RBI Deputy Governor Swaminathan J red-flagged diversion of funds by some micro, small and medium enterprises (MSMEs), emphasising that it is important for them to use bank funds for the purposes they were borrowed for.
He observed that sometimes it is noticed that working capital funds are diverted for other purposes.
“A few have been found to be not investing their equity fully or diverting funds borrowed from banks to purposes outside of their businesses. Many a time, unplanned and improperly funded capacity or market expansion has become a major source of stress, impacting the credit history and thereby the credibility with their banks,” Swaminathan said in his recent address at the CEO Forum of the Federation of Telangana Chambers of Commerce and Industry, held in Hyderabad.
All of these are eminently avoidable; doing business ethically and prudently helps overcome such short-sighted actions, he added.
Formalisation is key
He emphasised that MSMEs should prioritise formalisation, strive for greater credit discipline, invest in capacity building and prioritise the use of TReDS (Trade Receivables Discounting System) for better access to finance as well as improving their financial health.
He said that many MSMEs operate informally, making it challenging for lenders to assess their creditworthiness due to information asymmetry, particularly regarding their financial performance.
So, MSMEs should prioritise formalisation. By registering on the Udyam Portal and filing GST returns, they can enhance the transparency over their level of business activity and financials, Swaminathan said.
This will enhance their credibility and may qualify them for priority sector lending and government schemes, by reinforcing their trustworthiness in the eyes of financial institutions, he added.
He observed that along with formalisation, adopting digital payment systems like UPI (Unified Payments Interface) and online banking creates a digital footprint of financial transactions, making it easier for lenders to assess financials of the firm.
Digital payments also improve cash flow management, offering MSMEs greater control over their finances and helping them maintain a clear financial record.
Credit discipline
Swaminathan said that MSMEs should strive for greater credit discipline which starts with careful selection of the appropriate credit product — term loans, working capital loans, overdrafts and invoice discounting — suited to their requirements and cash flows.
“It is vital to tailor borrowing to business cycles and avoid over-leveraging. Comparing terms across lenders and negotiating for better interest rates and repayment options can result in more favourable credit terms,” he said.
Building and maintaining a good credit score is fundamental for accessing formal financing. MSMEs should ensure timely repayment of loans and bills, which reflects positively on their credit history.
Capacity building
Swaminathan emphasised that MSMEs must invest in capacity building to strengthen their operational and financial management skills. He said that MSMEs can leverage the ecosystem for capacity building and financing.
“Engaging with industry bodies and trade associations provides MSMEs with mentorship, funding opportunities and market linkages. Collaborating with incubators and accelerators can offer access to training, networking and funding,” Swaminathan said.
Additionally, fintech solutions that use alternative credit scoring based on sales patterns or supplier feedback can help MSMEs secure funding more effectively.
Use of TreDS
Swaminathan asked MSMEs to prioritise the use of TReDS, which provides a platform to access working capital by discounting invoices raised to larger buyers. Pursuing buyers to onboard onto TReDS ensures smoother transaction processing and timely payments.
By integrating TreDS, which facilitates MSMEs’ trade receivable financing through electronic platforms, into their operations, they can unlock liquidity, improve cash flows and build stronger trust with lenders.
