Credit rating for SMEs is uncharted territory, but can it help firms get easy and cheap access to loans?

Did your enterprise fail to get loan from a bank? Do you think that despite having a substantial business plan […]


Did your enterprise fail to get loan from a bank? Do you think that despite having a substantial business plan and good past record, the bank was unfair in assessing your ability to service a loan? Or, did you miss out on obtaining or servicing an order due to delay in getting a loan approved?Most micro-small-and-medium enterprise (MSME) owners face such problems when they seek loan facility from formal banking sector. However, most of these problems can be resolved with a simple decision of getting your company rated by a credit-rating agency.

More often than not, MSME promoters are either afraid, ignorant or just reluctant to go for credit rating for their firms for various reasons. This acts as an impediment at the time of raising funds for a new and a bigger project. However, a small effort on the part of the owners of the MSMEs can change things in future, allowing their unit to take up large amount of loans from the banks without much hassle.

Why it is important

According to industry estimates, there is a requirement of Rs 32.5 lakh crore financing facility for the the MSME sector, which comprises Rs 26 lakh crore in debt and Rs 6.5 lakh crore in equity. But, the total outstanding loan of the banking system to the MSME sector is just around Rs 11 lakh crore. The fourth all-India survey of MSMEs states that close to 90 per cent of MSMEs are dependent on informal sources of finance. The cost and risks associated with borrowing from the informal sector are big, yet in the absence of paper work and creditworthiness analysis, it become difficult for small enterprises to get loans from the banks.

While banks have their own loan-sanctioning departments that perform background check for every SME before approving a loan, in the case of bigger amounts just an internal check may not be enough. Moreover, due to rising non-performing assets in the banking sector, the formal sector lenders are becoming cautious in extending loan facilities. This scenario is turning against those firms that do not have third-party certification on their creditworthiness. Therefore, to improve the firm’s chances of getting a loan without hassle, a positive credit rating from a third party can prove to be important.

How does it work?

A credit rating agency assesses the past records of a firm to check its financial viability, capability to honour business obligations, provide an insight into its sales and operational and financial composition among other factors. This helps bank in assessing the risk element and highlights the overall health of the firm.

For this, a credit-rating agency not only seeks the past and present financial records of a firm but also interviews the management to understand its understanding of the business. Rating agencies usually use eight grades, ranging from 1 to 8, with 1 denoting the highest rating and 8 the lowest. However, there is no standard practice across agencies, and the definition of rating grades may differ from agency to agency. The rating agencies charge a fee for providing this service that many range anywhere between Rs 22,500 and Rs 1,50,000 per annum, depending upon the turnover of the firm under consideration. The rantings are revised annually.

Benefits of rating

Getting a firm rated by a third party adds credibility to the status of the enterprise. This is turn improves the comfort level between prospective/existing lenders and the borrowing firm. Since a good rating indicates a lower level of risk in getting the loan serviced, a firm with a higher score on the rating card can negotiate better terms with its lender. It also cuts down the time for obtaining loan approvals from the bank’s loan department. According to various surveys, the time taken for loan disbursal for firms with a good credit rating can be less than a month. On the other hand, firms without a good credit rating may have to wait for more than three months, leading to a loss or delayed delivery of a project/order from its clients.

The benefits of credit rating are not limited to dealing with lenders. A good rating helps improve the image of a firm with its prospective/existing trade partners. Rating agencies, like Crisil, provides a free listing on its website and also mentions the entity’s name in its journal SME Connect that reaches out to all leading banks and financial institutions as well as over 1,10,000 MSMEs, according to Crisil. This automatically improves the visibility of a firm in the business fraternity. In addition, firms that opt to get credit rating are also motivated to adopt good-governance practices.

Moreover, credit rating agencies, in their rating reports, inform the firm of its weaknesses that can be worked upon to get better ratings in future. So, if an enterprise has been rated with grade 5 in the first year, by working upon the areas of concern, the firm can improve its rating the next year.

The government also recognises the value of credit rating. The Raw Material Assistance/BG Scheme of the National Small Industries Corporation offers concessions on interest rates for enterprises with good credit ratings.

Who should you approach?

There are multiple credit-rating agencies in the country, including SME Rating Agency of India (SMERA), Crisil, ICRA, CARE Research, Onicra and Fitch. They offer a wide range of SME products along with rating methods to handhold SMEs in the world of credit rating.

Rating methodology

The rating criteria of different rating agencies may have slight variations. Yet, the principle criteria remain the same for all agencies. They use quantitative factors, which are based on statistical models, and qualitative factors, which are based on due diligence and site visits, to arrive at their ratings.

Under the quantitative analysis, a firm is judged on the basis of its financial position, indebtedness, liquidity ratios, growth rate, profitability ratios, working capital management, efficiency ratios, accounting standards and contingent liabilities, among others. While under the qualitative analysis, a firm is judged on the basis of its operational risks, managerial risk, macroeconomic risks and project risks, among others.

One time pain leads to long-term gain

While the process of getting a firm rated may look cumbersome initially, but for companies interested in growing their business, it proves to be a small investment both in terms of time and cost in the long run. In fact, resources spent in getting a firm’s credit rating approved by a third party turn out to be a fraction of the benefits that are enjoyed at the later stage by the company. In most cases, this proves to be the most important move in getting access to quick money for an enterprise.

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