This project was supported by Sa-Dhan and GIZ. It involved the development of a tool that can be utilized to perform appraisal of risks in microenterprise loan applications. The work involved review of ten microenterprise clusters and analysis of the relationship among Investments required (Capital expenditure and Working Capital), cashflow from the enterprise available for debt service, duration of the cashflows and Internal Rate of Return (IRR).
MSME sector as a whole is the second most important sector after agriculture in providing employment opportunities in India. It was estimated in 20101 that the micro, small and medium enterprises (MSMEs) is estimated to contribute 8% of the country’s GDP, 45% of the manufactured output and 40% of its exports. India is estimated to have more than 26 million MSMEs. While a few of the MSMEs operate as registered entities (with at-least minimal registration required as per the taxation laws) a large majority (94%) of them operate as very small unregistered proprietary concerns owned by micro entrepreneurs.
Despite being of great importance to the economy, financial needs of these enterprises have not been adequately addressed. MSMEs in the country face constraints on account of:
- Lack of availability of adequate and timely credit
- High cost of credit
- Collateral requirements
- Limited access to equity capital
- Small sizes and unregistered formats
While creating the credit risk appraisal tool, M2i focused on addressing the critical bottlenecks that hamper the provision of credit to MSMEs.
- Informational asymmetries: Informational asymmetries emerge when lenders do not have accesses to reliable information about the businesses of the microenterprises
- Transaction costs: Costs of processing a small loan is almost the same as that of a large loan in absolute terms. Costs are also incurred for monitoring the loans
- Lack of collateral: The lack of collateral is probably the most widely cited obstacle encountered by microenterprises in accessing finance. Microenterprises are not able to provide collateral required by the lenders
The tool development involved review of ten microenterprise clusters and analysis of the relationship among:
- Investments required (Capital expenditure and Working Capital)
- Cashflow from the enterprise available for debt service
- Duration of the cashflows
- Internal Rate of Return (IRR)
The tool developed had the following components:
- Loan Application Form
- Client Information Sheet
- Loan evaluation Form
- Appraisal Sheet
M2i also identified the pre-requisites for successful utilization of the tool. These are
- Industry and Sector Research: A research should be carried out by the organization to prepare the risk profile of different business sectors, activities in different sectors and client segments, to identify the risks and opportunities in these sectors as well as to provide a industry and sector risk guidance to the operational staff
- Organizational structure and systems: The organizational structure should effectively be able to handle microenterprise financing. Organizations need to develop its systems to address the requirement of microenterprise financing.