Contributed by: Meera Siva, CFA
Friday, August 4, 2017, Chennai
Credit growth fuels economic growth but lending is a sober business where the upside is capped and risks are uncertain. IAS Balamurugan, Managing Partner, Anicut Capital LLP, a SME-focused debt fund, introspectively looked at the issues in the credit business in India, based on his over two decades of banking experience at ICICI, UBS and Citibank. Bala is also the Co-founder of Metis Family Office Services, in Chennai and handles HNI investments.
A banker’s problems in lending – to individuals and small companies – has changed for the better over the last two decades. Lending was an occupational hazard in the past as there was no concept of Know Your Customer. There were cases where the borrower will skip town and these skip cases made lending a nightmare for the banker in the 1990s.
After the fall of the twin towers, the risks in lending – loss of capital – was considered manageable compared with the risk of letting a wrong person open an account – terrorism or money laundering. With strict KYC and now eKYC in place, people are more traceable and life is that much simpler for lenders.
Online lenders such as LendingKart (in which Anicut Capital has invested) complete the loan process online, thanks to online data and identity being established with Aadhar etc. There is a lot of efficiency and credit is available faster and at lower operational cost. But, it does not mean lending rates will go down. There may be a tendency to take more risks in lending to reach scale and this may push up defaults, and hence rates may go end up higher.
Often credit risks seem obvious in hindsight but at the time of lending, the idea looks too safe and fail-proof. For example, SMEs that supply to foreign clients – Nike, Tesco – were considered good bets in lending as there was a pipeline of orders from these safe customers. But after 9/11, all orders were cancelled and suppliers were left without a recourse and the loans became non performing assets.
It would have been wise to diversify across sectors and geography but an event of that scale was not thought of in any model or analysis. And the reality is that rare events occur regularly. The take-away for lenders is that events are unavoidable and must be dealt with calmly. Bala takes it a step further and says that Anicut Capital bets on events – buyout of PE holding by promoter, equity fund raise, asset sale – to lend to smaller companies.
Many C’s of Credit
When deciding whether a SME is credit worthy, Bala advises looking at the character of the promoter first. Unlike a corporate, a SME is dependent on the founder and if the person is not rock solid, other positives do not matter. It is an art to assess character and reliance on online often kills this fine art of judging a person.
The second C to look at is the capability of the founder. This is to ascertain if the person has the capacity to grow the business and hence repay the loan. Here again, too much safety in judging may let you miss opportunities; that is still a smaller issue compared with taking a bad call and losing capital.
The other C’s are cashflow, collateral, credit rating and many more which are part of the detailed analysis that is done if the first two are met. When SMEs transfer asset to the next generation, there may be risks a lender should be aware of and assess. The style of operation of the inherited promoter and focus may differ from that of the earlier generation entrepreneur. The transitions call for re-evaluation of the two important C’s as they would have changed substantially.
Bala says that over-reliance on collateral by lenders is not a good thing as it is not easy to recover capital. Also, one must look at the financial asset and operational assets differently. An alarm clock making plant is not a good operational asset as it may not produce revenue or profit. But a good business in some financial trouble may be salvageable.
Often, the biggest risks to a business come from the government. The case in point is Nokia factory near Chennai. The factory asset could have been better transferred and jobs could have been saved. It also impacts smaller businesses in that area who rely on a larger manufacturer.
All said, high growth, high inflation country such as India is credit starved and lending is a good business that will do well. Bala advises that one can close their eyes and open an NBFC.