SMEs largely availing loans from NBFCs for expansion

Vimal Bhandari & Ashish Kohli

Historically, Indian SME segment, accounting for a significant proportion of manufacturing and exports with the job creation capacity of 1.3 million jobs per year and employing around 60 million people, has largely been dominated by self-employed non-professionals such as traders, manufacturers and service industry. One of the major SME sector consists of self-employed professionals mainly doctors, CAs, architects and lawyers who encash their parental professionals. On a year-on-year basis, SMEs need a total funding of $650 billion for sustained business operations and mainly for growth capital. Gaps in funding procurement for the SME sector can be gauged from the fact that around 93% of the SMEs depend on the unorganised sector or self-finance like gold loans largely characterised by high interest rates. Despite the government’s push for improved lending fundamentals in the sector, a huge gap continues to exist between requirement of funds and actual availability of funds. However, with the emergence of a new generation of SME entrepreneurs whetting their appetite for existing business expansion plans and new business ventures in the form of start-ups, especially in tier-II and tier-III cities, there is a need for tailor-made financial products like secured loans, auto loans and machinery loans. Over here in this space, NBFCs play a vital role since they are known for lending customised products suitable for the needs of SMEs in these cities.

The younger generation of doctors, CAs and architects in Tier–II and Tier–III cities are largely looking to expand their professional practices by way of the geographical presence and this entails the need of funds at reasonable lending rates. These professionals are largely availing of customised secured loan products from NBFCs at competitive rates which results in lower EMIs coupled with longer tenor for revamping their existing businesses or setting up new premises like doctors starting up multi-specialty hospitals in small towns. The availability of cheaper loan products have enabled medical professionals to equip their hospitals and medical clinics with latest diagnostic tools and advanced patient monitoring systems. Nowadays, the pertinent need for any SME is technology and CRM which need funds and generally gives high returns. This has not only helped the medical fraternity to considerably improve their bottomlines but has also helped them to cater to populations in these areas, cheaper access to the latest medical treatment facilities which adhere to global standards. Easy funding from financial institutions have also allowed small-time professionals to set up 2-3 offices within the same geographical spread which can be serviced by them on a rotational basis or the same can be a joint venture with other professionals who do not have the means to set up their own facility.

With an increase in business and trade transactions in small towns and need for small traders and businessmen to comply with complex taxation procedures and maintain transparent balance sheets, there is a steady demand for accountancy professionals like chartered accountants. These professionals are also largely approaching NBFCs for loans to set up their own office space with modern amenities which include latest accounting software packages. The CA can also use funds availed in form of loans to expand their business through opening multiple offices and hiring qualified accounting staff. Typically these CAs need more professionals in the same field to attract the audits of the companies and government institutions. As they do not have a heavy interest burden on their loans, they become competitive and act as a win-win for both customers and them.

These professionals need funds against property or for purchase of new commercial property for self-occupation. Self-employed professionals like doctors and accountancy professionals in small towns and cities hold commercial and non-commercial properties which they can mortgage for loans at a comparatively competitive rate of interest as compared to a personal loan which entails a huge interest component and are generally for shorter tenor. SMEs can avail of offerings like Loans against Property (LAP) as it provides them with the much-needed cushion of a longer tenor and reduced EMI which can be easily serviced by the cash flows of the SMEs. Small entrepreneurs also avail of loan facilities for buying properties which are long-term value enhancing assets rather than paying rentals. Lower loan servicing costs and easy documentation processes are making these loan products a huge draw among the SME communities in Tier-II and Tier–III areas.

Normally leading NBFC/banks lend to these category of borrowers secured loans against property ranging from Rs 30 lakh to Rs 5 crore. The end use of such loans can be growth capital or acquisition of new assets. Such SMEs should look at the cost of borrowing vs yield they expect by deploying these funds. Foreclosure charges play a very vital role in this as these are high-value loans and being larger tenor, principal run off is lower in first 2-3 years. For example, a normal loan against property loan for 15 years, the runoff in first year is only 2-3% of the principal and rest goes as interest. Thus exit cost is very pertinent for SMEs to decide from where to avail such facility.

NBFCs have largely contributed to the creation of a large entrepreneurial community in Tier-I and Tier-II areas. Smaller cities are also developing at a faster pace and witnessing increased investment and employment opportunities with presence of modern amenities as a large number of SME professionals with increased liquidity at their disposal set shop and plough their returns back into the economy.

The writers are MD and Head-SME Business at IndoStar Capital Finance Ltd., respectively. IndoStar Capital is an NBFC promoted by leading global financial institutions and private equity players, including Everstone and Goldman Sachs