Finance Minister Nirmala Sitharaman in Budget 2020 has proposed to launch a scheme for giving subordinate debt to MSMEs stressing on the working capital challenge faced by them. The scheme is useful with respect to npa management and recovery.
Subordinated debt (also known as a subordinated debenture) is an unsecured loan or bond that ranks below other more senior loans or securities with respect to claims on assets or earnings. Subordinated debentures are thus also known as junior securities. In the case of borrower default, creditors who own subordinated debt will not be paid out until after senior bondholders are paid in full. Certainly, it will control npa in india up to some extent.
The government has asked the Reserve Bank of India to extend the debt restructuring window for micro, small and medium enterprises by a year to March 31, 2021, in measures aimed at imparting thrust to the MSME sector. It is proposed to introduce a scheme to provide subordinate debt for entrepreneurs of MSMEs. This subordinate debt to be provided by banks would count as quasi-equity and would be fully guaranteed through the Credit Guarantee Trust for the Medium and Small Entrepreneurs (CGTMSE).
This move is beneficial and will boost the financial health of MSMEs. Compared to other alternatives the subordinate debt will be less expensive. Also, it will aid to faster npa recovery process. So surely this is a welcome move and will enhance the economic and financial sustainability of MSMEs. However, the success of the model will hinge on the quality of the due diligence done prior to the lending. Even within the MSME sector, albeit it is crucial, the quality of the borrower will have to be maintained for this to be a long term model which can be supported by lenders notwithstanding the government of India’s support.
"An app-based invoice financing loans product will be launched. This will obviate the problem of delayed payments and consequential cash flow mismatches for the MSMEs".
Necessary amendments will be made to the Factor Regulation Act 2011 to enable non-banking financial companies (NBFCs) to extend invoice financing to the MSMEs through TReDS thereby enhancing the economic and financial sustainability
The MSME borrower should have less than Rs 25 crore outstanding as on 29.02.2020 Turnover of Rs 100 crore.
The tenure of the loan would be 4-years with 12-months moratorium on Principal repayment.
How will the Subordinate Debt scheme work for the MSMEs?
MSMEs require more liquid funds than large corporates, but banks and NBFCs are often unwilling to extend them the requisite line of credit due to scepticism around the MSME sector in general, and the added fear of bad loans.
Subordinate debt, though it carries a higher rate of interest, is listed as a long-term liability on the company books – it gives them more liquid capital to invest in their growth in the present. In case of any defaults, the entrepreneur is required to first clear the senior loans (known as unsubordinated loans) before the subordinate debt.
For lending institutions, subordinate debt fetches higher interest rates but is a bigger risk in the case of defaults. However, according to the Budget proposal, the subordinate financing will count as quasi-equity and will furthermore be guaranteed by the CGTMSE. The Trust’s funds will be augmented for this very purpose. Therefore, in the face of a government guarantee, the banks will not find it as risky to extend subordinate financing to the MSME sector. It will reduce the burden on nclt lawyers Mumbai.