“Heer Ranjha”, “Romeo Juliet”, and “Virat-Anushka”: these love stories are nothing when compared to the romantic affair of the Indian Bankers with “Collateral Security” these days.
Conceptually, a “primary” security is the one that gets created out of the lender’s finance and proportionate promoter’s margin and a “collateral” security is an additional security (typically in the form of immovable properties) to further secure the debt. This classification of securities into “primary” and “collateral” is very peculiar to the Indian banking system only.
The love of Indian bankers with collateral securities is so strong that sometimes they don’t see anything beyond. If you ever approach a banker for funding, more often than not the “% of collateral coverage” will be the first and most important question. If you probe for reasons as to why collateral security is needed at all, you would be explained how the poor banks were able to recover in past defaults only by selling the collateral securities. Fair enough?
But then what is the problem that I have with their fair and reasonable ask? Let me explain by way of an example:
Most of the major banks only provide credit facilities to ‘trading and service firms’ against collateral security of a minimum of 50% value of the loan amount. This collateral security is over and above the stipulated promoter margin of 25-33% to maintain the Debt: Equity ratio. So, for a credit facility of Rs.25 Crores, the promoter is expected to infuse equity of Rs.12.50 Crs (at D/E of 2:1) and further provide collateral security of Rs.12.50 Crores.
Say, somehow the promoter uses all his resources and provides the bank with a stipulated margin and required collateral and starts the business and does well. All the earnings and accruals are ploughed back into the business so that the business can be expanded further. Now, to support the higher level of business operations when he again approaches the bank for higher limits, the banks simply answer that they cannot dilute their security coverage ratio and that more collateral is required. Is he expected to divert some portion of the accruals for buying this collateral that too only for the bankers? Won’t the bankers later call this a ‘diversion of funds’?
So, the reasons for my agony on the subject are as under:
Firstly, this extravagant collateral security requirement is only for the already struggling small and medium enterprises. Do you think the Adanis-Ambanis of the corporate world would agree to such unreasonable requirements? That looks unfair to me. I would have at least expected the government banks to be not prejudiced ‘against’ the small borrowers.
Secondly, why should a business owner invest money in real estate more than what is necessary? Just for providing collateral to banks? Ideally, the businessman should invest any surplus money in his own business to grow it further.
Thirdly, shouldn’t the lenders lend based solely based on their comfort with the project and the promoter? Isn’t the whole requirement of collateral security simply posterior protection?
Lastly, this entire scheme is against the first-generation entrepreneurs who do not get the ‘family’ assets in inheritance to build on. It is regressive; keeps the poor always poor and makes the rich even richer. Young entrepreneurs with great ideas and meticulous execution also deserve bank funding. The government and the banks have done practically nothing for these ‘start-ups’.
You might point out that there is a CGTMSE scheme where banks provide small loans without collateral to MSMEs against the guarantee of the Government. The scheme is practically a steal. Bankers charge at least 2-3% higher interest and extra processing fees for CGTSME loans making most small businesses unviable from the inception.
This entire requirement of collateral security is a serious deterrent to credit growth. Small businesses are getting strangled for funds. The Government should start pushing these banks to do some ‘real’ business and that too with courage. It’s high time now that lenders start “serving” small and medium business enterprises. If they don’t lend, how will the economy grow?
So, let us all fall in love with the “success stories” of these new emerging small and medium businesses and play whatever positive role we can.