K C Chakrabarty: Welcome to India - state of the Indian economy,
banking sector and factoring services
Opening address by Dr K C Chakrabarty, Deputy Governor of the Reserve Bank of India, at
the International Factors Group's Annual Conference, New Delhi, 7 October 2013.
* * *
Assistance provided by Smt. Lily Vadera is gratefully acknowledged.
1. Mr. Gerhard Prenner, Chairman, International Factors Group (IFG); Mr. Pramod
Bhasin, Founder & Vice Chairman, Genpact Limited; Mr. Sanjay Chamria, Co-founder &
CEO, Magma Fincorp Limited; Mr. Ravi Gupta, Managing Director, Blend Financial Services
Ltd.; delegates to the conference, ladies and gentlemen! It gives me great pleasure to
welcome you all, especially the foreign delegates, to India and to this historic city of New
Delhi for IFG's Annual Conference. It is heartening to note that IFG, the global association for
Commercial Finance with 150 members from more than 60 countries, has chosen to hold its
annual conference in India, signifying the growing interest of the global financial institutions in
India. At the outset, let me thank Mr. Ravi Gupta and Ms. Margrith Lütschg-Emmenegge, two
people, who influenced me to enter into the realm of factor financing while I was serving as
the Chairman and Managing Director of Punjab National Bank. In fact, together with
FIMbank, which Ms. Margrith represented, we jointly laid down the foundation of a factoring
company in India. So, when Mr. Gupta requested me to speak at this conference, I could not
refuse the invitation.
2. I have been asked to speak today on the topic "Welcome to India" - which, of course,
I have already done! So, what next? I am told that the participants are interested in learning
about the state of the Indian Economy, the barriers, opportunities and expectations for the
near future as well as the Central Bank's views on banking, SME financing and factoring.
Therefore, during my address today, I intend to give you a brief lowdown on the prospects of
the Indian economy, the structure of banking sector and Reserve Bank of India's
perspectives on the issues and challenges faced by the Micro, Small and Medium
Enterprises and the factoring sector in India.
A. State of the Indian Economy - barriers, opportunities and expectations
3. Over the years, the Indian economy has gone through phases of remarkable
transformation. After witnessing the Hindu rate of growth for the first three decades
postindependence, the Indian economy got its first "big push" with the first phase of economic
reforms in 1980s while the second major push came post 1991, following liberalisation of the
economy, which helped it to move on to a sustainable higher growth trajectory. India made a
radical break in 1991 from its past policies of inward orientation and started a process of
opening up to trade and foreign investment. The growth response emerged a decade later as
the cumulative impact of the gradual reforms began to be felt on the investment environment.
India's GDP growth was of the order of eight-plus per cent per annum during 2001-11. In the
five years prior to the global financial crisis of 2008, the Indian economy had averaged 9 per
cent annual GDP growth. In the aftermath of the crisis, there has been a slowdown and a
question on the minds of most observers is whether this slowdown is temporary or is the
economy moving to a lower growth rate in the medium term. While RBI estimates that the
trend/potential growth rate of the Indian economy, which averaged around 8.5 per cent
during 2005-06 to 2007-08, dipped gradually thereafter and presently stands at about
7.0 per cent, the draft Twelfth Five Year Plan (2012-2017) document prepared by GoI
indicates that India's full growth potential remains around 9 per cent.
4. Like the other emerging market economies, the Indian economy is also facing
certain challenges: inflation is high, growth is down, investment is slowing down, current
account deficit is above the sustainable levels, fiscal deficit is high, and the exchange rate is
under pressure. While, global slowdown is an important factor, the domestic factors are no
less important.
5. At the macro level, there are concerns. But we need to separate noise from signal.
The fundamentals of the economy remain strong. An important point to note is that in the
more recent period, growth has become more broad-based across the many states of India,
poverty has declined but financial inclusion has emerged as a major concern. There has
been much more spending on inclusion and social protection.
6. Going forward, there are challenges - some old, some new. The ongoing challenges
are: (i) providing world-class infrastructure for a rapidly-growing economy, particularly in
telecom and power sectors, and (ii) macroeconomic management involving fiscal reform and
monetary policy in an open economy context.
7. The new challenge are: how to bridge the gap between a growing demand for
different skills as the economy resumes its journey on a high-growth path, and their supply.
The demographic opportunity needs to be turned into a dividend: Today, 50 per cent of
India's population is under 25 years of age. Aspirations are rising. The demographic
opportunity is increasing for India because the percentage of population of working age will
continue to increase for another 40 years. This needs to be harnessed with greater focus on
skill building, higher education, innovation, knowledge creation, and knowledge sharing. The
Government of India's National Skill Development Initiative uses public-private partnership to
address this challenge. India is uniquely placed for attracting investments in education
because there is a hunger for education in emerging economies and a strong commitment to
education at the family level. Global educational institutions will have to look at building a
presence in India as they will have to gravitate where human resources are available.
8. In the coming years, millions of people in India are expected to move out of the
agricultural sector and that jobs will have to be provided for them. India, therefore, needs to
increase its manufacturing capability. Though in the recent past, the growth of the
manufacturing sector has generally outpaced the overall growth rate of the economy, at just
over 16 percent of GDP, the contribution of the manufacturing sector in India is much below
its potential. Every job created in manufacturing has a multiplier effect of creating two to
three additional jobs in related activities. Therefore, a thrust on manufacturing is integral to
the inclusive growth agenda of the Government. The National Manufacturing Policy
announced by the Government of India proposes to increase the sectoral share of
Manufacturing in GDP to 25% over the next decade.1
9. As we capitalize on these strengths, I see India delivering on the aspirations of a
young and growing middle class. And we will do so while increasing our integration with the
world. India is now closely integrated with the rest of the world both by way of financial
integration and trade integration. It is the intent and objective of the Government of India to
attract and promote foreign direct investment in order to supplement domestic capital,
technology and skills, for accelerated economic growth.
While India can look at an 8% growth based on domestic opportunities, for a 9-10% growth
to occur the external environment has also to be hospitable
B. Banking structure in India
10. The existing banking structure in India has evolved over several decades. It is
elaborate and has been serving the credit and banking services needs of the economy. The
Indian banking sector has come a long way since independence, more so since the
nationalisation of 14 major banks in 1969 and 6 banks in 1980. In the post financial sector
reforms (1991) phase, the performance and strength of the banking structure improved
perceptibly. Over the years, the reach of banking has widened significantly to include
relatively under-banked regions, particularly in rural areas. Commercial bank credit as per
cent of GDP picked up steadily from 5.8 per cent in 1951 to 56.5 per cent by 2012. The
population per bank branch came down from 64,000 in 1969 to 12,300 in 2012 (RBI, 2013).
The key feature that distinguishes the Indian banking sector from the banking sectors in
many other countries is the fostering of different types of institutions that catered to the
divergent banking needs of various sectors of the economy. Credit cooperatives were
created to cater to the credit, processing and marketing needs of small and marginal farmers
organised on cooperative lines. Cooperatives expanded also in urban and semi-urban areas
in the form of urban cooperative banks to meet the banking and credit requirements of
people with smaller means. Regional Rural Banks were created to bring together the positive
features of credit cooperatives and commercial banks and specifically address credit needs
of backward sections in rural areas. Further, there was an experiment of establishing Local
Area Banks, albeit on a smaller scale, to bridge the gap in credit availability and strengthen
the institutional credit framework in the rural and semi-urban areas.
11. While fostering a multi-tier structure, the regulatory effort has been to ensure
stability and soundness by addressing weaknesses as and when they arose. The soundness
of the system was evident from the way it withstood the recent financial crisis rather well,
even as the banking systems in many countries across the world were adversely affected.
12. Notwithstanding the growth in number of branches opened by banks, Indian banking
sector is yet to reach the desired level of banking penetration and inclusion as witnessed in
most advanced and some of the emerging economies. It is estimated that rural India had
only 7 branches per 1,00,000 adults in 2011 in sharp contrast with most of the developed
and even BRICS economies having over 40 branches. Regionally, north-eastern, eastern
and central regions are more excluded in terms of banking penetration. Given the fact that
there is a large unbanked population in the country and a large informal sector that still does
not have access to the formal banking sector, there is considerable scope for the expansion
of India's banking sector. This would also require greater presence of private entities at
national and local levels. The assessment and comparison with other economies brings to
the fore the need for imparting dynamism through expanding the commercial banking system
in terms of its size and number of banks; need for expanding smaller banks in unbanked and
under banked areas; need for focus on consolidation; need to relax barriers to entry for
improving competition; and the need for enhancing operational efficiency.
13. With a view to ensuring that the banking system grows in size and sophistication to
meet the needs of a modern economy and improving access to banking services, Reserve
Bank of India is considering giving some additional banking licences to private sector players
subject to their meeting our eligibility criteria as announced by the Union Finance Minister in
his Budget speech for the year 2010-11. Consequently, the Reserve Bank of India, released
the Guidelines for "Licensing of New Banks in the Private Sector"2 on February 22, 2013. RBI
is in the process of issuing new bank licenses consistent with the highest standards of
transparency and diligence. Further, Reserve Bank has recently (on August 27, 2013)
released a Discussion Paper on "Banking Structure in India - The Way Forward"3 which is
placed on the website for comments from stakeholders. The document explores the
possibility of differentiated licences for small banks and wholesale banks, the possibility of
continuous or "on-tap" licensing, and the possibility of converting large urban co-operative
banks into commercial banks. We propose to carry forward these ideas and come up with a
detailed road map of the necessary reforms and regulations for freeing entry and making the
licensing process more frequent after we get comments from stakeholders.
14. As the real economy is dynamic, it is imperative that the banking system is flexible
and competitive to cope with multiple objectives and demands made on it by various
constituents of the economy. From the financial inclusion perspective too, there is a pressing
need to extend the reach of financial services to the excluded segments of the society.
Viewed from this perspective, today's banking structure in India has both the need and scope
for further growth in size and strength. With a view to strengthen the banking structure in
India, based on the lessons from the global crisis, to cater to the needs of a growing and
globalizing economy as well as deepening financial inclusion a Discussion Paper on
"Banking Structure in India - The Way Forward" has been placed on our website as
mentioned earlier. The discussion paper has identified certain building blocks for the revised
banking structure with a view to addressing various issues such as enhancing competition,
financing higher growth, providing specialized services and furthering financial inclusion. It
also emphasizes the need to address the concerns arising out of such changes with a view
to managing the trade off for ensuring financial stability.
15. As the Indian economy expands with increasing focus on manufacturing and
infrastructure, the credit intensity is higher and more resources will be needed for supporting
the growth process. In order to support an annual economic growth of 8 per cent, as
envisaged by the 12th Five Year Plan, banking business needs to expand significantly to an
estimated Rs. 288 trillion by 2020 from about Rs.115 trillion in 2012. Expansion of the
existing banking business requires additional capital support. Indian banking is dominated by
the public sector, which accounted for about 73 per cent of total assets of the banking sector
at end-March 2012. Hence, an important way to achieve an expansion in capital of the
banking sector, while managing fiscal consolidation, would be to widely distribute the
ownership stake in banking.
16. India also has a number of foreign owned banks, many of whom have been with us
a long time and helped fuel our growth. They have been in the forefront of innovation, both in
terms of improving productivity, as well as in terms of creating new products. We would like
them to participate more in our growth, but in exchange we would like more regulatory and
supervisory control over local operations so that we are not blindsided by international
developments. The RBI will encourage qualifying foreign banks to move to a wholly owned
subsidiary structure, where they will enjoy near national treatment. We are in the process of
sorting out a few remaining issues so that this move can be made4.
C. MSME Financing
17. The critical role and place of the MSME sector in employment generation, exports
and economic empowerment of a vast section of the population in the Indian economy
cannot be overemphasized. As per estimates released by the Ministry of MSME, there are
about 36.1 million enterprises in this sector employing nearly 80.52 million people5. The
sector accounts for 45 per cent of manufactured output and 8 per cent of the GDP. MSMEs
contributed close to 40 per cent of all exports from the country.
18. As availability of timely and adequate bank credit without the hassles of collateral
and third party guarantees is of essence to small first generation entrepreneurs, the Reserve
Bank of India had enjoined upon banks to provide collateral free loans to Micro and Small
enterprises with credit limits up to Rs.1 million. The Credit Guarantee Fund Trust for Micro
and Small Enterprises (CGTMSE), set up by the Government of India operates the "Credit
Guarantee Scheme" (CGS) which guarantees grant of collateral-free and/or third party
guarantee-free credit facilities to Micro and Small Enterprises by banks.
19. The MSMEs primarily rely on bank finance for their operations and as such ensuring
timely and adequate flow of credit to the sector has been an overriding public policy
objective. Over the years there has been a significant increase in credit extended to this
sector by the banks. As at the end of March 2013 the total outstanding by all Scheduled
Commercial Banks (SCBs) to the micro and small sector (MSE) sector stood at
Rs. 6847.96 billion as against Rs.5276.84 billion in March 2012, Rs.4785.27 billion in March
2011 and Rs. 3622.91 billion in March 2010. Despite the increase in credit outstanding to the
sector, availability of timely and affordable credit is still one of the issues for the MSME
sector. Recognizing the important role played by MSMEs in economic development and its
sizeable contribution to employment and GDP, and realizing that financial access is critical
for MSMEs growth and development, Government and Reserve Bank of India are taking the
lead in supporting initiatives that improve access to finance.
20. A number of measures have been taken by the Reserve Bank to facilitate credit
growth to the sector. As the level of financial exclusion is high in the micro and small
enterprises sector (93% as per the Fourth Census of small enterprises), drive to universal
financial access, including MSME finance, is no longer a policy choice but a compulsion.
With an objective of ensuring uniform progress in provision of banking services in all parts of
the country, banks were advised to draw up a roadmap to provide banking services through
a banking outlet in every unbanked village having a population of over 2,000 by March 2012.
Banks have successfully met this target and have covered 74398 unbanked villages. In the
second phase, Roadmap has been prepared for covering remaining unbanked villages i.e.
with population less than 2000 in a time bound manner. About 4, 90,000 unbanked villages
with less than 2000 population across the country have been identified and allotted to various
banks. The idea behind allocating villages to banks was to ensure availability of at least one
banking outlet in each village. The Reserve Bank advised banks that such banking services
need not necessarily be extended through a brick and mortar branch but could be provided
also through any of the various forms of Information and Communication Technology (ICT)
- based models, including Business Correspondents (BCs).
21. The Government of India also set up an Inter-Ministerial Committee to boost exports
from the MSME sector6 (Chairman: Shri R. S. Gujral, Finance Secretary). The Committee has
since submitted its report which is being examined by the Government.
22. As the incidence of sickness in the sector is high, timely identification of sick micro
and small enterprises and their rehabilitation is critical. In order to hasten the process of
identification of a unit as sick, early detection of incipient sickness, and to lay down a
procedure to be adopted by banks before declaring a unit as unviable, the revised guidelines
for rehabilitation of sick units in the MSE sector have been issued for rehabilitation of sick
units in the MSE sector.
23. A structured institutional mechanism has been set up at the Reserve Bank, both at
the Central office and Regional Office level, to monitor the issues concerning the sector. A
Standing Advisory Committee has been constituted at the Central Office level and an
Empowered Committee functions at the Regional Offices of the Bank with all stakeholders as
members. These Committees examine issues relating to improving of credit to the MSME
sector, difficulties / constraints being experienced and steps being taken to overcome them,
etc.
24. Further, a large section of Micro and Small Enterprises need handholding. The lack
of financial literacy represents a formidable challenge for MSE borrowers underscoring the
need for facilitation by banks in these critical financial areas. To effectively and decisively
address these handicaps, Scheduled commercial banks have been advised to either
separately set up special cells at their branches, or vertically integrate this function in the
Financial Literacy Centres (FLCs) set up by them, as per their comparative advantage. With
a view to spreading financial literacy in the MSE sector and more so for the new
entrepreneurs in this sector, we have made an endeavour to take out a guide book which
answers some basic questions for a budding entrepreneur and the advantages of linking
themselves with the formal banking sector. This, we hope, will be used by banks in their
MSME camps and by the industry associations to circulate to new entrepreneurs.
25. While a number of initiatives have been taken a lot more needs to be done
especially in the area of access to equity finance, delayed payments, technology
upgradation, skill building etc.
26. Access to equity capital is a genuine problem. At present, there is almost negligible
flow of equity capital into this sector. Absence of equity capital may pose a serious challenge
to development of knowledge-based industries, particularly those that are sought to be
promoted by the first-generation entrepreneurs with the requisite expertise and knowledge.
Such firms typically look for venture capital to provide them with the financing they need, to
expand, break into new markets and grow faster. Thus, the ability of MSMEs (especially
those involving innovations and new technologies) to access alternative sources of capital
like angel funds/risk capital needs to be enhanced considerably to encourage and develop
entrepreneurship. In the Union Budget 2012-13 the Finance Minister has announced to set
up a Rs.50 billion India Opportunities Venture Fund with SIDBI to enhance the availability of
equity to the MSME sector. Based on the recommendations of the PM's Task Force on
MSMEs, the Bombay Stock Exchange and the National Stock Exchange have also set up a
separate dedicated exchange / platforms for listing and trading of shares of SMEs, making it
easier for them to raise equity capital.
27. Timely payments from customers will help SMEs in reducing their working capital
requirements leading to lower interest costs, improved profitability and a positive impact on
the long-term health and sustainability of India's SME sector. Delays in settlement of dues
adversely affect the recycling of funds and business operations of the SME units. It is,
therefore, critical to ensure that the small entities are able to raise liquidity against their
receivables. This problem can be institutionally tackled by factoring, which provides liquidity
to SMEs against their receivables and can be an alternative source of working capital. World
over, factoring is a preferred route of accessing working capital for SMEs and even larger
organisations. Some banks and financial institutions in India have already launched factoring
services and I would urge more banks to offer such services, particularly for the MSMEs. To
provide a legislative framework for factoring services, the Parliament has recently passed the
Factoring Regulation Bill that would address delays in payment and liquidity problems of
micro and small enterprises.
28. With the increasing competition, globalization and the uncertainty due to the global
downturn, SMEs will have to continuously incorporate the latest technology into their
production processes as well as in their marketing and management functions, to cut costs,
gain efficiency and consistency. The Prime Minister's Task Force on MSMEs recommended
several measures having a bearing on the functioning of MSMEs, viz., credit, marketing,
labour, exit policy, infrastructure/technology/skill development and taxation.
29. The ability of SMEs to adjust to the competitive pressures that come with trade
liberalization and globalization will depend on the level of skills available domestically. Given
the growing requirements of the MSME sector and the huge "demographic capital" we
possess, significant efforts are still needed to enhance the skill and entrepreneurship
development. Investment needs to be made in a big way on skill and entrepreneurship.
D. Factoring in India and role of Reserve Bank
30. Factoring service, which is perceived as complimentary to bank finance, enables the
availability of much needed working capital finance for the small and medium scale industries
especially those that have good quality receivables but may not be in a position to obtain
enough bank finance due to lack of collateral or credit profile. By having a continuous
business relationship with the factoring companies, small traders, industries and exporters
get the advantage of improving the cash flow and liquidity of their business as also the facility
of availing ancillary services like sales ledger accounting, collection of receivables, credit
protection etc. Factoring helps them to free their resources and have a one stop arrangement
for various business needs enabling smooth running of their business.
31. The Kalyanasundaram Study Group set up by the Reserve Bank of India in January
1988 to examine the feasibility and mechanics of starting factoring organisations in the
country paved the way for provision of domestic factoring services in India. The Banking
Regulation Act, 1949 was amended to include factoring as a form of business in which the
banks might engage. Reserve Bank of India issued guidelines permitting the banks to set up
separate subsidiaries or invest in factoring companies jointly with other banks. However, it
was generally felt that absence of Factoring Law was one of the major impediments in the
growth of factoring business of the country including the heavy stamp duty over assignment
deed, ambiguity in the legal rights of Factors in respect of receivables etc.
32. Government of India enacted the Factoring Act, 2011 to bring in the much needed
legal framework for the factoring business in the country. It has provided definitions for the
terms factoring, factor, receivables and assignment. The Act also specifies that any entity
conducting factoring business would need to be registered with RBI as NBFCs; while
exempting banks, government companies and corporations established under an Act of
Parliament, from the requirement of registration with RBI for conducting factoring business.
The Act, thus, gave clarity to the activity of assignment of receivables and also granted
exemption from stamp duty on documents executed for the purpose of assignment of
receivables in favour of Factors thereby making the business more viable. The Act also
envisages that all transactions of assignment of receivables shall be registered with the
Central Registry established under the SARFAESI Act, 2002 to reduce the possibility of
frauds and for strengthening the due diligence process for the clients.
33. The Act has given powers to the Reserve Bank to stipulate conditions for "principal
business" of a Factor as also powers to give directions and collect information from factors.
Subsequent to the passing of the Act, the Reserve Bank has created a separate category of
NBFCs viz; NBFC-Factors and issued directions for their regulation. The prudential norms as
applicable to NBFCs engaged in lending business, has also been extended to the
NBFCFactors. Further, bank finance to factoring companies and the factoring business conducted
by banks are also regulated by the RBI.
Challenges faced by factoring sector
34. Though the enactment of the Factoring Regulation Act has potentially removed all
the major impediments that the factoring sector faced in the country, nevertheless, the sector
has few other items on its wish list, the primary among which are introduction of credit
insurance in the factoring business and extending the scope of SARFAESI Act to cover
NBFCs for speedy enforcement of security interest7. As regards credit insurance, the
Finance Minister, in the Union Budget 2013-14, has made an announcement for setting up a
Credit Guarantee Fund with SIDBI for factoring, with a Rs 5 billion corpus. As far as
extension of the provisions of the SARFAESI Act to NBFC is concerned, the final call rests
with the Government of India.
35. Low penetration of factoring business in the country still remains a challenge which
could be on account of lack of awareness among the users. With the necessary law now in
place, sincere attempts need to be made by the industry through its associations and other
fora for articulating the benefits of factoring as not just an alternative source of finance but
also an avenue for providing a bouquet of financial services vis-à-vis traditional finance, to
small scale industries. They should be able to identify the untapped potential clientele,
especially in various SME industry sectors, and create awareness on how the higher cost of
factoring vis-à-vis the traditional finance is justifiable and cost effective for the businesses in
the long run. Factoring companies should also constantly endeavour to upgrade their
expertise on both technological front as also on the operational level for offering cost
effective services to their clientele.
36. I thank the IFG for holding its annual conference in India as I sincerely believe that
organizing more such events would have two-pronged benefits of one, creating general
awareness about the potential benefits that the factoring services holds for the businesses in
general and more so for the SME segment and more importantly, helping the Indian
companies learn from the experiences of their counterparts in the developed economies
where factoring business is well entrenched. I hope that the deliberations during the two day
conference would throw up some practical ideas on increasing the penetration of factoring
services in the country. I am quite sure that the distinguished speakers would bring a lot of
valuable inputs to the table about what could be the most appropriate and cost-effective
delivery model for the factoring services in its nascent stage in India. However, it is
imperative that the domestic factoring industry works hard to take the momentum generated
by this conference forward by implementing the ideas emanating from the conference in right
earnest. Only then will the gains from the conference be truly realized.
I once again thank the organizers for inviting me and giving me an opportunity to share my
thoughts on the subject. Thank you!