In a significant shift in its lending norms, the Reserve Bank of India (the “RBI”) on August 06, 2020 has announced that going forward, start-ups will be included in Priority Sector Lending (“PSL”).1 While the detailed outlay and guidelines on the inclusion are awaited, the revision aims to ensure that start-ups have access to easy credit from banks.
Till now, priority sector included micro, small and medium enterprises (“MSME”), agriculture, export credit, education, housing, social infrastructure, and renewable energy amongst others. Under the PSL guidelines, banks are required to provide 40% of Adjusted Net Bank Credit to PSL.2 Inclusion of start-ups in PSL will allow them to access bank credit which otherwise is difficult to procure due to risk profile attached to their projects.
Prior to this inclusion, start-ups could qualify for PSL if they also fell under MSME category and met conditions of profitability and creditworthiness applicable to MSMEs. The revision in PSL guidelines will open up more funds to be lent to start-ups, distinct from MSMEs.
- INDUSLAW VIEW
We believe that the inclusion of start-ups in PSL will reduce their cost of capital by allowing them better access to bank credit. Going forward, equity infusion will not be the only route to follow when start-ups need funds for working capital requirements, and this will greatly ease the risk of ordinary shareholders being wiped out due to ‘down-rounds'. Although traditional lenders do not look favourably at start-ups, it will be interesting to see if they are ready to diversify their risk appetite and lend to start-ups which do not meet traditional security/collateral/cashflow requirements.
The inclusion will also expand the scope for start-ups and emerging businesses in various sectors to tap newer sources of funding. The RBI provides for various modes of collaboration between banks and non-banking financial companies (“NBFCs”), and one such mode is lending by banks to NBFCs for on-lending to certain priority sectors. Currently, the RBI allows bank credit to registered NBFCs for on-lending to MSMEs and agriculture sector (subject to certain conditions), to be classified as PSL.3 It is expected that the same recognition will be extended to NBFCs on-lending to start-ups.
We had earlier expressed concerns over the fine print in Small Industries Development Bank of India's COVID-19 Start-up Assistance Scheme4.Thankfully, the RBI has also recognised the need to inject mainstream debt capital into the start-up ecosystem to prevent it being blown away by the pandemic. There is an expectation that the conditions for a start-up to be sanctioned loans as PSL will be aligned with the criteria for MSMEs, and be more relaxed compared to the criteria set out in the COVID-19 Start-up Assistance Scheme5. The move will act as a booster for the start-up ecosystem and we hope that the moral hazard inherent in aggressive lending can be dispensed with in this unusual year at least.
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