it is recognized, recommended and/or required by morethan 50 global, industry and trade associations

7. SMERA : An initiative of leaders

SME Rating Agency of India Limited (SMERA) is a jointinitiative by Small Industries Development Bank of India(SIDBI), Dun & Bradstreet Information Services India

Private Limited (D&B), Credit Information Bureau (India)Limited (CIBIL) and several leading banks in the country.

SMERA is the country's first & only dedicated ratingagency that focuses primarily on the SME segment.SMERA's primary objective is to provide ratings that arecomprehensive, transparent and reliable. This would

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facilitate greater and easier flow of credit from thebanking sector to SMEs.

8. Fair evaluation amongst peers

SMERA Ratings categorize SMEs based on size, so thateach SME is evaluated amongst its peers. This enablesrational comparison of companies of the same size, thusensuring that the smaller companies are not at adisadvantage while applying for credit.

9. Benefit to SME & SSI Units

SMERA Rating adds credibility to the status of the

SME unit. It also helps opens doors to deal with large

companies, esp. those who deal with a big number ofvendors.

SMERA Ratings serve as motivation to adopt goodgovernance practices which are beneficial in the longrun.

SMERA Ratings also help in international trade andcommerce and serve as first point to generateinterest among potential trading partners.

Ratings also act as a tool for self correction & selfimprovement.

In event of a 0.25 % interest reduction to a unit gettingrated by SMERA the reduction in interest cost comes toRs. 25000/- on a loan of Rs 1 crore for 1 year therebyoutweighing the cost of rating from SMERA.

10. Benefit to Banks

SMERA Ratings facilitates Pricing of loan products /attractive terms for banks. It is also useful in compliancewith regulatory and capital adequacy norms. SMERAhelps the banker through early warning signals throughreview ratings as mandated by it.

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11. Industry-benchmarked ratings

SMERA Ratings take into account industry dynamics byfactoring in a system through which an SME could

compare its strengths and weaknesses with those ofother companies in the same line of business. This isdone through statistically derived industry benchmarksfor various ratios.

SMERA Rating Process

Based on receipt of application form, applicable ratingfees and documents from the SME, SMERA will beginits process of evaluation.

A Questionnaire is to be filled by the SME. It seeks information on financial and qualitative

factors and it needs to be filled by an authorizedrepresentative of the SME.

A SMERA correspondent will contact the SME to collecta duly filled questionnaire to facilitate the ratingprocess.

The correspondent would conduct a site visit as partof the evaluation process. SMERA shall complete the evaluation exercise andprovide SMERA rating within 15 business days ofreceipt of all documents from the SME.

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In the above rating matrix, it is clear that the ratings are

based on Net Worth of the SME and the Composite Appraisalor Condition Indicator. The companies are divided into 4categories viz. A, B, C & D depending on its Net Worth. Thecondition indicator shows the credibility of the company.Indicator of 1 is the best and indicator of 8 is the worst.

It means an SME rated B1 would mean that the condition ofa particular SME with Net Worth between INR 5 Crore andINR 20 Crore is the besting that category. Any bank or anyfinancial institution or suppliers can trust on the SMEsintentions and ability to repay back the outstanding

obligations. It also tells about the companys creditworthiness in the industry vis--vis the other players in theindustry. The banks, financial institutions, lenders and othertake in to consideration the other factors as well and do notdepend only on SMERA rating. The lending parties do followtheir procedures as well and do not blindly follow theseratings. These ratings are just one step towards financing tothe SME sector.

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Factors considered while Rating

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RATING METHODOLOGY

SMERA rating framework considers a number of financialand non financial parameters of the enterprise as shown inthe above diagram and also the impact of the macroeconomic factors like government policies, trade policiesand regulations and the industry specific dynamics. SMERAalso believes that the industry in which a SME operates hasa direct bearing on the overall performance of the SME andtherefore rates SMEs based on industry benchmarks.Further the dynamics or the risk factors affecting a tiny SMEunit, a medium size job work manufacturer or a large SMEmanufacturer are different and has therefore subdividedthe SME spectrum based on size as well. (Size is indicatedby Networth). Thus SMERA Rating is a comprehensiveassessment of the enterprise taking into considerations theoverall financial and non financial performance of thesubject company vis--vis the other peers in the industry inthe similar line of business and size criteria.

Based on its assessment and understanding, SMERA hasdeveloped rating methodology framework which mainlyaddresses the following areas:

A)IndustryRisk

B)BusinessRisk

C)ManagementRisk

D) Financial Competency

E) Proficiency Risk

F) Project

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AssessmentRisk

RATING FEE CALCULATOR

Fees Structure for Rating December 01, 2008.

A : NSIC

A .1 : Fresh Rating Cases

Turnover Fees (Rs.)Service Tax 10.3%

(Rs.)Total (Rs.)

< 50 Lacs 7,500 773 8,273

50 to 200 Lacs 9,000 927 9,927

> 200 Lacs 12,000 1,236 13,236

A : NSICA .2 : Renewal Rating Cases


(Rs.)Total (Rs.)

< 50 Lacs 7,500 773 8,273

50 to 200 Lacs 9,000 927 9,927

> 200 Lacs 12,000 1,236 13,236

B : Non NSIC

B .1 : Fresh Rating Cases


(Rs.)

Total (Rs.)

< 50 Lacs 30,000 3,090 33,090

50 to 200 Lacs 36,000 3,708 39,708

> 200 Lacs 48,000 4,944 52,944

B : Non NSIC

B .2 : Renewal Rating Cases


(Rs.)Total (Rs.)

< 50 Lacs 18,000 1,854 19,854

50 to 200 Lacs 21,600 2,225 23,825

> 200 Lacs 28,800 2,966 31,766

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9. Credit Rating &Information Services

of India Ltd (CRISIL)

Background

Recent years have seen rapid growth in the Small andMedium Enterprises (SME) sector, and an enhancedappreciation of this sector's critical role in drivingeconomic growth. However, authentic andindependent credit research in this sector has so farbeen minimal. With many private and public sectorbanks directing resources and focus towards SMElending, the need has arisen for independent creditopinions. CRISIL offers its rating services to SMEs tomeet this need. SME ratings are offered on anexclusive rating scale, distinct from regular ratingsoffered to large corporations, banks and governmententities.

Credit evaluation in the SME sector needs aspecialized approach, as the issues and drivers ofcredit quality are different from those applicable forlarge companies. The weightings assigned to variousparameters of evaluation therefore need to bedifferent. There has to be a good understanding of theparticular cluster or area where the SME is operating.

CRISIL now offers rating services tailor-made for smalland medium enterprises.

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Benefits of CRISIL Ratings - The CRISIL

Edge:

1. A Trusted Third Party Opinion:

Rating from CRISIL is a stamp of quality from the mostrenowned rating agency in India.

2. Access to Funding:

A good rating from CRISIL carries weight with lenders,and can help you get faster and cheaper credit. TheIndian Banks' Association (IBA) has endorsed the NSIC-CRISIL rating, and informed its member banks of thesame. CRISIL has working arrangement with 29 banksand financial organisations and extends concessionalpricing to their borrowers.

Allahabad Bank, The Federal Bank Ltd, State Bank ofIndore, Andhra Bank, HDFC Bank Ltd, State Bank ofMysore, Bank of Baroda, ICICI Bank Ltd, State Bank of

Saurashtra, Bank of India, Indian Bank, State Bank ofTravancore, Bank of Maharashtra, Indian Overseas Bank,Syndicate Bank, Canara Bank, Kerala FinancialCorporation, UCO Bank, Central Bank of India, PunjabNational Bank, Union Bank of India, Corporation Bank,State Bank of Bikaner & Jaipur, United Bank of India,Dena Bank, State Bank of Hyderabad, Vijaya Bank, TheDhanalakshmi Bank Ltd, State Bank of India

3. Credibility and confidence building withbusiness partners:

Credit Rating is an indicator of your performancecapability and financial strength. A good rating givescomfort to

New Customers

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Foreign Partners

Suppliers

Collaborations for Joint Ventures

Added advantage while bidding and tenders filings

4. Self-improvement tool:

With its rating, CRISIL gives you a detailed analyticalreport on your company's strengths and weaknesses. Thereport will help you strengthen your operations and

improve the working of your company. This insightful,credible and independent feedback is supported by thestrongest industry and company research in India.

5. Improved Visibility:

With the CRISIL rating, your company will get a freelisting in CRISIL's RatingScan, a publication that is usedas a reference for lending decisions by banks. We will

also feature your company on CRISIL's website. Inaddition, your company name will also feature in themonthly newsletter CRISIL SME Connect that is sent tomore than 1800+ bankers and 3000+ companies acrossIndia.

Key features of CRISIL SME Ratings

/

1. Ratings assigned to all types of business enterprises

All types of business enterprises, including public and private limcompanies, cooperative societies, partnership firms, and proprietorships, are eligible for CRISIL SME Ratings.

2. Entity rating

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CRISIL SME Ratings are entity-specific ratings, unlike CRISIL's bond ratiwhich are issue-specific. Thus, all debts of an SME, including worcapital bank loans, term loans, and other debt, are assigned the same rating, irrespective of the tenure of the loan and any security/collat

provided for the loan.

3. Surveillance based on specific requirement

A CRISIL SME rating is provided as a one-time assessment. The ratinvalid for one year from the report date, provided no signifchanges/events occur during this period which could materially affectbusiness or financial parameters of the organisation. CRISIL encourSMEs to obtain rating reviews periodically, and will carry out revwhenever requested by the SME or the lender.

Rating Process

Send a rating request to CRISIL along with preliminary backgroundfinancial

information along with rating fee.

CRISIL's representatives will interact with the promoters/managemecompany.

CRISIL will then analyse the information and inputs obtained duringinteractions

and arrive at the rating

CRISIL will forward the rating report to the SME (and to the lendemandated by a

lender)

Rating DurationThe entire process will take three to four weeks from the time of receipt ofnecessary information and documents. However, if required, CRISIL canensure a faster turnaround time.

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Rating Scale

Two rating scales for the SME sector

CRISIL has two separate scales on which it assigns ratings to SMEs:

the NSICCRISIL Performance and Credit Rating (NSIC-CRISIL) scalesmall scale industries (SSIs), and

the CRISIL SME Rating scale.

For SSIs:

The NSIC-CRISIL scale has been specially developed for units registereSSIs. Typically, SSIs that are eligible for subsidies on rating fees fromNational Small Industries Corporation Limited (NSIC, owned by Ministry of Government of India) are rated on this scale. However, it can also be userate entities that are not eligible for NSIC subsidies.

The NSIC-CRISIL scale measures performance capability and financial streas two distinct dimensions. Performance capability is measured on a five-pscale (from 1 to 5), and financial strength is measured in three categorieto C). The rating symbolises the relative positioning of the rated eadjudged in relation to other SSIs. The below table outlines the rating matr

the NSIC-CRISIL scale:

Performancecapability

Financial Strength

High Moderate Low

Highest SE 1A SE 1B SE 1C

High SE 2A SE 2B SE 2C

Moderate SE 3A SE 3B SE 3C

Weak SE 4A SE 4B SE 4C

Poor SE 5A SE 5B SE 5C

For SMEs

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CRISIL offers SME Ratings to the larger domain of SMEs, of which SSIs asubset. The SME Rating Scale is an eight-point scale (SME 1 to SME 8) symbolises the rated entitys creditworthiness in relation to other SMEs.below table outlines the CRISIL SME Rating Scale and rating definitions:

CRISIL SME Rating DefinitionSME 1 HighestSME 2 HighSME 3 Above AverageSME 4 AverageSME 5 Below AverageSME 6 InadequateSME 7 PoorSME 8 Default

How to apply / Rating Process

The SME has to send a rating request to CRISIL along with prelimbackground and financial information along with rating fee. The formthe rating request as well as the information requirement can be obtafrom CRISIL website 'www.crisil.com' or from any of the CRISIL offices

Upon receipt of the request form, CRISIL's representatives interact

the promoters/management of the company. CRISIL will analyses the information and inputs obtained during

interactions and arrive at the rating.

CRISIL forwards rating report to SME (and to the lender, if mandated lender)

The entire process takes three to four weeks from the time of receiall necessary information and documents. However, if required, CRcan ensure a faster turnaround time.

Rating Methodology

Outlined below is the rating methodology used to assess the creditworthiof SMEs with ongoing business units and without any large projects. The ramethodology for assessment under both rating scales is the same. methodology is comprehensive and covers three broad categories of risk

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Business risk Management risk Financial risk.

Although these are similar to the credit assessment framework for lcorporates, the approach to assessing the risk elements, peer gcomparisons, and weightages for the various parameters, are different.

Business Risk:

Under business risk, CRISIL assesses the sustainability of the business and the long-term viability of the unit. This comprises qualitative assessmof the track record of the business, the profile of the rated entitys customrelationships with customers and suppliers, and the level of infrastructuretechnology of the business. In order to assess the SMEs business risks, CRcontacts the promoters of the SME to understand their business plansgrowth strategies. Most SMEs form part of larger industries value chainsare usually not in direct contact with the end users. Moreover, in industries, the degree of competition is high owing to factors such aspresence of a large number of players, low capital intensity and, in scases, low technology levels. Hence, SMEs rarely have control over pricingSMEs pricing flexibility stems from its relationship with key customers anstrong control over costs. For SMEs, control over costs is a function ofquality of technology and manufacturing facilities, and relationships employees and suppliers. Assessing the quality of an SMEs relationships its key customers is a critical part of CRISILs assessment of an SME; parameter is assessed by directly contacting the entitys key customersassess the entitys manufacturing facilities, CRISIL insists on a visit tofacilities, either by a team of CRISIL analysts, or by CRISILs busiassociates. CRISIL also contacts the SMEs key suppliers to assess the quof their relationships with the SME being rated.

Management Risk:

For SMEs, management evaluation, which is typically an evaluation ofpromoters competence, is critical to the rating. Unlike most large corporawhich have several layers of professional managers, performance in the of SMEs often depends on the entrepreneurship and resourcefulness ofpromoters.

In assessing a promoters competence and track record as an entreprenCRISIL looks at the past performance of the entity and group companies.

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provides an insight into the promoters ability to successfully manageentity through business cycles. In addition, the entitys ability to devsuppliers, integrate with customers, and manage banking and larelationships, also provide critical inputs to the management evalua

process.

Most SMEs are managed by first generation entrepreneurs, whose continpresence is crucial to the very existence of the business. CRISIL believes factors such as the presence of a second tier management, a fosuccession plan & a high degree of professionalism are vital to the long-sustainability of the entity. CRISIL, therefore, critically assesses organisational structure of the entity and the quality of its systemprocesses.

Financial Risk:

SMEs are typically set up as proprietorships, partnerships, or private limcompanies. SMEs that are constituted as companies are mandated to foaccounting standards prescribed by the Institute of Chartered AccountanIndia (ICAI) and the guidelines of the Companies Act, 1956. CRIexperience suggests that entities whose financial statements are governeregulation are generally stronger in accounting quality, disclosure, transparency.

CRISILs financial risk analysis is based on disclosed financial statemeCRISILs assessment of financial risk includes an assessment of size (salesnet worth), profitability, efficiency of capital and working capital managemand credit protection measures such as interest coverage, debt secoverage, and cash accruals to debt ratios. CRISIL uses propriespreadsheets that are developed especially for SMEs. The ratio calculatare broadly the same as those followed in the assessment of the lcorporates, but have been fine-tuned to suit the requirements of the sector.

For example, promoters often bring in investments in the form of unsecloans instead of equity or capital to take advantage of favourable taxapolicies; such loans are treated as quasiequity while assessing SMEs. CRIassessment of an SMEs financial risk profile also attempts to assessentitys financial flexibility. This is done in two ways by analysingpromoters net worth, and by assessing the strength of the SMEs relationswith banks.

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CRISIL asks promoters to disclose their personal net worth; based ondeclaration, CRISIL assesses the additional funds that the promoter wiable to infuse into the SME, in the event of distress.

CRISIL also contacts the SMEs bankers in order to assess the nature history of the relationship, and performance of the loans and bank accoBankers can also provide keen insights into the promoters integrity.

Rating Fees

Companies under operation

Turnover (Rs Crore)

< 10 10-25 25-50 50-75 >75Rating Fees (Rs.) 60,000 65,000 70,000 85,000 110,0

Service Tax (Rs.) 6,180 6,695 7,210 7,755 11,33

Total Fees (Rs.) * 66,180 71,695 77,210 93,755 121,3

* Special Concessional Fees are applicable for CRISIL's partner MoU Bank customand Industry Assoiation members. The fees mentioned above are inclusive of allexpenses CRISIL will incur in connection with the exercise. Please get in touch witCRISIL representatives for further details on Concessional fees.

Units with green-field projects

Turnover (Rs Crore)

< 10 10-25 25-50

Rating Fees (Rs.) 100,000 125,000 150,000

Service Tax (Rs.) 10,300 12,875 15,450

Total Fees (Rs.) 110,300 137,875 165,450

* Note: Companies under operation refer to SSIs / SMEs with audited results of oncomplete year of operations.#: Concessional Fees are applicable for CRISIL's partner MoU Bank customers andIndustry Assoiation members. The fees mentioned above are inclusive of all expeCRISIL will incur in connection with the exercise. Please get in touch with CRISILrepresentatives for further details on Concessional fees.

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List of documents required

Authority letter to sign the application. Documents supporting registration (memorandum and

articles of associations, partnership agreements,registration documents). (if applicable).

Documents supporting name change and legalstructure. Brief write-up on history of the firm /company

Documents supporting changes in capital (if any). Copy of income tax, sales tax, excise and wealth tax

returns, if filed.

Copy of the audited accounts for the last three years(where accounts for the last year have not beenaudited, provisional accounts duly certified by aChartered Accountant, along with two years auditedaccounts, are to be submitted).

Copy of insurance policies of assets. Certified net worth statements of all directors/

partners/proprietor.

In case of new project/expansion, copy of the projectreport containing a brief project profile, cost of project,source/means of finance.

Details of subsidy and tax concession available, if any. Quality certificates, export awards won, membership of

any associations, etc.

Any other information that would enable us tounderstand your business better.

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10. ONICRA CreditRating Agency

ONICRA analyzes financial and operational performance,

connects suppliers & buyers through our online marketplace and provides a holistic financial and IT solution forMSME development and progress. The rating processincludes: a physical visit, collection, verification &authentication of data. Analysis is conducted, where factsare presented and reported. Its rating is accepted by PublicSector Banks & approved by Indian Banks Association (IBA).

Understanding the urgency faced by the MSME units,Ministry of MSME, Government of India through NSIC hassigned a Memorandum of Understanding with ONICRA to

provide Performance and Credit Rating services. Thescheme was launched by the Honorable Finance Ministerand is approved by Indian Banks Association (IBA). THEMINISTRY OF MSME IS OFFERING A SUBSIDY OF 75% ON THEONICRA RATING FEE. The scheme is set to educate MSMEunits about financial matters.

BENEFITS

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To MSME Units

Enhances acceptability with Banks, Lenders andFinancial Institution. This gives fast access to creditat low interest rate.

Creates confidence among buyers and suppliers byestablishing credibility & goodwill.

Awareness is created about the strengths, weakness,opportunities and threats. This helps in identifyingareas where improvements are needed.

Highlights parameters measuring operational,financial, business and management risk.

Higher productivity levels by highlighting strengthsand weakness of the existing operations andrecommends corrective measures.

To Banks & Financial Institutions

The rating is an additional input to objectively andscientifically decide lending options and determineterms such as interest rates, margins and collateralrequirements for SSI borrowers.

This leads to comfort level for prudent decision-making

Symmetric flow of information in the SME sector Reduction in allocation of risk capital due toenhanced asset quality Warning signals through periodic rating review Focus can be driven towards exposure on low risk

accounts

Rating Process

Submission of application by MSME unit Application has to be accompanied by the list of

documents and MSME share of rating fee (i.e.25% ofthe total fee). (The payment should be in the nameof "Onicra Credit Rating Agency of India Ltd."payable at Delhi)

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Conduct basic research Site visit & meeting with MSME management Research analysis and preparation of report approval

by rating committee

Approval of rating by the Rating Committee Communicate rational of Rating to MSME and NSIC ONICRA will assign rating within a month after the

receipt of all the documents from the MSME unit

Eligibility

A Registered MSME Unit in India is eligible to avail the

benefit of the rating scheme. A proof of registration isrequired.

Rating Scale

The rating scale is based on parameters of Performance andCredit assessments in 5 X 3 matrix methodology. Pointsrange from 1 to 5 to highest to poor performance. A, B, C forhigh, moderate, low financial strength.

PerformanceCapability

Financial StrengthHigh Moderate Low

Highest SE 1A SE 1B SE 1CHigh SE 2A SE 2B SE 2C

Moderate SE 3A SE 3B SE 3CWeak SE 4A SE 4B SE 4CPoor SE 5A SE 5B SE 5C

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Arguments against SME Financing:

SME market knowledge is difficult to acquire

A Corporate market composed of a few hundreds oflarge well-known companies as against mass marketcomposed of hundreds of thousands of SMEs indifferent Industry Sectors and Geographic areas

SME Risk is difficult to manage fortraditional banks

Financial information on the business is scarce andoften non reliable

SMEs are often under-capitalized SMEs are often unable to provide adequate collaterals SMEs lack Financial Management culture

SME banking has high cost-to-serve

One Large Corporate transaction can generatethe same Net Banking Income as 50 SMEtransactions

Also serving to Large corporate is notcomparatively costlier to the Bank than 1 SMEtransaction

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SWOT OF SME

STRENGTHS

Self relianceManufacturing flexibility Abundance of raw materialproduction Design expertise Availability of cheap labour Growing economy & domesticmarket

Progressive reforms

WEAKNESS

Highly fragmented High dependence on cotton Lower productivity

Declining mill segmentTechnological obsolescence Non-participants in tradeagreements

OPPORTUNITIES

End of quota regime Shift in domestic market tobranded readymade garments Increased disposable income Emerging mall culture and retailexpansion

THREATS

Stiff competition fromdeveloping countries; especiallyChina Pricing pressure Locational disadvantage International labour and

environmental laws

12. Conclusion

The mechanism of rating of small and medium enterprises(SME) is a formal step in the right direction to revitalise SME.It is in its nascent stage, but the same, after stabilizationmay bring in good results for the banks. Comprehensive

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rating is going to help the banks as they will have an easytool in the form of third party evaluation.

As the fast changing global economic scenario has broughtmany challenges and opportunities, the mechanism of

rating of SME's would avert the risks caused by thesechanges.

A good rating enhances the acceptability of the SMEs withBanks, FIs, SME's customers and buyers. It also facilitatesprompter credit decisions from banks on proposal of SME.Rating would help a company in easy approach to variousbanks and also facilitates in getting cheap interest rates onloans. It would also infuse a sense of confidence amongstbuyers.

CRISIL has come up with special rating scheme which isfocused on bringing benefits to SME and accommodatesspecific industries and issues. It requires less informationand the reliability is based on the data collected fromstakeholders and beneficiaries.

Credit risk constitutes default risk, exposure risk andrecovery risk. Credit risk is inherent in all banking activitiesand banking failures can be attributed to poor credit riskmanagement. Hence credit rating is of at most importance.

SMEs have now become competitive and currently usecutting-edge technology.

Credit rating schemes have become a path-breakingmeasure. The National Small Industries Corporation hasrecently launched an attractive scheme for Small ScaleIndustries, providing a subsidy of as much as 75% of therating fees.

Clearly, ratings have the potential to transform the waySMEs are integrated into the financial system. But rating

agencies must recognise the special initiatives they willneed to take in this regard. They need to launch outreachinitiatives, educating the SME sector on the benefits ofratings. Rating agencies also need to have specialisedteams and analytical tools customised for the SME sector.

For the SME sector as a whole, ratings can provide animportant impetus in raising standards through better

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financial discipline, disclosure and governance practices.Surveys among larger enterprises clearly show thatmanagements feel ratings have provided value that goeswell beyond the rating symbol. In the SME sector too,ratings can be an important feedback tool for

managements. An interactive rating process helpsmanagements gain unique perspectives on business andfinancial issues and on best practices, from rating expertswho have in-depth sector knowledge and understanding ofrisk.

A rating exercise can help SMEs better understand whatinitiatives they need to take to improve their operating andfinancial positions. Additionally, as the number of ratedplayers in the SME sector increases, there will be greatertransparency, as more and more information is demanded

and made available

Because of all this Banks are entering in to MOU withexternal rating agencies for rating of SMEs. Rated accountsare taken up easily for processing of credit proposals. Therating agencies may also share vital information on specifictype of industries, which may affect the banks. Further, thebanks may also seek the assistance of the rating agenciesto develop products suitable to a particular industry/activity.

Clarity and transparency in the methodology of rating and

the parameters considered for rating by the external ratingagencies would enable the bankers to match the same totheir internal credit appraisal parameters. Integration ofexternal credit rating with credit appraisal is necessary toensure efficiency in credit delivery.

BIBLIOGRAPHY

http://www.smera.in

www.crisil.com\ratings

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http://www.smera.in/http://www.smera.in/


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http://www.smeworld.org/

http://exportable.nafenindia.com/intro.php

http://www.crisil.com/credit-ratings-risk-

assessment/nsic-ratings.htm

http://www.smallindustryindia.com/ssiindia/statistics/economic.htm

http://www.banknetindia.com

http://www.onicra.com

http://msme.gov.in/

http://www.ciol.com/News/News-Reports/SME-contribution-to-GDP-is-projected-to-go-up/29908111015/0/

http://www.unitedbankofindia.com/sme-segment.asp

http://www.axisbank.com/corporate/credit/smedefinition/smedefinition.asp
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