In the current era, the SMEs occupy a prominent role as they are the main growth drivers and economic transition to a higher plane. In India, they have played a vital role in achieving overall economic development. Adequate finance with utilisation of enhanced risk management practices is one of the significant factors to assure SME segment to grow in India. In fact, SMEs rely on their individual investments and bank finance to offer financing options. However, SMEs face issues in terms of adequate credit delivery, improved risk management, technological up gradation of banks, and attitudinal change in the bankers majorly. Among these issues, inadequate financing to SMEs need much concentration
Based on the above context, this thesis aims at analyzing the best practices of SME financing and credit risk management in India with special reference to State bank of India (SBI) and Oriental Bank of commerce (OBC). At the end, few suggestions for improving the current situations of SBI and OBC are also offered.
CHAPTER-1 INTRODUCTION
1.1. SMEs in India:
India, being a developing economy relies on SME segment drastically to preserve its economic development, trade, and generate employment and for organising new entrepreneurship. In light of this view, various development initiatives like five -year plans have been designed by the Indian government for preserving SME growth. In fact, they have accounted a steady growth in the last five decades.
Indian MSME Annual report 2011-2012, published that the anticipated position of SMEs according to the Ministry of Industries during 2010-11 is expected to be 311.52 lakh units(1 lakh=100000), 732.17 lakh employment, investment of Rs.773487 crore (1 crore= 10 million) and Rs.1095758 crore productions. Thus the performance of MSMEs is valuable and worth noting. About 45 percent of the manufacturing productivity and 40 percent of the national exports of the country have been contributed by the SME sector. SME units in India are being funded by foreign and local fund providers. However, to constantly improve their business operations, develop new products, invest new staff or production facilities, financing is needed at this instance. This is because small business begins with the support of one or two individuals who gradually seeks out for financial assistance. Hence, SMEs need the financial support from banks, capital markets and other suppliers of credit when they desire to expand or innovate furthermore (Ayyagar et al., 2007).
Fig 1: Data of SMEs in India Fig 2: Comparative data on growth rates of MSME sector
http://www.smeworld.org/userfiles/R%20Jaiprakash%20Tabel%201.jpghttp://www.smeworld.org/userfiles/R%20Jaiprakash%20Tabel%202.jpg
Source: Jayaprakash Reddy. 2012. (Aug) A New Model for Indian MSMEs to End Their Woes, available at: http://www.smeworld.org/story/top-stories/a-new-model-for-indian-msmes-2.php (accessed on 11th sept, 2012)
The following are the major hurdles faced by the SMEs in India:
Financing:
The issues such as inadequate access to finance and timely credit, escalating costs are considered as the major concerns for under-utilisation of the manufacturing abilities of SMEs.
Infrastructure:
Also, the infrastructural capabilities have not accomplished to the required phases. Therefore, this limited the execution of private initiatives in this sector. Hence, there is need to create enhanced infrastructural capabilities for SMEs as a higher priority.
Taxes and regulations:
The multiplicity of regulating agencies contribute harassment and inspections with higher influence on operations of SMEs when contrasted with large units
Marketing:
Due to the rising access to modern means of communications, especially revolution in the information technology created no longer market to the SMEs products. Therefore, SMEs should join hands globally in order to create the commodity chain. The overall SME mother units of the marketing and production should be endorsed in prospects.
Technology:
The cutting-edge technology has turned to be complex for SMEs owing to huge primary expenses. As a result, they left them behind in the competition race. The inability to access timely and adequate finance is the major hurdle faced by them. Having low market credibility, insufficient credit information and constraints in evaluations are the main reasons behind low credit penetration in SMEs. This ultimately contributed sub-optimal credit distribution and services to the sector.
Since the access of SMEs to investment market is very restricted, they rely hugely on borrowed funds from banks and financial institutions. When investment credit to SMEs is offered by financial institutions, commercial banks extend working capital. However, in the recent past, Term loans and the working capital are becoming much important one accessible from the same source with respect to the rising demands of universal banking service predominantly. Thus, the changed global atmosphere has generated demand for advent of new financial and support services by SMEs in addition to the traditional finance requirements used for asset creation and working capital. Hence, there is critical need to regenerate SME financing which must be timely and cost effective.
1.2. SME financing:
In both industrialised and developing countries, Small and medium enterprises are important for achieving economic development and in creating new jobs opportunities. Financing is essential to assist and extend the operations, improve new products and afford new staff or production capabilities. A majority of small businesses initiate their industry with their individual investments and move onto the relatives and friends in return for a share in the business. The SMEs will be successful if they acquire new investment to extend or innovate further. Sometimes, they witness failure if they find it harder to acquire financing banks, capital markets and other credit suppliers. In a fast-changing knowledge-based economy, the 'financing gap' is considered as important one due to speed of innovation in this regard. Innovative SMEs having huge development prospective which are high -technology sectors occupies an active role in increasing output levels and sustaining competitiveness in the current days. However, based on the potential of offering new products and services, SMEs require investment in order to expand their functioning. As a result, SMEs are in need of potential investments otherwise they encounter potential growth loss for the economy. Though there are variations in the emerging SMEs when contrasted to others, this segment has been very dynamic and stood as the detriment of job creation and competitiveness in the present days.
SME financing refers to the funding of small and medium sized enterprises and regarded as the major function of the general business finance market where the capital for dissimilar firms is supplied, acquired and priced. Capital is supplied through the business finance market in the forms of bank loans and overdrafts , leasing and hire -purchase arrangement , equity or corporate bond issues, venture capital or private equity and asset based financing like factoring and invoice discounting. However, these SMEs face issues in terms of adequate credit delivery, improved risk management, technological up gradation of banks, and attitudinal change in the bankers majorly. Among these issues, inadequate financing to SMEs need much concentration. At this point of time, it is very important to mention that Small Industrial Development Bank of India has accomplished outstanding results in the SME financing domain and in fulfilling their credit necessities time to time in dissimilar forms like long term project finance, working capital finance, bill discounting and many more.
Based on the above context, this thesis aims at analysing the best practises of SME financing and credit risk management in India with special reference to State bank of India and Oriental Bank of commerce (Beck & Demirgüç-Kunt, 2006).
1.3 About the different type of credit risks and methods of computation:
In India, banks play a key role in SME financing. A number of banks are supporting SME businesses by offering financial options. Usually, specialized loans are the means used by SMEs for fulfilling its financial needs. The core reason behind the choice of bank loans by SMEs rather than other financing sources such as PE funding, venture capital is that 'only interest is to be paid and stake is not diluted'. Hence the owner would not loose complete command over the SME. As the banks keep on investing on SMEs, certain risks would emerge into picture, out of which credit risk is the most predominant one (Ciby, 2006).
In context of banking, credit risk consigns to the risk probed by borrower towards any kind of debt due to failure in making payments as per obligations. Primarily this risk is related to lender and involves lost interest and principal, interruption of cash flows and augmented collection costs. The loss due to credit risk can be partial or complete and evolves in several conditions (Charles, 2010).
Credit risks faced by banks while funding small and medium scale organizations can be of different types. One such a classification of credit risk consists of credit default risk, concentration risk and country risk. A brief account of such credit risks is as follows: (Amalendu, 2012)
Credit default risk: it refers to the risk of failure caused by a debtor who is unable to repay the loan completely or the debtor has a due of above 90 days towards any material credit debt; default risk can affect the whole credit-responsive deals involving securities, derivatives and loans.
Concentration risk: This risk is linked with any individual exposure or set of exposures having the prospective to cause huge losses which challenges core operations of banks. It can crop up either in the form of industry concentration or name concentration.
Country risk: The threat of loss resulting due to a independent state blocking foreign exchange payments (conversion/transfer risk) or in such cases it evades its debts (sovereign risk) (Morton & Johnathan, 2008).
In addition, some different kinds of credit risks exist which arises due to SME financing such as:
Transaction risk: it causes complexities for companies transacting with multiple currencies, since exchange rates can vary majorly constantly. This unpredictability is generally hedged or minimized by involving in currency exchanges and different identical securities (Dennis, 2007).
Portfolio risk: This type of risk arises from activities of finding on markets which are not related to the bank's core competencies or determined credits towards a specific segment or investing for limited big borrowers (Shrimohan, 2008).
The current methodologies exercised for measuring credit risk differ from each other owing to their suppositions related to aspects such as credit exposure, recovery arte and default probability. Credit risk rating is one of the best methods to estimate credit risk. For this purpose usually S&P (Standard & Poor) methodology is widely used. In this method, ratings offer an estimate for the comparative creditworthiness of the unit considering the extensive range of aspects like competitive status, environmental circumstances, management quality and financial soundness of the company (Ashan, 2008).
Alternatively, financial statement analysis (FSA) models are also extensively used for credit risk calculation. The models in this category offer a risk rating depending on the assessment of several items as well as ratios of financial statement of all borrowers. Good examples of such models are Moody's RiskCalc and Z score (Gutzeit & Yozzo, 2011). Additionally, structural models can also be used to gauge variations to default chances depending on the DD) distance to default) concept of a company which is an amalgamation of debt, asset values and standard deviation of fluctuations in asset values. Other method like credit metrics and credit portfolio view can also be used by banks to effectively measuring credit risk exposure (Allen & Powella, 2011).
1.4 Best practices of credit risk in State Bank of India (SBI):
Credit risk is one of the major challenge occurred in the banking institutions which adversely affects the performance and outcomes. It is required to employ appropriate strategies and best measures against the credit risk for business intelligence. The process of credit risk management referred as recognizing, evaluating, computing, monitoring and managing of the exposure concerned to credit. Particularly in state bank of India, the key components for mitigating credit risk are working beneath sound credit funding process, developing proper credit risk circumstances, ensuring sufficient power upon credit risk and upholding a proper credit administration, computation and organizing (Benerjee, 2004). The basic approaches for mitigating the credit risk and managing the financing in SBI are described below:
The approach like internally oriented centres upon approximating the anticipated costs as well as the instability of credit losses in future on the basis of assessment activity of the organization.
Future credit risks upon a lent loan referred as the financial product of the probability which the users will default and part of lent cash that would be lost within default case. Such part relies upon both user and the loan type.
To some extent that risks could be expected, anticipated losses must be differentiated into product costs and enclosed as common and recurring price of performing trade that implies they must guide the charges to verify loans. Instability of risk rates concerned to credit approximate anticipated levels should be enclosed by means of losses-mitigated returns (Raghavan, 2003).
In addition, SBI being employed various models intended to manage credit risk. Those models or well-structured credit risk measures are industry exposure norms, Credit Risk Assessment (CRA), substantial exposure norms, counterparty exposure limited and macro financial stress tests etc. Recently, this bank set in procedure a significant project in order to migrate into approach namely Internal Ration Based (IRB). Varied models for assessing the credit risk are Exposure at Default (EAD), Probability of Default (PD) and Loss Given Default (LGD), which are being incorporated in the enterprise. In addition, for mitigating credit loss, data mart is being arranged. Additional strategies against risk are behavioural scoring and retail scoring. These models or strategies are developed for assisting the risk organizer towards project risk, make sure profitability and explore contemporary opportunities of the business. Successfully managing the credit risk relies upon intelligent execution, responsible application and sound design of the structure of the practice (Aggarwal and Bhavet, 2011).
1.5 Best practices of credit risk in Oriental Bank of Commerce:
Credit risk management in oriental bank of commerce is a part of management practices that organizes the credit risk constantly with the appropriate strategies. Risks are influenced by single user exposure, group exposure towards sensible facets, constrained and prohibited fields of providing money, inter-bank, considerable and industry exposure.
In regard to oriental bank of commerce, various policies and procedures for and a representation of utilizing on and off balance sheet netting by the bank to some extent for the purpose of mitigating the credit risk and managing the financing concerned to SMEs. The loan agreements attained by the oriental bank from their users carry a clause that the banking firm shall contain a charge, lien and authority to set-off, change or identify upon each and every security and all cashes owned to the user or borrower. As there is the instance might be reputing to their credit in any bank accounts and financing firms must comprises all powers, authority and rights to change or clear up the dues associated with loan accounts from the volume of protections so that identified and recovered the exceeded earnings from the user accounts by means of collateral management policy, which referred as credit risk management strategy (Sumant, 2009).
This policy significantly assists in organizing the collateral which encloses appropriate rules and strategies for choosing proper collaterals, problem within the activity, eligible economic collaterals and assurance. In perspective of banking sector, collateral defined as the assets or powers offered to the banking firms by the user or borrower for providing the security to the credit facility. Other practices that are employed in the oriental bank of commerce for managing the credit risk are facilitating the bank to execute Basel II requisites and policies, web facilitated and user or borrower based alongside user interface designed by means of appropriate technology. In addition, this bank has comprised credit risk management committee (CRMC) which assists in revising the strategies, processes and structures pertaining to the credit management and organizing over a period of time. The main mitigation model developed by the risk managers pertaining to credits of oriental bank of commerce is scientific and robust (Vibha and karthik, 2010).
1.6 Comparison of best practices of credit risk management of SBI and OBC:
A majority of prominent banks have eliminated the classical methods of organising risk. As a substitute, banks are implementing an enterprise credit risk management approaches that offered a combined view of the risks witnessed by the organisations. Usually, a tier-1 investment bank views enterprise credit risk management as the overall banking arrangements discarding IT. This includes Credit risk, market risk, financial control, data centres in the corporate bank in which technology is an external entity. However, the process of executing a scalable and reliable enterprise risk management framework is a challenging attempt for a majority of banks. But, banks accomplish credit risk management by following various strategies.
Considering the cases of SBI and OBC, Both of these banks are leading top position over their competitors in India as they successfully recognized the benefits of credit risk management and accordingly to mitigate it, relatively various best measures have been employed in the firm. As a result, incorporated strategies and developed policies towards credit risk are efficiently performed and derived best outcomes to the SMEs that in turn accelerated the financial position, firm performance and growth. With the reduction of risks especially credit risk, these two banks achieve prominence position across the market. As per their financial outcomes and status, it can be considered that the practices implemented by SBI and oriental bank of commerce are well developed and efficient compared to the other banks in India (Sumant, 2009).
1.7 The best practices of managing credit risk and financing internationally:
Over the years for number of years, the financial institutions like banks have witnessed a lot of complexities. However, the major reasons for causing severe banking issues are directly associated to lax credit principles for borrowers and counterparties, deprived portfolio risk management or insufficient attention to variations in economic or other situations that contributes to a deterioration in the credit standing of a bank's counterparties. This experience is very same to the G-10 and non G-10 countries.
Credit risk is normally described as the potential which a bank borrower or counterparty will not be ready to accept its obligations with respect to the approved terms. The significant objective of the Credit risk management lies in increasing the bank's risk -adjusted return rates by preserving credit risk exposure within the adequate limitations. The banks are required to organise the credit risk inherent in the overall portfolio and the risk in individual credits or transactions. Hence, the banks must take into the association among the credit risk and other risks predominantly. The successful organisation of credit risk is regarded as one of the main components of a complete method to risk management and vital to the enduring victory of any banking institution.
Loans are considered as the largest and most important source of credit risk in majority of banks. The other sources involve the common action that takes place in the banks such as banking books and in the trading books and on and off balance sheet. Today, banks witness credit risk owing to loans and including approvals, interbank transactions, trade financing, foreign exchange transactions, swaps, bonds, equities, financial futures, options and in the extension of commitments and assurances and the transaction defrayal.
As exposure to credit risk pursues to be as of the prominent sources of complexities in banks in the world, the banks and the supervisors must be capable to extract the needed lessons from the prior experiences. In fact, the banks must develop intense understanding about the requirements to recognize, determine, scrutinise and leverage the credit risk and to calculate that they maintain adequate investment against this risk and that they are adequately waged for risks acquired. the On a global level, the Basel Committee came into existence so as to boost the banking supervisors and to promote vigorous credit risk management practices. Although the principles contained are most clearly applicable to the business of lending, they can be applied to all activities where credit risk is present.
Generally, the fund managers executes a complete and clear appraisal of their portfolio in order to assure the best practice for managing risk and financing. The aspects such as Asset-class, size, diversity, exposure to developing markets, and future extension into the data -poor atmosphere are paid attention. Consequently, describe the methodology and the information required to develop risk management capabilities. Holistic frameworks in view of overall classes in blend are also recommended as significant practices for managing credit risk and financing. This contributes to a realisation of how asset classes interconnect and how they can impact and be influenced by one another. In the corporate bond market definitely, signals in the equity market can contribute arbitrage opportunities and vice versa. In fact, the association among the probability of default and market or liquidity risk and the spread on corporate debt versus a company's share price can offer actionable insights for investors and risk managers.
Simultaneously, on the global level, different workshops have been conducted to identify the best practices of managing credit risk and financing. These workshops revealed that the Basel committee principles occupy a prominent role in order to assess the overall risk to which the banks are exposed. Primarily, the process of computing risk includes gathering statistical data and compiling various indicators of financial institutions consistent with the IMF approach (Clerc, 2004). As a difference, these workshops stated that there are comprehensible synergies and connections linking the international community compliance to calculate risks at the global level and the execution of IASB's international accounting principles underlying the work of the Basel Committee on Banking Supervision (BCBS) on the other. Based on the data accessibility, various highly-developed instruments and models can be employed by the banks to assess the credit risks. All these practices are based on two significant aspects, the emergence of a risk culture and the risk mitigation by constructing regulatory investment consistent with the risk exposure level of every credit institution [1] .
Basel committee's principles of credit risk management:
A forum for regular cooperation on banking supervisory matters is offered by the Basel Committee on Banking Supervision. Four different papers are issued by the BCBS in order to offer guidance to the banks and the banking supervisors on dissimilar concepts of managing credit risk in banking actions. All these papers are served as the ongoing attempts made by the committee so as to strengthen procedures for risk management in banks. The core motive of this committee is to extend the realization on significant complexities and develop the excellence of banking supervision in the world. It looks into various means by exchanging the information on national supervisory issues, approaches and techniques with a consideration to approve a common realization. The committee at times employs this standard realization to initiate guidelines and supervisory standards in key regions that are assumed to be enviable. In this perspective, the committee is regarded as the best one for offering international principles on capital adequacy and offering core principles for Effective Banking Supervision and the concordat on cross-border banking supervision.
All the practices provided by the Basel committee identifies the following regions specifically
Incorporates a relevant credit risk circumstances
Functions under a sound credit -granting process
Preserves an accurate credit supervision , determination and scrutinisation process
Assuring adequate control over credit risk
Though, specific credit risk management practices vary with in the banks based on the nature and difficulty of their credit derivatives, a wide-ranging credit risk management program will always identify all these four regions effectively. Also, these practices can also be executed consistent with the sound practices associated to the asset quality, the adequacy of provision and reserves and the disclosure of credit risk.
The best practices of financing or investment selected by individual investors depends on a set of factors both onsite - offsite supervisory method and the extent to which external auditors are also employed in the supervisory function. However, all the members of the Basel committee concurs that the principles explained are utilised for analysing bank's credit risk management system. The supervisory estimations for the credit risk management approach utilised by individual banks must be proportionate with the extent and complication of the bank's proceedings. Therefore, the supervisors required to measure that the credit management method utilised is adequate for their proceedings and that they have instilled adequate risk-return regulation in their credit risk management process in case of smaller or less developed banks [2] .
Also, one of the significant principles of the Basel Committee is to extend cooperation of supervisors internationally and to permit an effective information exchange. Such kind of coordination and interaction act as cornerstone for promoting a robust risk management practices and initiating sound supervisory standards. Significant norm, Cross-border cooperation is indeed a requirement for incorporating resolution methods for vital banks with cross-border operations thoroughly. The committee has worked a lot in analyzing a well-defined set of complexities relation with the declaration of complex international banking institutions. Sustained attempts are put forwarded by the committee in order to make stronger the resolution procedure of cross-border banking groups. As a key response, the Basel Committee and the International Association of Deposit Insurers (IADI) worked in partnership in order to initiate the core principles for effective deposit insurance systems. Thus , these significant core initiatives stands as a significant benchmark for countries to employ in framing or transforming deposit insurance systems and recognize a range of issues such as deposit insurance coverage, funding and prompt compensation. In fact, they recognize the complexities related to public understanding, resolution of unsuccessful institutions and cooperation with remaining protection net respondents involving central banks and supervisors. The committee also believed that the risk management is required to preserve with rapidity having financial innovation by expanding the members in it. In fact, the governance body needs to be enlarged so as to extend the capability to execute its core mission, and to reinforce the regulatory practices and standards worldwide.
Effective credit risk management practices: The cases of some international banks
Bank of America believes that their lending and investment actions have environmental liabilities related with them. As a result, they consider that environmental sensitivity occupies as a vital unit in the credit, investment, underwriting and payment processes. Additional policies are developed in order to recognize, evaluate, and avoid environmental threats furthermore though the bank's regulation needs that consumers should be in full compliance with environmental laws and regulations.
The bank's environmental policies established an Environmental Due Diligence process (EDD) which is normally implemented by a loan officer or relationship manager. The furthermore analysis will be executed by consultants and many other experts and can involve questionnaires and explorations. Credit officer revises the customer's adherence to organisation's policy. An additional audit procedure is utilized to analyse compliance with the bank regulations and can be implemented in the life of a financial commitment or loan at any time. Particular environmental liabilities and threats have ensued in thorough lending regulations related with lofty -risk business. At this point of time, the US superfund regulation contributed to financial principles for due diligence related with commercial real estate lending. Primarily, in the early 1990's, Bank of America initiated particular environmental standards including the commercial real estate and small business segments.
The credit policy of the bank includes the relevant phases of EDD that should execute so as to prevent risks from borrowers who may be developed as a significant theme to liabilities arising from regulatory actions, and other circumstances. However, the level of EDD in a transaction is dependent on several factors involving the past and present real property utilization and situations of the loan at Bank of America credit policy initiatives.
Deutsche Bank has maintained in technology and solutions in order to provide greater understanding of clients and control over cash flows and balances surrounding Europe. Subsequently, the banks believed that Counterparty risk is the primary risk in the wake of credit crisis in the treasurer's mind who desire to work with banks that have the balance sheet and financial strength to pursue to invest in solutions distributing higher investments, cost efficiencies and consistency. However, Deutsche bank is constructing an additional amalgamated resolution that offers a solitary scrutiny across overall treasury proceedings including investments and robust cash forecasting tools. These assist the companies to attain a higher leverage and visibility over the cash so that they can generate enhanced and informed decision making successfully.
The global reach and the investment in technology facilitates Citi bank to distribute a creative mix of solutions that can be customized to local, regional and global necessities of consumers. The banks introduced its Cash2Mobile solution across various markets in Asia in the year 2011. In fact, this solution discarded the risks related with the use of cash by facilitating payment for merchandise to be gathered using a mobile devices. The bank has also beefed up its analytics capabilities with its treasury diagnostics product which assists the client benchmark their performance against industry best practice (Torre et al., 2008).
1.8 Areas of growth and improvement in India as compared to international best practices
With the knowledge on best practices of credit risk and financing in national and global context which is gained from the previous sections, it is perceived that the Indian banking institutions are required to advance the existing mitigation strategies or measures as it causes various difficulties to the business management while extending the financial business in further. Also, with respect to the global mitigation standards pertaining to credit risk and financing, Indian standards must reinforce their strategies furthermore for effective risk management to compete with the global environment. Firstly, banking sector in India must develop an individual credit-risk management policy which must specify about their credit appetite as well as the approval rate of risk-reward financial exchange at macro as well as micro levels (Basel, 2000).
Banking institutions must comprise an arrangement of checks and balances in location and bank authorities tackling with the credit will be responsible for organizing risk and in concurrence with the management structure pertaining to credit risk and financing. Its main intension is to establish and uphold proper risk constraints and risk management processes for their financial trade. In addition, banking firms must have a reliable approach for prior identification, categorization of risks & issues and its countermeasures. For effective management of credit risk and financing, it is required to uphold a varied risk possessions in conjunction with the investment needed to assists such portfolio (Chakra borty, 2005).
Additionally, it is required to work under a sound credit granting process for increasing the standards of mitigation process of credit risks and managing the financing. In this context, banks should work under well-stated and sound credit-granting criteria, which must indulge a clear representation of target marketplace of the bank and a detailed comprehending of the user or their party and also the rationale and framework of the credits and their means of repayment. The improvement with another measure is maintaining a proper computation, credit management and organizing process. Under this scenario, banks must position in the system for ongoing management concerned to their various portfolio associated with credit risk-bearing. Also, it is need to position within a system of scrutinizing the circumstances of private credits indulging the illustration of sufficiency of reserves and provisions. Banking institutions in India are stimulated to design and make use of an internal issue rating framework subject to monitoring credit risk and financing (Ferguson, 2001).
1.9 SME finance solutions:
In the current world, the eminence of SME sector is adequately identified in view of their notable offerings in attaining several objectives like employment production, creation of new entrepreneurships, input to nationwide efficiency and exports and the quantity they present to the manufacturing support of a country's economy. The Indian SME segment is so exciting that they occupy an active responsibility in maintaining the country's economic development in the present days. In fact, the General Finance Market of the country recognizes their major function in order to finance the SMEs of the country.
Recently, the World Bank has offered a $400 million extra financing loan to the Small Industries Development Bank of India (SIDBI) in order to develop the financial assistance to the small and medium enterprises of the country and to support them in the global financial crisis and the following liquidity restraints. This also identified delay in the credit development of the Indian financial sector. However, this credit facility concentrates on long- standing working investment loans for small and medium enterprises in the country and the extension of credit facilities to new geographical regions in Indian economy and thereby upholding inclusive growth surrounding the country.
The organisations whose capital units for plant and machinery do not exceed Rs. 10 million come under SME segment according to Indian government. SIDBI is incorporated in the year 1990 with an intension of upholding and financing SMEs in the country in parallel with the bank's functions engaged in financing small scale segments. SIDBI plans can be categorized into four different segments such as refinance, Bills finance; project associated direct finance and promotion and development schemes.
SIDBI provides financial assistance for small sector SMEs covering three major measures by offering indirect support to primary lending institutions (PLIs), an open support to tiny units and entire improvement proceedings and support services. It expands its functions via primary lending institutions like State Financial corporations, Scheduled Commercial banks, State Industrial Development Corporations. Thus, it presents the fiscal support to SSIs via its branches and primary lending institutions either directly or indirectly.
Moreover, SIDBI provides indirect finance (refinance and rediscounting of bills) via small scale industries and Primary lending institutions (PLIs). The line of credit is offered in lieu of finance with reference to some institutions. They provide direct finance via specially made schemes aiming particular groups or measures promoting SSIs. Various kinds of loans, promotional and developmental services, Grants and Corpus Support offered to non-governmental organisations, technology and management institutions are involved in direct Finance Services. In fact, they perform as executing agencies for SIDBI's developmental initiatives. To execute national level programmes, SIDBI looks forward to a partnership with NGOS, associate corporate bodies, financial institutions, and marketing agencies and so on (Sumant A. Palwankar, 2009).
Hence, the future of banking will certainly remained on risk management dynamics. The banks which posses the effective risk management system can only exist in the long term. In fact, the effective management of credit risk stands as a prominent element in the comprehensive risk management required for long-term banking institutions' success. Though, investment acts as the main objective of reaching unanticipated losses, it is not a replacement for insufficient decontrol or risk management systems. In the prospects, the banks should strive in order to make sound internal control or risk management processes. With the concentration on the regulation and risk management in the Basel II framework attaining significance, the post-Basel -II era will be to the banks that organise their risks evidently. In fact, Basel -II was considered as prominent drivers in forming the bank's methods of credit risk management. It is regarded as the primary framework that imposes corrective investment rate for procedural flaws; restrict violations and other operational threats by creating effective risk management control when required.
The banks having regular risk management systems would attain competitive benefit by lowering the regulatory capital charge and by adding value to the shareholders and other stakeholders by properly pricing their services, adequate provision and sustaining a robust financial structure.
The future belongs to bigger banks alone, and to those which have minimized their risks considerably.
CHAPTER-2 LITERATURE REVIEW
Literature review accounts for the critical evaluation of published knowledge about the research topic. With reference to current research area that is issues related to SMEs and credit risk management, a number of studies are been performed by foreign researchers. Nevertheless, in India little contribution is made towards it. Several studies had been executed in relation to financing schemes of SMEs by banks of public sector. A review of some relative past studies is been presented in this section to form strong theoretical foundations for current study.
According to a study conducted by Wtterwulghe and Jannsen (1997) about the contribution of banks in funding Belgium medium-scale companies, it is evidenced that similar to small-scale enterprises, the medium-sized companies are also interested towards self-financing. To the extent that external financing is considered, generally debt is their key source. Nonetheless, their small debt ratios signify that, in comparison to large-scale organizations, such companies need less way out to banks, and consequently, give less importance to their monetary function. Here, the banker has limited role and does not acts as an adviser, unless when the company decides to increase investments via stock market. This paper identified the greater need for more specialization behalf of banks such that it is possible to prevent conflicts of interests caused due to misalignment of service preferences and the customer requirements.
In a study of Kaura & Sharma (1999), attempt is made to appraise the behaviour of financial organizations which belongs to state government, central government or governmental societies endorsed for this function. Following MSME act established in 2006 towards the concern of small scale segment by Indian government, the behaviour of monetary organizations for the SMEs segment is completely transforming. Several innovations are taking place to discharge the monetary requirements of SME entities. The approach of workforce related to the aforementioned financial corporations' is also shifting.
In 2002, a research carried out by Raju by re-examining the Seoul & Bologna Charterson the small and medium scale enterprises. This paper elucidates that the definition of SME in India centres encompassing the small-sized businesses in the dearth of evidently exemplified medium business segment. An appraisal of the laws, policies and also the authoritarian and institutional structure has been carried out in adequate detail with an intention to focus on the reality that the Indian SSIS need internationally well-matched facilitation so as to maintain competitiveness regionally as well as globally. The author affirmed that appropriate and simple maintenance of institutional monetary support is highly needed, however not adequate stipulation for the development of this vibrant and dynamic segment. As well, author had predicted an apparent role for associations of small industry identified on the foundations of distinct principles. Raju (2002) argued that ratification of widespread enabling rule for this sector is needed in order to restructure the DC-SSI office and to achieve envisioned competitiveness.
A research conducted by Nambiar (2007) regarding the financing towards priority markets had laid path for thinking strategies for investment of small and medium sized businesses farmed by the bank executives. The Indian government, by means of its business strategy clearly affirmed that the business banks must provide priority management for SMEs. The behaviour of banking executives is as well argued by the researcher. However, it is not enough to empower the SME market, as this sector was completely ignored over the past few decades owing to the evolution of multinational companies. By implementation of MSME act 2006, the Indian government clearly specified the indication to the banking staff to offer the credit utilities to the small and medium scale firms.
In an investigation executed by Raju (2008), analysis revealed the fact that SMEs are backbones for manufacturing sector of Indian market and emerged as vehicle of economic development of nation. It is guesstimated that about 90 percent of business entities of India is contributed by SMEs and accountable for 40 percent of value count to manufacturing segment. In this article, researcher closely evaluated the development and progress of small scale industry of India starting from 1991. The third section of this paper argues about the current status of SMEs and issues faced by them while marketing, lending, license related problems in detail. The MSME (micro, small and medium enterprise) act introduced in 2006 is aimed to improve the segment. The terms and conditions of this Act are investigated thoroughly. The last section presents idea about future strategy framework to maintain sustainability in this sector.
Rani & Rao (2008) carried out an investigation which exposed the reality that SME sector is a lively and pulsating one and it operates as an engine of development in current millennium. Funding of MSEs (micro and small enterprises), which is a segment of SME market, has been provided with unusual consideration by banks as well as financial organizations and is involved in priority area lending. Notwithstanding the special attempts, simply 14.3 percent of approved small companies have used the benefits of institutional credit according to third All India Census regarding Small Scale companies (2001-2002). In between the period of 2000-2004, organizational credits towards MSEs has evidenced distributing patterns in spite of the increased liquidity level in Indian banking system and programs conducted by RBI (reserve bank of India) and Union Government. Rani & Rao (2008) investigated the current trends in MSE credit flow, more specifically medium companies in a narrow manner, beginning with commercial banks and then the SIDBI (small industries development bank of India), then summarizes the suggestion of working group headed by A S Ganguly and the internal group managed by CS Murthy. The instruction of Union Ministry of finance for the public banks is to increase the credit flow to two times for SMEs while framing the five-year plan of 2005-2010. A significant progress is been observed towards this direction in 2005-2006. This mission is to be followed seriously in the coming four years, out of which the duration of 2007-2007 is been accomplished with positive outcomes. New approaches and trends for next years' are put forward in this paper. The SMEs require unique and innovative treatment by framing exceptional credit instruments to improve their potential.
A study is made by Torre et al., (2008) and examined the conservative knowledge in policy and academic circles. In this paper the authors argued that, whilst the large-scale and overseas banks are usually not concerned about lending in SMEs, the niche and small banks possess an benefit in serving such companies, because it is possible to overcome opaqueness of SME by means of relationship financing. Also, this paper represents that there exists a gap in between this perception and what banks usually do. In general, banks perceive the SMEs in the form of strategic and core business and appear well placed to extend their business relations with the SMEs. The latest improvements in bank engagement with small and medium companies in different developing economies are presented in this paper, which evidenced that neither niche nor small banks are extremely reliant on the relationship funding. Instead, any kind of banks are providing to SMEs and majority of multiple-service-based banks possess a competitive benefit in supply a broad variety of services and products in large-sale by the implementation of innovative technologies, risk handling systems and business models.
Another research is performed by Mercieca et al (2009) and assessed about the manner in which the concentration as well as competition of banking sector of Europe impacts the investing associations between the banks and SMEs. Latest empirical account recommends that competition and concentration incarcerates various features related to banking system. Implementing an exclusive dataset for the SMEs for the purpose of chosen European areas, the researchers of this paper had empirically studied the effect of budding competition and focus on different funding relationships sustained by SMEs. In addition, they identified that competition shows a positive impact on the financing associations, weak substantiation that focus decreases the volume of banking bonds and feeble persistent fact that they use to balance each other.
As per the study of Popli & Rao (2009) concerned with the banking sector, it is observed that maintaining quality in customer service is having a great role, specifically in light of increasing competition and persistent business progress. This research is an effort towards determining the quality of service offered by the banks belonging to public sector for the SMEs which contributes a lot for the economy of India. The key conclusions of the research are: (1) sophistication and communication shows a larger impact on the services and there exists a requirement for providing training to the workforce in order to enhance the service experience of the customers (2) in comparison, the quality of services provided by private banks is better than public banks (3) most of the survey participants stated that there is no sufficient credit flow for the SME market and accordingly the government need to take essential steps to make the needed finance accessible simply on convenient conditions (4) majority of the participants think that the procedures for SME segment of various nations are more efficient when compared to Indian policies; (5) setback in processing of loan application owing to uncooperative behaviour of bank staff, is mentioned as issue faced by many of the respondents. Usually, banks sanction funds in opposition to any securities and as majority of 86 percent of the participants are in a opinion that the management of bank request for guarantee security or assurance by a third-party, though the project is been evaluated as doable and principal security is sufficient.
In a preceding investigation by Popli & Rao (2009), the authors scrutinized that SMEs are been internationally identified as key elements of a domestic wealth and key contributors for generation of employment in a nation, despite the global boundaries. The SMEs have become the lifeblood for any progressing economy. For a developing nation such as India, SMEs are vitally important as they work as socio-economic actor to make sure complete progress of country. In India, electronic sector is a budding market. Over years, electronic business in India is experiencing a huge transformation owing to the innovative economic strategy and business conditions in the position (world trade organization) WTO system. The researchers have examined the issues, policies of competences, finances, up gradation of technology, progress, improvement of quality, equity engagement and government policies by the multinational organizations and complete development of this segment. As well, this research has been carried out by utilizing the information obtained from an in-depth assessment of SMEs of India related to textile business and from the experience of officials, bankers and policy makers working under Indian government. From this study, the key findings are that the development conductive atmosphere, deficient quality awareness, insufficient support from government and issues in increasing finances from the industry are been identified as major problems. Additionally, the research focused the necessity to improve the technology in electronic small and medium companies and as well devise a potential and supportive economic system.
The scrutiny of existing literature studies evidenced that the SMEs are encountering a number of issues and insufficient funding is the major problem among them. An affluent literature abode has been formed in due course, majorly in foreign nations in light of SME financing. A limited amount of research has been undertaken by Indian authors about the efficiency of financing systems adapted by public segment banks for SMEs. This is the reason behind performing an investigation in context of India and more specifically about the financing schemes towards the SMEs made by public banks and their implementation which has not been research in-depth. Also, the literature reviewed so far revealed that there is a need for explore the best practices for overcoming the issues faced by banks of public sector in supplying funds to SMEs which is the main theme of the current research.
CHAPTER 3 RESEARCH METHODOLOGY
3.1 Overview:
The research methodology will provide certain methods and strategies enabling researcher to execute the study successfully. This chapter comprises segments that support for generating a research report accurately such as research philosophy, research approach, research strategy, data collection methods and quality assessment strategies. The particular method chosen from all these segments are suitable and justified for utilizing them to generate this research.
3.2 Research Process:
The process of acquiring suitable methods to accrue the research project is allowed by this present chapter. The method that is found apt for this study from research philosophy is positivism. Inductive approach is considered from research approach as it best suits for handing out this project. Qualitative strategy is selected as suitable method from research strategy that allow researcher acquiring right information. Secondary data collection method literature review is chosen as right method that can be finest representation of information for this study. The methods like validity and reliability are measured for current project under quality assessment [Kotler, 2008].
3.4 Research Philosophy:
The research philosophy allows gathering information relevant to phenomena of issue being researched. Positivism, interpretive and realism are three type of philosophies commonly used in probing. Among them, positivism philosophy is selected that can meet facts strengthening the purpose of study. Depending upon nature of phenomena on which observations made will derive a theory correlating to existing situations [Nicky, 2000]. Based on the aim of the study, required data is collected the rest of the study will tend reach prominent survey, on whole can attain successful completion of research project. While performing research as a positivist, researcher's views and personal opinions are never supposed to influence the observations made for respective study [Hinkel, 2011]. This may cause certain changes in concluding the facts from observations performed. Hence, positivism is considered to be apt for carrying out this research [Altmann, 2010].
In the current study, positivism philosophy is employed by the researcher in order to complete the research process successfully.
3.5 Research Approach:
Research approach will guide a specific path that directs investigation flow to acquire the core objectives of this research. There are two approaches inductive and deductive in this research approach [Goodwin, 2009]. The inductive approach usually depends on observations and hypothesis constructed according to the nature of issue. This probing flow for obtaining accurate information is adopted from observations made [Kasi, 2004].Upon gathering facts related to topic a theory is derived from existing scenarios of hypothesis framed. This is approach is known as top-down approach that ultimately seek for true information by moving from specific issue to a generalized theory. The consistent results are acquired for research accomplished through this inductive approach [Jerry, 2008].
In the present study, inductive approach is selected and employed by the researcher in order to complete the study successfully.
3.6 Research Strategy:
Research strategy will enable researcher to explore essential issues of topic in considerable mode that are enough capable for better understanding of phenomena. These strategies will acquire success for study by involving questions, objectives and information gathering methods. There are two types of strategy qualitative and quantitative strategies. Unfortunately, current research does not require any survey comprising of questions [Debra, 2005]. The qualitative strategy will depend on primary research method interview that gather information in depth. Data acquired from qualitative strategy will result in empirical data that is required for making research strong. Quantitative strategy gathers data from questionnaires method of primary research and this mostly used only when numerical estimation is needed [George, 2010].
In this study, quantitative strategy is used by the researcher for the successful completion of the research objectives.
3.7 Data Collection Methods:
The data collection methods will provide various methods to collect information according to issue. There are two types of data collection methods they are primary and secondary collection methods. The selection of which method to be utilized in present research is identified by considering nature of topic being surveyed [Hilary, 2010].
3.7.1 Primary Data Collection Methods:
The primary data collection methods will gather information from original sources. These methods obtain facts that are presently in progress and are acquired from participants existing in current experience of issue. The data collected here is essential because it might not be entered to the other parts of world [Malhotra, 2008]. This will be latest and updated information where surveyor can ever find. The primary data collection methods are interviews, questionnaires, focus group and observations. Based on the necessity of information required the researcher can approach particular method that results in respective data [Kadriye, 2009]. Primary as well as secondary data collection methods are chosen to complete the study.
Interviews will gather in depth data from every participant with one on one interaction and researcher can indulge in structured interview or unstructured interview. Stipulated questions come under structured interview where researcher will seek responses for respective questions only [Stella-Maria, 2008]. Unstructured interview allows researcher to ask questions as conversation builds and there are chances to divert from required topic. Questionnaires method will obtain responses from a larger limit of population than that of interviews. All questions are common and are framed before with different answers as choice for respondent. The responses are recorded by participants and produces quantitative data that is useful for further analysis [Frank, 2010]. In the current study, only questionnaire survey primary research techniques are employed b y the researcher in order to collect the accurate information about the research theme. These surveys are conducted to the financial managers of SBI and Oriental Bank of Commerce and SMEs in order to collect their opinions regarding the study. In this manner, by using these surveys, precise and real time information is collected. This data is more useful for successful completion of the study.
Primary data refers to the information that had been gathered by executing surveys through questionnaires. In the current thesis, questionnaire survey is executed by including bank managers of SBI and Oriental Bank of Commerce, India primarily in order to realize the best practices of SME financing and credit risk management. At the same time, an additional questionnaire survey is executed by involving the senior managers working in dissimilar SMEs, India known to the researcher.
Thus, the key facts about the SME financing will be known by executing both these surveys.
3.7.2 Secondary Data Collection Methods:
The secondary data collection methods will gain basic information from sources that already posse's document about this topic. The secondary resources considered to obtain information are books, magazines, articles, journals and other websites. The methods of secondary data collection are literature review and case study. Literature review is considered as best suitable method that can acquire significant data regarding the topic [Smith, 2010].
The literature review is considered as capable method of secondary data collection methods for gathering the required data about the study. This method can give clear insight for reader to understand the issue being researched [Denzin, 2003]. Hence, these papers or articles have turned to be major secondary sources for present literature review method. This empirical evaluation will lead visualization of essential affects that contribute fluctuations in market. The present research requires evaluation by reviewing related documents of the present research theme [Mertens, 2009]. Along with the primary data, lots of information is gathered from different articles, journals, books, white papers, books and texts to realize the theoretical background of the study.
In this study, only literature review secondary research technique is employed to gather the vast information about the study.
3.8 Quality Assessment Strategy:
The quality assessment strategy will verify quality of data for information gathered. Quality research is mandatory for study that is accomplished and on basis of validity; reliability measures quality strategy is attained [Nicky, 2000].
Validity: The validity strategy is necessary to maintained by study as findings are derived from entire research as conclusion. The information concluded will be true by acquiring valid data in study. Validity at the same time depends on reliability because valid data is attained from reliable information [Reyes, 2004]. This measure would seek for a degree of certainty that assures accurateness. Validity is divided into internal and external in order perform evaluation. Both qualitative and quantitative studies support internal validity. External validity includes generalizing data obtained from research methods and not all methods sustain this external but only few that acquaint quantitative studies [Cohen, 2007].
Reliability: Reliability of data is ensured if data collected from different observations for same group on same research yield same results and if same research conducted by different researchers yield similar results. Mostly information collected through primary sources like interviews and questionnaire will require accuracy to meet reliability [Saunders, 2003]. Interviews in organizations may sometimes cause threat to reliability when employees are forced to answer particularly by their superiors and researcher should come to know such potential problems that occur internally will affect the complete research [Marlow, 2010].
In present research project the quality assessment strategies validity and reliability are utilized by researcher to result in successful study [Michael, 2004].
3.9Sample plan:
In the current project, 2 questionnaire survey sets are conducted to collect the crucial information about the study. In this study total sample size is 20. First questionnaire survey set is conducted to the 10 financial managers of SBI and Oriental Bank of Commerce and second questionnaire set is conducted to the 10 financial managers of SMEs.
3.10. Research Summary:
The main aim of the present study is to analysing the best practises of SME financing and credit risk management- a case study on state bank of India and oriental bank of commerce. The current thesis is accomplished successfully using the above various methods that research methodology supported. The methods that were chosen to complete this study accurately. Positivism philosophy is selected from philosophies such as positivism, interpretive and realism. Inductive approach was chosen as beat method among inductive and deductive approaches of research approach. The data collection methods having primary and secondary data collection methods where only secondary are considered for current research. The method of secondary data collection methods utilized for this study is literature review. In this study, questionnaire survey primary research tec
