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Submitted by Nachiket Mor on
Dear Dr. Demirguc-Kunt, This is a very important and interesting finding and I guess leads to the question of which policies, amongst the many listed in your note, have the potential for the most impact on SMEs. As a former banker who has tried to engage the SME sector in India I feel that the information asymmetries and the systematic risks faced by SMEs are so large that any attempt to try and provide them with formal sources of equity finance at a sufficiently large scale is likely to be met with failure as are attempts to push larger banks to lend to them through priority sector mandates. In my view what is much more promising is to reduce the need for external equity itself by: 1. Reducing the risks faced by these business through carefully chosen supply chain interventions that take away systematic risks and replace them a with a flat supply chain charge. This has met with considerable success in India for existing supply chain linked SMEs (such as dealers and vendors of large companies) and IFMR Ventures is attempting to synthesis these supply chains in sectors where natural ones have not / cannot evolve. 2. Unlocking the embedded equity in the equipment that is sought to be used by the business (this is the resale value of the equipment for which a vibrant second hand market would need to be developed -- an insight I have gained from Professor Antoinette Schoar of MIT). This is the direction that IFMR Rural Finance is taking in its local financing work through their KGFS model. 3. Unravelling the information asymmetries either through standardised ratings templates in manner that CRISIL has done in India (they now rate over 20,000 SMEs) and / or by working through very local financiers who have an intimate knowledge of the business such as the KGFS entities of IFMR Rural Finance. There is a real opportunity here for Mutual Funds in India to launch Fixed Maturity Plans (FMPs) which have the goal of providing high yield debt to SMEs rated by CRISIL. I have also been involved in entrepreneurship training programmes and have found them to be ineffective, very expensive and non-scalable. Attempts to offer SMEs subsidised credit through state owned institutions encourages capital intensity at the cost of labour intensity and perhaps introduces several other distortions. If the rates of interest are kept risk-adjusted (and therefore sufficiently high) but the quality and speed of access is improved perhaps there will be no need to worry about which SMEs are efficient users of capital and which ones are not -- the cost of equity and the cost of debt will do that. To address this issue well regulators in India will have to start to take a more balanced view of the respective roles of banks and regulated non-banks and find a way to encourage banks to provide financing to non-banks instead of pushing banks to directly lend to these "priority" sectors -- their cost of operations and the national and centralised nature of their operations and now increasingly the shortage of capital under the new guidelines are all such that they are poorly placed to this effectively. Sincerely, Nachiket Mor