Research-Based Policy Initiative

We like our research findings to inform and influence business practices and government policies in India and other emerging markets. It is an important priority for CAF. In this context, we are excited about our new research-based policy initiative. The policy recommendations were developed by Sankar De when he was working with the Raghuram Rajan Committee on Indian financial sector reform. The recommendations were accepted by the committee and are included in the committee’s report.

We are very optimistic that the initiative, if implemented, will be very beneficial for Small and Medium Enterprises (SMEs) in India and in generating positive and significant societal impact. Trade credit is a very important source of financing for Indian SMEs, as documented by all existing studies/reports on the subject including several CAF research reports. Trade credit financing involves direct transactions between two companies outside the usual intermediated financial system. However, market financing should involve lower transactions as well as lower recurring interest costs than bilateral trade credit financing. Extensive research undertaken at CAF confirms this intuition. How can trade credit financing of SMEs be brought into the market system? The initiative proposes a strategy to do just that. SMEs often sell on credit to their large customers and then wait for long periods for payment. If the receivables owed to the SMEs by large firms could be securitised, it would result in both deepening and broadening of Indian credit markets. In principle, such receivables are comparable to commercial paper with the high credit ratings of the large firms. The potential benefits include the following:

  • The SMEs could reduce their investment in working capital, and thus their need for finance, significantly.
  • The ensuing balance sheet clean-up would improve the credit worthiness of a typical SME, qualifying the company for more bank loans as well.
  • A new market for securities will come into being, creating new financial sector assets and jobs.
  • Growth in the SME and financial services sectors will have strong positive multiplier effects throughout the economy.
Our role in the initiative is to first seek feedback from the relevant constituencies (SME associations, financial institutions, finance ministry, the RBI) on this and, given a broad agreement on the value of the initiative, to persuade the constituencies to initiate the securitisation process. We are delighted to report that the initial reaction of all concerned parties, including the SMEs, the banks, and especially the regulators, has been uniformly positive. At a high-level policy conference in Washington DC coinciding with the 2011 bilateral summit on US-India economic and financial cooperation between the Indian Finance Minister and the US Treasury Secretary, Sankar De’s presentation on the initiative was enthusiastically received by the audience. Following the conference, the Indian Finance Ministry has announced a new initiative to provide factoring services to help improve SME financing. It is a major step toward full-fledged securitisation. As another encouraging development, the summit has led to the formation of an international working group of specialists with experience of securitisation in different countries, to take the initiative forward. Sankar De will lead the deliberations of the working group.

More details on the initiative can be found here.

As a first step, CAF is organising a symposium on financing challenges of SMEs in India. Details on the symposium can be found here.