Opinion | A conflict-ridden SIDBI needs the government to clarify its role

In their book, In Service of the Republic, Vijay Kelkar and Ajay Shah warn against distortions caused by the government and its entities being both player and umpire in various sectors . In financial services, we have an array of apex financial institutions (FIs). Some of these have quasi-regulator status, a market-development mandate and also commercial aspirations—a problematic trinity. It is pertinent to examine the role they play, whether their interventions are strengthening the markets they serve, or, indeed, if they have become an anachronism. We focus here on Small Industries Development Bank of India (SIDBI) for the micro, small and medium enterprises (MSME) sector.

SIDBI and its various subsidiaries (MUDRA, SIDBI Ventures, etc.) have been dominant players in the MSME landscape. As per its 2019 Annual Report, SIDBI’s asset portfolio of over ₹1.5 trillion comprises primarily refinance to financial institutions (about 90% of its portfolio), and then direct lending to MSMEs. On the liabilities side, SIDBI raises significant resources from the priority sector shortfall (PSS) funds of banks, among others—these are fairly low-cost liabilities. Now consider the credit demand of MSMEs in India. This credit gap (difference between formal supply and MSME demand) is estimated to be in a range of ₹20-25 trillion by the 2019 Report Of The Reserve Bank Of India Committee On MSMEs. The big question is whether SIDBI’s resources are being used efficiently to close this credit gap. A large balance sheet is not a relevant metric for a development FI. Rather, we should evaluate incremental credit flows to the sector as a whole by all FIs and the reduction in credit spreads over time on account of better information about the credit quality of these enterprises.

In this context, refinance and direct loans are instruments with a limited multiplier impact. They provide low- cost liabilities to the FI to then lend on to MSMEs, but do not adequately address fundamental frictions in the MSME credit market; ₹1 trillion of direct lending/refinance will at best produce a proportionate ₹1 trillion of lending to MSMEs. When refinance is not performance-based, it has the added challenge that it may not be deployed for the most efficient intermediaries and high-potential MSMEs. Alternately, if these resources were deployed in MSME loan securitization or bond programmes as a first-loss default guarantee, the same ₹1 trillion could unlock extra resources of ₹10 trillion. Similarly, a market-making role for SIDBI on an MSME bond issuance platform would catalyse participation by a broad range of investors, while enhancing transparency with respect to the underlying borrowers.

The direct lending portfolio of SIDBI, albeit considerably smaller than the refinance portfolio, is also problematic as it ends up competing with market participants/FIs, which is a direct contradiction of its development mandate. The RBI Committee on MSMEs chaired by U.K. Sinha had recommended discontinuation of direct lending activities.

While SIDBI’s Credit Guarantee Fund Trust for Micro and Small Enterprises is a credit guarantee programme, it guarantees MSME customers individually and offers fairly generous credit coverage in theory. However, all banks report significant delays in payment of these guaranteed amounts. The low off-take of a 100% guarantee structure announced in the context of the MSME covid relief measures, particularly among private banks, is a reflection of the low credibility of the guarantee administration. The UK Sinha Committee had also noted that there are multiple credit guarantee schemes in operation that are aimed at the MSME segment with quite a few overlaps and several of them closely administered by SIDBI. It recommended that all credit guarantee schemes be delinked from SIDBI, and brought under a single professionally-managed institution that would be subject to RBI regulation and supervision, so that there is no build-up of risk over time.

While this column has focused on SIDBI, the broader question we posed at the beginning of this article is the real issue. The State cannot be both a player and the umpire at the same time. Even further, the mandate, the performance and the limited efficacy of financial institutions—banks or apex institutions—are artefacts of their ownership, operating culture and the regulatory environment. Apex institutions were conceptualized as part of a financial system vision characterized by “grand bargains” (a term coined by Raghuram Rajan)—low-cost liabilities in exchange for development mandates. Priority sector lending has a similar flavour. The basic task, thus, remains to realign the financial system to focus on its core goal of allocational efficiency and achieve market development through a combination of well-designed instruments and institutions, not blunt mandates.

India had arrived at the fork in the road perhaps a few years ago. It has to make a choice, learn from others’ and its own experiences and chart a path in the financial sector, including a clear vision for the role of government to deliver on economic development and growth imperatives. We realize that many of the changes we have proposed may not come about independent of the answers to these questions.

Bindu Ananth & V. Anantha Nageswaran are, respectively, chairperson of Dvara Trust, and member of the Economic Advisory Council to the Prime Minister. These are the authors’ personal views