The Chartered Accountant • Journal of ICAI January 2022 • Vol. 70 • No. 7 • pp. 50–58 (Journal pp. 826–834)

MSME Sector

MSME Banking Finance – An Overview of Credit Procedures

CA. Nitin Kumar Agrawal

The author is member of the Institute. He can be reached at ca.nitin7989@gmail.com and eboard@icai.in

“MSMEs are the backbone of the Indian economy because of their enormous contribution to GDP, exports and employment. Creating opportunities for MSMEs in the emerging markets is a key way to advance economic development. However, there is a huge understanding gap between the entrepreneurs and bankers when it comes to concluding the eligible finance to an MSME. This article attempts to clarify the understanding of credit assessment among entrepreneurs and finance professionals so that majority of the check points can be cleared at their end to improve the overall Turnaround Time (TAT). Read on…”

Introduction: The Credit Assessment Framework

Micro, Small, and Medium Enterprises (MSMEs) serve as the primary catalyst for economic expansion in India through significant contributions to national manufacturing output, gross domestic product (GDP), export earnings, and massive employment generation. While government policies actively encourage formal institutional credit to this vital sector, entrepreneurs and financial advisors frequently encounter substantial delays, misunderstandings, and procedural friction during loan appraisal.

When an enterprise submits a loan application to a commercial bank or financial institution, the credit underwriting team evaluates the proposal against six core pillars of credit assessment:

1. Business Profile: Legal structure, industry sector, plant capacity, market standing, and enterprise vintage.

2. Credit History: Commercial CIBIL, Consumer CIBIL, dedupe checks, SMA/NPA status, and defaulter lists.

3. Financial Assessment: Turnover trend, EBIDTA/PAT margins, ATNW, TOL/ATNW ratio, current ratio, and operating cycles.

4. Banking Conduct: 12 months bank statements, credit summation matching, bounce track record, and debt servicing.

5. Collateral Comfort: Nature, occupancy, valuation, legal title search, ROC charge registration, and security coverage ratio.

6. Other Aspects: Supplier/buyer references, factory unit inspection, routing conditions, and limit utilization covenants.

Pillar 1: Business Profile Analysis

The business profile constitutes the primary bedrock upon which a credit underwriting manager establishes baseline comfort for an advance. Commercial enterprises are classified into three primary categories:

Manufacturing Firms: Credit assurance is inherently higher for manufacturing enterprises compared to pure traders. A manufacturer commits substantial permanent equity capital into land, physical buildings, and specialized plant and machinery following exhaustive planning, demonstrating a long-term economic stake in the establishment. Credit appraisal for manufacturers is directly supported by rated plant capacity, production bottleneck analysis, and machine specifications.
Trading Firms: Because traders possess high liquidity and low fixed asset commitments, credit assurance is predominantly derived from the commercial vintage (age) of the business, established distributor channels, and multi-year turnover growth consistency.
Service Enterprises: Assuredness is evaluated based on the certainty of running service contracts in hand, the reputational standing and creditworthiness of the principal corporate clients for whom services are executed, and historical fee generation trends.

Vintage & Promoter Track Record: Business vintage and promoter background in the exact line of activity provide critical comfort. Substantial operational vintage demonstrates resilience across macroeconomic cycles. Furthermore, credit managers evaluate the specific product lines handled:

General Commodity Products: Goods globally traded in high volumes—such as textiles, pharmaceuticals, chemical intermediates, agricultural food products, ferrous/non-ferrous metals, and paper—enjoy ready liquidity and established secondary markets.
Requirement-Specific Products: Specialized custom capital goods, customized engineering moulds, heavy industrial equipment, and niche consumer durables involve higher market risk, client concentration, and longer absorption cycles.
Negative & Restricted Industry Lists: Most commercial banks maintain restricted lending sectors due to regulatory, volatility, or environmental risks. Commonly un-funded or restricted sectors include stockbroking, bullion and precious metal trading, private real estate development, speculative land trading, news media channels, distilleries, and alcoholic beverage manufacturing.

Pillar 2: Credit History and Dedupe Checks

Credit track record verification represents an uncompromising regulatory screening stage. Underwriters perform comprehensive checks covering both the borrowing legal entity and all individuals involved as promoters, partners, directors, or personal guarantors:

Commercial CIBIL Report: Assesses historical repayment conduct, fund-based/non-fund-based limits, and past defaults of the commercial entity.
Consumer CIBIL Score: Evaluates the personal credit discipline, credit cards, retail loans, and repayment histories of all promoters and guarantors.
Negative Regulatory Lists: Comprehensive screening against the Reserve Bank of India (RBI) Wilful Defaulter List, Export Credit Guarantee Corporation (ECGC) Exporter Defaulter List, and the bank’s internal Customer Profile Checking System (CPCS).
Dedupe Analysis: Cross-verifying tax identification numbers (PAN, GSTIN), residential addresses, mobile numbers, and director identification numbers (DIN) across existing database exposures to identify concealed inter-connected defaults.

“The credit manager requires audit reports of the entity for financial assessment. Generally, the borrower is asked to submit audit reports of 3 years.”

Handling Adverse CIBIL Flags: If an applicant’s credit bureau record reveals past instances of default, loan settlements, Days Past Due (DPD), or loan write-offs, the borrower must furnish legitimate justifications supported by documentary evidence. Special Mention Accounts (SMA-1, SMA-2, SMA-3) and Non-Performing Asset (NPA) classifications in any existing facility require rigorous scrutiny.

Depending on case merits, credit underwriters may stipulate formal pre-disbursement conditions requiring full settlement of disputed dues with existing lenders and submission of formal No Due Certificates (NDCs). While credit scores improve over time with pristine ongoing conduct, many institutions enforce strict minimum cut-off threshold scores below which applications are summarily rejected.

Pillar 3: Financial Assessment and Core Banking Metrics

Financial underwriting requires submission of audited financial statements (Balance Sheet, Profit & Loss Account, Schedules, Audit Reports, and Tax Audit Form 3CD) for the preceding three financial years. For entities possessing a shorter track record (vintage under three years), deviations may be granted under institutional policy matrices subject to stringent minimum vintage covenants.

Critical Financial Parameters Evaluated by Underwriters

1. Working Capital Limit Eligibility (Turnover Method)

Turnover constitutes the foundational baseline for determining working capital requirements (under Nayak Committee norms). Typically, banks sanction fund-based working capital limits equivalent to 20% to 25% of the last audited or CA-certified provisional annual turnover. Where limits are sought against projected sales, the credit manager validates projections against confirmed orders in hand, Letters of Credit (LCs), and contracted production capacities.

2. Turnover Trends and Operating Margins

Banks scrutinize the 3-year turnover trajectory (increasing, stagnant, decreasing, or gradual). Exceptional top-line spikes require economic justification regarding capacity and future sustainability; declining sales require comprehensive operational explanations. Underwriters examine Operating EBIDTA (Earnings Before Interest, Depreciation, Tax, and Amortization) and PAT (Profit After Tax) margins relative to established peer industry benchmarks.

3. Adjusted Tangible Net Worth (ATNW)

ATNW represents the genuine, unencumbered equity stake committed by the business owners. It is mathematically derived as:

          ATNW = (Paid-up Capital / Partner Capital + Reserves & Surplus + Subordinated Unsecured Loans from Promoters/Relatives) − (Loans & Advances to Related Entities / Non-Core Asset Diversions)
        

Underwriters demand an expanding ATNW trend, confirming that earnings are retained in the business rather than diverted to external personal ventures.

4. TOL / ATNW Leverage Ratio

Total Outside Liabilities (TOL) encompasses bank borrowings, trade payables, statutory dues, and provisions. Underwriters maintain a strict benchmark comfort threshold of TOL / ATNW < 5.0 times (inclusive of the proposed bank exposure). If total leverage exceeds 5.0 times, credit sanction requires upfront promoter equity infusion or subordinated debt prior to fund release.

5. Current Ratio (Liquidity Benchmark)

The regulatory benchmark Current Ratio (Current Assets / Current Liabilities) is established at 1.33. Industry deviations are permissible: capital-intensive manufacturing units locking funds into specialized fixed assets, or infrastructure contractors whose liquidity is tied into long-term Earnest Money Deposits (EMDs) and bank guarantee margins, may be sanctioned at lower ratios.

6. Operating Cycle: Debtors vs. Creditors Dynamics

Debtors’ collection period normally oscillates between 60 to 90 days or 90 to 120 days, corroborated against trade practices. Creditors’ payment terms typically involve advance payment, payment upon delivery, or 30 to 60 days credit. The structural net working capital gap between customer realization and supplier payments defines the true financing requirement.

“The creditor’s cycle gives an idea of how the firm is meeting its trade payables and the overall gap between the debtors and creditors realization period for which working capital is desired.”

Pillar 4: Banking Conduct & Forensic Cash Flow Scrutiny

Underwriters evaluate proposal banking conduct under two distinct scenarios: (a) a first-time institutional borrowing entity, or (b) a balance transfer (takeover) from another commercial bank. Borrowers must submit 12 continuous months of bank statements for all operational operative accounts.

“The bank demands the latest 12 months bank statements to observe the banking conduct of the borrower.”

Credit Summation Matching: Cumulative annual credit entries in bank statements must broadly match the reported revenue in financial statements and GST GSTR-3B filings, validating reported business scale.
Legitimate Party Invoicing: Operational receipts and disbursements must align with legitimate trade counterparties. Payments to unrelated entities or cash withdrawals indicate fund diversion.
Cheque Bounce Analysis: Inward cheque bounces point to weak debtor creditworthiness and customer payment stress. Outward cheque returns indicate working capital mismanagement and severe liquidity stress.
Debt Servicing Track Record: Timely servicing of monthly interest and scheduled loan EMIs must adhere strictly to original sanction repayment amortization schedules.

“The bank verifies the nature of payments received by the firm and the parties from whom the payments are received. Payments and receipts should be invoiced to and verified with those parties who are related to the business of the firm.”

Pillar 5: Collateral Comfort, Valuation & Legal Security

To mitigate default risks, banks secure credit exposure via primary movable assets and secondary collateral security:

Immovable Properties: Residential buildings, commercial offices, industrial plants, or open plots. Highest underwriter comfort attaches to self-occupied residential properties, followed by commercial spaces, while industrial factory premises rank lower due to limited secondary market liquidity.
Movable Assets & Liquid Securities: Hypothecation of current assets (raw materials, work-in-progress, finished goods, book debts), fixed deposit receipts (FDRs), approved government bonds, mutual funds, listed equities, and surrender values of keyman/individual life insurance policies.
Security Coverage Ratio: Where financial parameters or vintage are weak, banks demand security coverage exceeding 100% of the loan amount. For established enterprises with sterling repayment records and strong market standing, coverage below 100% may be approved.
Legal Title & Mortgage Formalities: Comprehensive Title Search Reports (typically covering 30 years) from empanelled advocates; registered or equitable mortgage execution with appropriate stamp duty; registration of charge with the Registrar of Companies (ROC) under Section 77 of the Companies Act, 2013; and mandatory comprehensive insurance covering fire and perils.

Pillar 6: Operational Covenants, Factory Visits & Underwriting Covenants

Beyond audited figures and collateral documentation, credit managers implement crucial qualitative underwriting checks:

“Reference check is an important aspect about the proposed borrower, which the banker does many times with buyer/suppliers of the applicant firm.”

Trade & Market Reference Checks: Discreet background calls made to top suppliers and buyers, as well as peer competitors within the bank’s existing portfolio, verifying business ethics and market standing.
Mandatory Factory / Unit Inspection: Physical pre-sanction inspection assessing operational activity, machinery running condition, raw material storage, production cycle, labor strength, and dispatch infrastructure.
Conditional Phased Disbursements: Sanctioning limits with milestone riders—linking credit tranches to demonstrated turnover milestones or physical construction stages.
Sole Banking & Current Account Routing: Enforcing strict covenants disallowing multi-banking current accounts, mandating exclusive transaction routing through the lender bank.
Minimum Limit Utilization (NII Protection): Enforcing penal clauses and requiring an average minimum facility utilization of 60% of sanctioned limits to protect the bank’s Net Interest Income (NII).

“Banker may stipulate conditions for release of funds with riders. They may sanction an applied limit and disburse/release by linking it with turnover achievement or fulfilment of particular conditions.”

Comprehensive Client Information Dossier for Bank Submission

To compress Turnaround Time (TAT) and eliminate repetitive underwriting queries, finance professionals and MSME promoters should assemble a complete loan docket structured across the following five exhaustive schedules:

(A) Business Overview Checklist

Sr No.	Particulars & Operational Detail	Underwriting Focus / Client Remarks
1.	Product Configuration: • Name of Product that entity is manufacturing/going to manufacture under expansion • Monthly production capacity of each Product	Quantify rated machine capacity vs. actual operational throughput per shift.
2.	Raw Material: • Raw Materials required for manufacturing such product/products	Technical grades, bill of materials (BOM), substitute viability.
3.	Sources of Raw Material: • Locality of Suppliers • Whether purchased from original manufacturer or trader/dealer • Average stock of Raw material maintained by the entity • Transport mode of RM procurement • Import/Domestic procurement Percentage	Lead time risk, price hedging, LC requirements for imported inputs.
4.	Manufacturing Process: • Manufacturing process in brief • Average manufacturing time • Percentage of Wastage	Standard conversion cost analysis; scrap recycling and net yield margins.
5.	Product Applications: • Industries where the product is used • Whether the product is RM or FG of its customers	Assess consumer industry cyclicality and bargaining power over pricing.
6.	Factory Land Details: • Obtain land allotment letter if GIDC land • GPCB applicability and clearance • Obtain soft copy of plans if available	Freehold vs leasehold tenure; lease payment status, master plan layout.
7.	Status of Statutory License / Registrations / Approvals: • Udyam Registration • Building Approval / Layout Approval • Factory License • GPCB approval (Consent to Establish / Consent to Operate) • PF / ESIC registration • GST registration • Drug License (if applicable)	Mandatory regulatory compliance dossier; validation of operating licenses.

(B) Revenue and Cost Estimations & CMA Data Checklist (Project & Working Capital Finance)

Sr No.	Financial / Cost Estimation Parameter	Underwriting Focus / Client Remarks
1.	Capacity Utilization: • Total Month wise production capacity of each product • Capacity utilization percentage presently and in upcoming years • No. of Operational Hours per day • Prepare Excel Sheet for Capacity Utilization	Pragmatic ramp-up assumptions (e.g., 60% Year 1, 70% Year 2, 80% Year 3).
2.	Revenue Estimation: • Selling price of each product • Selling price hike over a period • GST applicability of Sales • Monthly sales Unit and Finished goods • Closing Stock units monthly • Prepare Excel Sheet for Revenue Projection	Reconciliation with GST return tax rates and historical pricing power.
3.	Raw Material Cost: • Raw Material cost per unit • Consumption pattern of Raw material per month as per production units • Raw material closing stock maintained per month • Price escalation percentage over a period in RM cost • Prepare Excel Sheet for Raw material Cost calculations	Sensitivity to commodity inflation and supplier credit terms.
4.	Power, Fuel, Water & ETP Cost: • Details of connected load/power requirement proposed • Details of alternative source of power in case of failure/DG sets if proposed in Cost in project • Prepare Excel sheet for power consumption calculation • Obtain details of fuel cost as percentage of production • Cost of Water and ETP (Effluent Treatment Plant)	Sanctioned power load sanction letters; environmental compliance outlays.
5.	Manpower Cost: • Prepare excel sheet for manpower cost calculation • Growth percentage in manpower cost over a period	Skilled, semi-skilled, administrative headcount with annual wage hikes.
6.	Repairs & Maintenance Cost: • R&M cost as percentage of Gross Fixed Assets per annum (say 1% of the FA Block each year)	Benchmark industry standard provision on plant maintenance.
7.	General and Administration Cost: • General and Administration cost as percentage of Gross sales per year	Corporate overheads, audit, legal, insurance, travel.
8.	Selling and Marketing Cost: • Selling and Marketing cost as percentage of Gross sales per year	Distribution freight, marketing commissions, sales promotional budgets.
9.	Depreciation and Income Tax: • Prepare Excel Sheet for above calculations	Companies Act vs Income Tax Act rates; deferred tax computation.
10.	Margins: • Obtain idea of EBIDTA and PAT margins industry specific	Benchmarking projected operating margins against peer companies.
11.	Inventory / Debtors / Creditors Cycle: • Average inventory cycle • Average Debtors realization period i.e., the credit period allowed to customers • Average credit period expected to get from suppliers	Foundation of CMA operating cycle working capital gap derivation.

Sr No.	Promoter / Guarantor Information	Underwriting Focus / Client Remarks
1.	Name of all Promoters: Full legal names as per PAN and Aadhaar.	Identity and shareholding pattern alignment.
2.	Name of all Owners of Collateral Offered: Legal titleholders of mortgaged properties.	Mandatory personal guarantee requirement for third-party mortgagors.
3.	Promoters / Guarantors Background: • Total experience in the field • Brief career/journey of the promoter • Current role in the business entity (Accounts / Finance / Production / Marketing and sales / Liasoning) • Age (can be taken from KYC) • Residential Address (can be taken from KYC) • Education (including name of the institute) • Family tree and Legal Decedents	Management succession risk, technical competence, and lineage verification.
4.	Net Worth of Promoter / Guarantors: • Net worth Details of each promoter/guarantor and supporting if available • Copies of Index 2 of the properties considered under net worth	CA-certified wealth certificates supported by property Index 2 deeds and ITRs.

(D) Collateral Security Details Checklist

Sr No.	Collateral Parameter	Underwriting Focus / Client Remarks
1.	Details of Collateral Offered: • Nature of Collateral viz Industrial / Commercial / Residential / Liquid etc. • Name of Owners of Collateral • Approx. Market value of collateral • Details of Leasehold / freehold collateral	Two independent valuer valuation reports, TSR from advocate, ROC search.

(E) Supplementary Operational Details & Additional Checkpoints

Sr No.	Operational Checklist Item	Underwriting Focus / Client Remarks
1.	About Technology Acquisition: Details of technical know-how, patent licenses, or proprietary manufacturing processes (if any).	Obsolescence risk and royalty commitments.
2.	Marketing Strategy of Company: • Targeted markets in India and Abroad • Marketing team at Ground level • Online Marketing (if applicable) • Brand name (if any) • Targeted segments viz., Pvt / Govt • Unique Selling Proposition (USP) of the product	Distribution channels, sales force presence, digital customer acquisition.
3.	Plans of Import / Export (if any): Foreign exchange exposure, Hedging strategy, Duty drawback benefits.	Requirement for non-fund-based LC / BG and Forex limits.
4.	Site Photographs: Current photographs of factory premises, plant machinery, inventory yards, and administrative office.	Visual confirmation of physical setup.
5.	Sample Invoices: Sample copies of 5 largest sales invoices and 5 largest purchase invoices.	Pricing verification, GST matching, and trade terms.
6.	Top 5 Raw Material Suppliers: Contact person, company address, phone, GSTIN, and annual purchase volume.	Supplier concentration check and market feedback.
7.	Top 5 Customers: Contact person, corporate address, phone, GSTIN, and annual sales volume.	Client concentration risk and debtor reference checks.
8.	Sister Concern Details & Cross Experience: Financials, banking limits, and promoter track record in group entities.	Assess contagion risk and related-party transactions.
10.	Unsecured Loans Analysis: Scrutinize whether promoter/relative unsecured loans are interest-bearing or interest-free.	Subordination covenants; interest outgo impact on cash flows.
11.	Machinery Suppliers Due Diligence: Due diligence note on equipment manufacturers and technological viability.	Validation of machinery quotes and commissioning performance.
12.	Competitive Quotations: Comparative quotes for capital equipment to present before the credit underwriting committee.	Prevent gold-plating of capital project cost.
13.	Additional Critical Legal Checkpoints: • Whether the specific business activity is permitted under the Memorandum of Association (MOA) / Partnership Deed. • Whether the entity and board have requisite borrowing powers under MOA / Section 180(1)(c) of the Companies Act, 2013. • Arrears of statutory dues (GST, Income Tax, PF, ESIC, Customs). • Pending litigation on company / promoters and adverse auditor remarks in audit reports. • Powers of the entity and partners/directors to mortgage property for secured borrowings.	Foundational legal validity of loan agreements and mortgage deeds.

Conclusion: Proactive Alignment to Optimize Loan Turnaround Time (TAT)

The prevailing disconnect between MSME entrepreneurs and commercial banks arises primarily from an informational asymmetry. By preparing financial dossiers that proactively address the credit manager’s mandatory assessment criteria—business profile stability, clean CIBIL track records, audited 3-year performance, realistic CMA operating cycles, spotless banking summation, and comprehensive legal collateral verification—chartered accountants and finance professionals can eliminate procedural bottlenecks.

A well-documented, transparently justified loan proposal significantly accelerates credit approval, minimizes pre-disbursement riders, and secures optimal working capital liquidity to fuel MSME growth. ■ ■ ■