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Need to promote Micro Equity Finance in India

microfinance2By Syed Zahid Ahmad, Founder – Economic Initiatives

Though India is doing better in financial inclusion, still much more is expected from the Government and bankers side. Considering the specific needs of the financially excluded section of Indian economy, Micro Equity Finance should be introduced as USP in India to counter side effects of demonetization and denial for Islamic banking.  The schemes like PMJDY may help connecting public with banks, but inclusive growth cannot be assured unless the poor are appropriately financed to allow poor increase their income. There are three basic modes of finance; debt, lease or equity.  While debt based finances are mostly provided by banks and NBFCs; leasing are executed by asset finance companies and equities may be availed through stock markets. Equity in general is understood as tradeable stocks in the capital market. But recent positive trend in growth of private equities outside stock market to finance the unlisted companies is opening new dimensions to deal with equity business. Considering huge number of micro and tiny establishments in India, proposed ‘Micro Equity Finance’ may be pivotal to help 50 millions micro and tiny enterprises existing in the informal sector. These establishments are deprived of equities; and also not favoured customers for Indian banks or MFIs.

What is Micro Equity Finance?

Micro Equity Finance may be defined as extending financial support to micro and tiny enterprises on terms of proportionately sharing associated profit / loss in enterprise existing in the informal sector. It may otherwise be categorized as equity financing with amount less than a certain limit (say Rs.10,00,000) to micro and tiny sized enterprises. The amount of finance and mode of repayment may be designed according to the cash flow of business catered by target customer. Under micro equity agreement; depending upon cash flow of particular business, the customer may be allowed to buy back investor’s equities along with paying returns periodically, or otherwise be allowed to pay profit periodically and return the whole amount of investment at lump sum after expiry of agreement period.

Target customer’s segment for Micro Equity Finance:

Basically the target customer’s segment for Micro Equity Finance may be micro and tiny sized establishments deprived of equities through stock market or private equity intermediaries. Their financial need in any case should not exceed Rs. 10,00,000. These establishment’s net-worth should not be more than Rs. 25,00,000. On liability side, all debts including trade credits etc. should not exceed more than fifty percent of the amount sought through micro equity finance. Preferably the establishments should have a track record of doing business for minimum 24 months.

Fifty Nine percent establishments are home based or without fixed structure:

According to sixth Economic Census (2013) out of 58.5 million establishments, about 77.6% establishments (45.36 million) were engaged in non-agricultural activities (excluding public administration, defence and compulsory social security activities) while the remaining 22.4% establishments (13.13 million) were found to be engaged in agricultural activities (excluding crop production and plantation). In non- agricultural activities manufacturing is providing employment to 30.3 million (23.1%) persons followed by retail trade with 27.19 million persons (20.7%). So, when we endeavour for inclusive growth by calling Sabka Saath Sabka Vikas we should actually need to know how Indian work force are placed into our economy.

number

 

Source: –  http://pib.nic.in/archieve/others/2014/jul/d2014073001.pdf

Less than one percent companies paid up capital are 78% of total paid up Capitals:

Around 8 lakhs companies are registered under Ministry of Corporate Affairs (MCA). This figure is just 1.36 percent of total number of establishments reported by Sixth Economic Census of India. In terms of paid up capital 85% companies are poor and thus share less than 3% of total paid up capital of all registered companies worth Rs. 18,12,258.70 crores whereas less than one percent companies shares around 78% of total paid up capitals.

Paid up capital range wise distribution of companies Limited by Shares

Capital Range Number of Companies Paid up capital % of total Companies % of Total capital
1.    Less than Rs. 50 lakh 6,70,875 46,244.93 84.55% 2.55%
2.    50 lakh to 1 crore 43,671 33,770.57 5.50% 1.86%
3.    1 crore to 5 crore 54,573 1,27,131.33 6.88% 7.02%
4.    5 crore to 25 crore 17,815 1,94,714.29 2.25% 10.74%
5.    25 crore to 100 crore 4,567 2,19,988.04 0.58% 12.14%
6.    100 crore to 300 crore 1,205 2,03,695.68 0.15% 11.24%
7.    300 crore and above 740 9,86,713.85 0.09% 54.45%
Grand Total 7,93,446 18,12,258.70 100.00% 100.00%

Source: – http://www.mca.gov.in/MinistryV2/paidupcapitalreports.html

50 millions neglected micro and tiny establishments:

The Ministry of MSME’s Annual Report 2014-15 suggests that 84% establishments are MSMEs with market value (of their total assets) worth Rs. 13,63,700.54 crores. So, around 75% of paid up capitals for companies registered under MCA may be owned by MSMEs. Only 3.6% establishments are registered under Udhyog Aadhar. Out of total registered 21,33,885 Udhyog Aadhar as much as 89% (19,06,781) are Micro enterprises. As much as 56% (11,90,264) establishments registered under Udhyog Aadhar are not into Manufacturing but services. The findings of Sixth Economic Census suggests that 35.41% (1,60,66,507) establishments are into retail trade activities followed by 22.77% (1,03,31,385) into manufacturing. Whenever ministry of MSME declares specific scheme related to manufacturing, 56% MSMEs miss to get any benefit from that. Unfortunately no specific scheme is there to help India’s micro and tiny establishments dealing in trade activities.

Registered Udhyog Adhar in India

Source: http://udyogaadhaar.gov.in/

Allowing micro and tiny establishments to access equities:

To support Indian MSMEs Government of India helped establishing special stock exchange for SMEs. But the progress so far is not satisfactory. The guidelines and procedure in SME exchange are so difficult that not even one percent MSMEs succeed to avail equities. There had been no trading in SME exchange during 2015-16; nevertheless total 50 listed companies raised amount of Rs. 379 crores through SME platform compared to Rs. 278 crore raised through 39 issues in 2014-15, registering an increase of 36.6 per cent. Observing the SME stock exchange as unfavourable route to put equities into Indian MSMEs, the foreign investors started preferring the FDI route to invest equities into unlisted companies. While Indian stock exchange observed 6.5% withdrawal of market capitalisation during 2015-16 compared to 2014-15, there is 36% growth in FDI during April to September 2016. This shows that while stock market is failing to protect capital from stock markets, private foreign investors now prefer to invest equities into unlisted Indian companies on their own terms. Here we should feel the need to ease up the norms and regulation for drawing more private equities especially for micro and tiny enterprises.

Resource Mobilisation through the SME Platform

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Source: – SEBI Annual Report 2015-16

Scope of Micro Equity Finance in Indian Economy:

If financial intermediaries can succeed drawing Rs. 1,44,674 crores in 6 months as private equities for unlisted Indian companies after Indian stock market lost Rs. 19,36,844 crores last year, we hope that liberalized regulations may support mobilization of required micro equity funds for more than 50 million micro and tiny establishments in India. This may also be a big opportunity for Indian banks to finance these establishments after observing lower NPAs through smaller industries and agriculture sector compared to medium and large industries. There is need that banks should also invent new financial product to focus upon micro enterprises, micro equity could be the most suitable product to help the micro establishments at one hand along with allowing the banks to earn more over investments without exploiting the poor through higher interest / usurious practices.

FDI

Source: – http://dipp.nic.in/English/Publications/FDI_Statistics/2016/FDI_FactSheet_April_Sep_2016.pdf

Micro Equity Fund for 50 million Micro and Tiny Enterprises:

Government has done much to ensure financial inclusion and to support MSMEs in India, but still around 50 millions micro and tiny size enterprises are deprived of financial scheme announced by the Government. They are too small in size to approach the specified MSE stock exchange. In most cases, the financial need of millions of micro and tiny enterprises (ranges between Rs. 1 to 5 lakhs) is falling below average finance extended by banks and above finance limit for MFIs. So, they are neglected segment in Indian finance.

Hope the Government while promoting digital money, may also like to support these neglected enterprises. If Government could help them by mode of micro equity fund through available network of banks, MFI and BCs in India, we may see upsurge in registered Udhyog Aadhar in near future. By now only 3.6% establishments are registered under Udhyog Aadhar. Ideally this number should be at least 80% of existing establishments reported by Economic Census. Besides Government support through Micro Equity Fund, the Banks can initially pay special focus to support these establishments..

Two Different modes of Micro Equity Finance:

There could be following two modes to extend Micro Equity Finance –

  1. Banker may invest fractional share in micro enterprises owned by any entrepreneur with option to buy back investors share periodically. Till the time investor possess unit share in the enterprises, the entrepreneur is supposed to proportionately share the earned profit / loss. This would allow the banker / financier to earn profit through investments along with optional disinvestments on monthly basis or otherwise after expiry of agreement period.
  1. Any asset (say Shop) be jointly purchased by the entrepreneur and banker; allowing the entrepreneur use the shop after paying monthly rent to the banker against outstanding unit shares in that asset. The entrepreneur should be allowed by the banker to buy back bank’s unit share in the asset at varied price on monthly / weekly basis. The entrepreneur should pay varied amount as rent to the banker according to bank’s outstanding share in the shop at particular month. After selling out all unit shares in the asset, the banker should execute release deed to transfer all legal rights in favour of the entrepreneur; and thereafter the entrepreneur need not require paying any rent to the banker.

Is there any observation report about Micro Equity Finance?

Yes! BASIX Social enterprise group has already taken lead into pilot for Micro Equity Finance in Mewat district of Haryana where actual repayment rate by bank customers are hardly 20%. Contrast to this fact, the repayment rate by customers served through Participatory Micro Finance model in same geography is 99%. BASIX group started the pilot of Participatory Micro Finance in July 2011. They directly finance the livelihood of target customers instead of sanctioning loan on interest. This process involves buying and selling of commodities (after adding profit) to the customers and allow repaying the whole amount in installments. There were investments in assets by mode of diminishing partnership also. Recently this group initiated pilot project of micro equity in enterprises by mode of diminishing partnership wherein customers are allowed to buy back investors’ share on weekly / monthly basis. Though this pilot is too small and incomplete to cite, interestingly so far the outcome of this pilot is far better than actually projected. Though like any cash driven activity, demonetization has also adversely affected the repayment in this model; nevertheless the retrieved profit is much higher than scheduled profit during June to December 2016.

Can Micro Equity Finance be used for financial inclusion?

On 9th December 2016, the State Minister of Finance has dejected RBI’s proposal to open Interest-free banking windows in Indian banks with object to achieve financial inclusion among those who are excluded for reason of interest component in banks. It was told that according to technical report of inter-departmental group, even to introduce selective Islamic banking products we need legal changes. Interestingly that technical report do suggests that there is no legal obstacle to execute equity finance. Notably equity is most genuine mode under Islamic banking. For bank there is no legal obstacle to test micro equity finance in India. This may help assuring financial inclusion of those who are excluded due to interest component.

Economic advantages of Micro Equity Finance:

Micro Equity Finance has added economic advantage over lending on interest terms because under micro equity finance, banker / investor may get higher return over investment compared to stipulated rate of interest. The average expected rate of return from micro equity finance may range between 15 to 30 percent on annual basis depending on identification of potential business activity. Moreover there could be provision to sell out outstanding financier’s unit shares in jointly purchased assets at increased prices if customer decided to extend period to buy back investor’s unit share in the sought asset. This would provide time for customer to buy back investor’s share in the asset at one hand; and compensate the financier with increased value of price for unit share in the asset against extended time. So banks and financial institution ambitious to earn better return over finance compared to fixed interest over loans, may better promote micro equity finance.

Political advantage through Micro Equity Finance:

Since the micro and tiny sized establishments are as much as 84% of total establishments in India, there is huge opportunity for the Government to announce special financial scheme for such enterprises. Keeping in mind that 36.19% of all the establishments in the country are home based establishments and 18.44% are operating from outside household without fixed structure, Government may induce such establishments by proposing micro equity finance enabling these enterprises own specific fixed structure (commercial fixed assets)  Such announcement would directly benefit more than 50% workers in India. And importantly neither the Government would require to subsidize finance in this regard nor banks or financial institutions would find it risky to recover the investments because sought asset may stand as collateral against sought finances through use of product like diminishing partnership. But the Government would need to make sought regulatory changes making it viable to execute such products. Most important would be to treat receivable rent by banks from tangible asset at par to interest income and relaxation in stamp duty and registration fee while banks need to execute release deeds.

Banks should launch pilot of Micro Equity Finance:

Considering limitations of various financial inclusion products (including JLG and SHG model) to reach needy micro and tiny establishments with affordable finance in India, it is not a bad idea to kick a pilot to test Micro equity Finance in India. Since NPAs are lower by smaller customers, banks should better focus more upon micro establishments. Banks intend to do so may need to support from experienced group who have tested such kind of products in Indian economy. They may require knowing about procedure involved in designing of product, identification of target customers, origination and evaluation of proposals, documentation, sanctioning of required finance, monitoring of financed projects, book keeping and accountancy along with recovery through monitoring the profitability in the livelihood financed.

All Banks Gross NPAs+ Restructured + Write Off Assets a % of total assets

Mar-13 Mar-14 Mar-15 Sep-15
1.    Agriculture 8.2% 7.4% 7.5% 7.9%
2.    Industry (Micro) 10.2% 10.0% 10.5% 12.3%
3.    Industry (Small) 13.2% 13.3% 14.8% 16.8%
4.    Industry (Medium) 20.2% 23.6% 27.0% 31.5%
5.    Industry(Large) 16.2% 19.0% 23.0% 23.7%

Source:- https://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/PPT1102166AB61D0F35C546539EF4DCD3C83B3668.pdf

Digitalization of Money may be supported through Micro Equity Finance

Government is making attempt to make India less cash economy by inducing majority of people to transact without cash so that maximum economic transactions could be recorded. If we like that micro and tiny enterprises should also disclose their all transactions and pay liable taxes, we need to evaluate the available institutional support for them. If we really want to make Digital India a success where corruption should not have any room, we need to first reform the tax structure, and arrange equity finance for them before inducing people transact through digital money. Micro enterprises are provided smaller amount of credits by micro finance institutions at interest rate over 24%; otherwise by private money lenders @ more than 36% annual interest. How can we expect that after paying so high cost for loans, these micro enterprises would be able to enough to meet their all expenses and earnestly pay all taxes?  Until we propose easy tax structure along with supply of affordable finance, we would be otherwise forcing them to cheat the system by manipulating their transactional accounts and hide taxes. Unless majority of million micro and tiny establishments are allowed to avail micro equity along with tax reforms, it is very difficult that we can fight corruptions in India. When we would be able to support our millions of micro and tiny establishments through equity funds, we may ask them to make maximum transactions without cash and induce them to pay all liable taxes.

Summing up:

Hope invention of product like micro equity finance would help boosting financial inclusion mission to assure inclusive growth in India without socio-political conflict. Banks may hopefully find it most effective product to finance customer who have lower capital / asset base, but higher profitability prospects in their businesses. Micro equity finance may enable customers own higher value assets without adding debt burdens. It would also allow banks earn better rate of return compared to common debt based products where interest is fixed. So besides attaining better financial inclusion through Micro Equity Finance, banks are likely to earn better profitability compared to use of common loan products.

There is also chances that banks taking lead into piloting micro equity finance may seek attention of potential investors looking to invest in Islamic banking / finance in India because micro equity finance in core Islamic financial product designed in secular manner to suit Indian economy as well as draw attentions of investors seeking opportunity to invest in Islamic banking / finance in India. Banks may also propose this product to the investors with an assurance that their investment by mode of subscribing bank’s own capital may be utilized to extend micro equity finance in India. Thus financial product like Micro equity Finance and Diminishing Partnership may be used as innovative tools to develop scope for bankers to raise capital investments from potentially larger investors based in gulf economies.

 

Be happy to share more thoughts and experiences for further discussion.

Thank you!

 

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