Session Coverage

• Importance of MSME Compliance 
• Duties of MSME
• Credit Monitoring    -  Concept  -  Significance  
• Monitoring -  stages
• Monitoring Tools
• Monitoring  through Accounts -  Modality
• Diversion of funds 
• Collection of Returns & Statements

MSME Compliance - IMPORTANCE OF MSME COMPLIANCE

• Compliance with laws and regulations is not only a legal requirement, but also a business imperative. 
• Failure to comply can lead to serious consequences such as sanctions, fines, legal action, loss of reputation, and even business closure.
• In addition, compliance helps SMEs build credibility, gain the trust of their customers, investors, and other stakeholders and create a level playing field for all market players.
• Navigating the regulatory landscape is a necessary aspect of running a successful MSME. 
• By understanding and complying with the relevant regulations, MSMEs can avoid penalties, gain access to benefits and incentives, and build a sustainable business. 
• Entrepreneurs must stay updated with changes in the regulatory framework and seek professional guidance when needed. 
• However various government schemes have been introduced to support MSME in India. With the simplification of compliances through online registration processes and initiatives, 
• MSMEs can focus more on their core business activities and drive growth and prosperity in the economy.

MSME COMPLIANCES

• Section 9 of the MSMED ((Micro, Small and Medium Enterprises Development) Act defines specific companies for which MSME Form 1 is very important compliance.
• These specified companies submit MSME Form 1 once every six months to the Ministry of Corporate Affairs (MCA).
• The listed companies are required to submit an annual return of outstanding payments to MSMEs to the Registrar of Companies (ROC) every year, which includes information on the amount due for payment and the reason for the delay. The above companies can file MSME Form 1 only if their outstanding payment to MSME suppliers has exceeded 45 days.

MSME Form 1 (MCA)

• MSME Form 1 shows detailed and complete information with the registrar about outstanding payments to micro or small enterprises for more than 45 days in a half-year. The Ministry of Corporate Affairs has made changes to the protection and safeguarding of the interests of small businesses or enterprises.
• MSME Form 1 on a half-yearly basis has to be filed by specified enterprises operating in India as MSME. To close the outstanding fees, these businesses must file the form and it must be filed within 30 days of the notification.
• Compliance is mandatory for running MSME businesses.
• Section 9 of the Micro, Small, and Medium Enterprises Development (MSMED) Act 2006 defines MSME Form 1. The said form should be filed on time.
• In India, every MSME has to file MSME Form 1 with the Ministry of Corporate Affairs of India once every six months.
• Director/CS/CEO/CFO/Manager can sign MSME Form 1 electronically as they are authorized by the company.
• DIN details for Director and Manager, Company Secretary, CEO, and CFO PAN card details must be provided.
• In the case of a supplier; FYI form, supplier name, PAN details of the supplier, the amount due and date from which the amount was due, the reason for late payment and if there is any optional attachment it must be. This data must be provided by each supplier.

Compliance Requirements for MSMEs
MSMEs in India need to comply with various laws and regulations, some of which are mentioned below:

• Registration: MSMEs need to register themselves with the Ministry of Micro, Small and Medium Enterprises (MSME) to avail various benefits such as credit facilities, subsidies, and exemptions.
• Goods and Services Tax (GST): MSMEs with a turnover of more than Rs. 20 lakhs need to register for GST. GST is a comprehensive indirect tax levied on the supply of goods and services and replaces all other indirect taxes.
• Employees’ Provident Fund (EPF): MSMEs with more than 20 employees need to register for EPF. EPF is a social security scheme that provides retirement benefits to employees.
• Employees’ State Insurance (ESI): MSMEs with more than 10 employees need to register for ESI. ESI is a social security scheme that provides medical benefits, sickness benefits, and disability benefits to employees.

Compliance Requirements for MSMEs

• Shops and Establishments Act: MSMEs need to register under the Shops and Establishments Act, which regulates the working conditions, welfare measures, and rights of employees.
• Environmental laws: MSMEs need to comply with various environmental laws such as the Air (Prevention and Control of Pollution) Act, Water (Prevention and Control of Pollution) Act, and the Environment (Protection) Act.
• Labour laws: MSMEs need to comply with various labor laws such as the Minimum Wages Act, Payment of Bonus Act, Payment of Gratuity Act, and the Industrial Disputes Act.
• Income Tax Act: MSMEs need to comply with the Income Tax Act, which governs the taxation of their income.
  

DUTIES OF MSME

Every MSME has several basic responsibilities after completing the registration process.

MSME Registration is not enough for MSME operations, all companies must meet mandatory compliances for MSME operations. The main duties include:

• All MSME suppliers must be registered under the MSME Act.
• If there is any payment due at the end of the financial year, MSME has to check it. The due date of payments must not be longer than 45 days from the receipt of goods and services.
• Filing of Payables Returns is a must and must be done by all MSMEs. In MSME Form 1 this would be done and the reason for the delay should be mentioned.
• Certain specifications are required such as:-
  • The total amount due is essential
  • Supplier company information
  • The liability starts on a certain date, so the date from which the liability started should be given.
  • PAN card of supply companies is a must.

PENALTIES

• It is mandatory to comply with these agreements, otherwise, there would be sanctions for non-compliance. 
• An MSME that fails to comply will be liable for the penalties listed below-
  • Under Section 405(4) of the Companies Act, 2013, a defaulting company would be fined INR 25,000.
  • Under this provision, any officer who failed to comply would also be liable to imprisonment for six months.

Issues MSMEs must tackle to ensure Compliances

• Organizational structure: It is important to have a good and organized structure for business to make it successful. Many businesses lack either well planned structure, skill, knowledge, administrative apprehension and other additional compliance burden and do not get their businesses registered. Therefore, registration is required for the business so that the opportunities for the business opens up from the state and the central enterprises, they get the benefits from subsidies, higher tax rebates, easy access of investment or working capital.
• Delayed payments: the problem of delayed realization of bills is faced by every organization. This becomes the reason for excess financial constraints which is one of the major reasons for their consecutive failure. Nonetheless, such companies must be aware that according to the MSME Act 2006, it is the liability of the buyers to clear their invoices within the time period of 45 days so as to avoid heavy penalties.
• Tax liability: with the introduction of GST, it has enhanced the ease of doing business for start-ups in India by bringing all state and central level levies and taxes under one cover but with that it has also increased the high pressure compliance on MSMEs.

6 STEPS IN THE LENDING PROCESS

• Finding prospective loan customers,
• Evaluating a prospective customer’s character and sincerity of purpose,
• Making site visits and evaluating a prospective customer’s credit record,
• Evaluating a prospective customer’s financial condition,
• Assessing possible loan collateral and signing the loan agreement,
• Monitoring compliance with the loan agreement and other customer service needs.

“AN EFFICIENT CREDIT APPRAISAL WITHOUT AN EFFECTIVE CREDIT MONITORING HAS NO ROOTS & AN EFFECTIVE CREDIT MONITORING WITHOUT AN EFFICIENT CREDIT APPRAISAL HAS NO FRUITS”

INTRODUCTION

• Once the decision to extend credit facility is taken and the sanction and documentation is completed, a relationship is established between the borrower and the bank and the facilities are availed by the borrower.
• Thereafter the finance given to the borrower is subjected to a systematic sequence of monitoring activities by the Bank which is called ‘Credit Monitoring’.
• Credit Monitoring if carried out effectively  plays a significant role in aiding the borrower to operate efficiently and profitably, especially in case of MSMEs, and can be described as:
  • A logical step after the sanction of credit facility.
  • A systematic sequence of activities right from extending to executing to winding-up the credit.
  • A tool to optimize the benefits of production.
  • A means of awareness for the lending institution about emerging issues or any other related aspects.
• In light of the above, credit monitoring can be defined as the process of keeping track of a borrower’s performance throughout the period credit facilities are in place to a borrower.
• Credit monitoring is post-disbursement activity which emanates after granting of a credit facility.
• As has already been described in the earlier unit, sanction of a loan is subject to certain terms and conditions which may be termed as ‘covenants’.
• The following are some of the standard covenants that can be applicable to all credit sanctions:
  • Submission of stock statements periodically
  • Submission of financial statements at intervals agreed upon
  • Submission of MSOD (monthly select operational data)
  • Submission of QIS (quarterly information system)statements
  • Submission of half-yearly statements
  • Submission of fund flow statement
• Apart from the aforesaid, banks also stipulate certain specific covenants that are specific to borrowers.
• Thus the need and extent of credit monitoring differs based on the credit rating and the covenants also differ from borrower to borrower.
• Credit Monitoring also involves credit risk monitoring.
• Credit risk monitoring is usually done at individual borrower’s level and portfolio level.
• Credit Administration synonymous with credit monitoring involves all activities after credit is sanctioned including issue of sanction letter, execution of documents, perfection of security etc.

For an effective credit monitoring system it is necessary to-:

• Ensure that the bank understands the current financial condition of the borrower or counterparty.
• Monitors compliance of the existing covenants.
• Assesses, where applicable, collateral coverage relative to the obligor’s current condition.
• Identify contractual payment delinquencies and classify potential problem credits on a timely basis.
• Promptly direct problems for remedial management.

MONITORING 

• What is credit monitoring?
• “Monitoring is a continuous supervision process enabling the bank to   
• ensure the quality of loan assets”
• This underlines three points viz.
• Supervision of loan accounts
• Continuous basis and not one time offer
• Ensuring Quality of loan assets 
• Confirmation of the various assumptions made at the time of sanction.
• Why credit monitoring?
• Avoid or minimize or eliminate NPA. 
• It helps the bankers to:-
• Ensure end use of funds
• Performance Vs. Projections
• Ensure quality of assets;  and 
• Adherence to regulatory IRAC guidelines.

When does the monitoring start?

• Day one the borrower comes to the bank?
• After disbursement?
• Once sanction is made? 
• Pre-disbursement stage
  • Sanction letter
  • Sanction terms – modification, if any
  • Letter of acceptance/terms & conditions
  • Documents/title deeds 
  • Legal opinion (Title clearance)/Valuation 
  • Confirm compliance  with pre-disbursement terms
  • Recovery of processing fees & other charges
  • Obtaining quotations/invoices etc
  • Inspection of collateral securities
  • Successful trial run
• Pre-disbursement inspection (especially if no inspection is done earlier)
  • Recovery of processing fees & other charges
  • Completion of joint documentation 
  • Obtaining certificate of registration in case of partnership
  • Search Reports  in respect of limited companies 
  • During disbursement 
  • Validity of sanction/validation 
  • Creation of mortgage
  • CERSAI registration
  • Charge creation with ROC
  • Credit Audit
  • Margin :  whether upfront? Source, NWC, etc.
• Exchange of pari-passu letter
• Releasing the loan
• Inspection 
• Educating the borrower
•  After disbursement    
  • Compliance with post disbursement terms of sanction
  • Residual matters (mortgage, insurance, etc.)
  • Recovery of interest, installments and other charges
  • Insuring the assets
  • Completing credit guarantee formalities, if any
  • Obtain fresh search report
  • Field visits/Overlimt/adhoc limits 

MONITORING TOOLS

Monitoring through Account operations

• Advantages 
• Operation of the account 
• Warning signals  

MONITORING THROUGH ACCOUNTS

MONITORING THROUGH ACCOUNTS

• Routing of sale proceeds 
• Diversion of funds
• Borrowed funds 
• Transfer of funds 
• Routing of funds
• Investments in other companies
• Shortfall in deployment of funds  
• Recovery of interest & other charges
• Collection of Returns and Statements
  • From customers:
  • Annual reports from the borrowing unit/s
  • Monthly cash flow statements
  • Stock statements/book debts statements
  • Monthly/quarterly operating data 
• Periodical reports from field functionaries/other agencies
  • Inspection reports    
  • Stock Audit Reports
  • Credit Portfolio Audit (Credit Audit)
  • Loan review mechanism (LRM)
  • Book debts inspection reports by branch officials
  • Consortium meeting minutes
  • Consortium inspection reports, etc.
  • Concurrent audit reports
    

MONITORING  - STATEMENTS

• Internal audit inspection reports
• Statutory audit reports (LFAR, etc.)
• RBI AFI Reports  
• Credit reports from other banks
• Media reports, etc.
• Stock/ book debts statements
• Obsolete stocks
• Damaged stock
• Returned stock
• Other dead inventories
• Goods purchased on credit

STOCK/ BOOK DEBTS STATEMENTS

• Goods purchased under LC (DA)
• Goods received against BG
• Stock received for job work
• Correctness of stock declared 
• Stock < creditors  for DP
• Comparison with actual lock-up with projections
• DP against current assets as per norms
• Clue from stock statements:   

Stock/ book debts statements

STOCK/ BOOK DEBTS STATEMENTS

• Book debts statements                 
  • Aging of debtors- < 90 & > 90 days
  • Recovery from debtors – account statement
  • Sales realization
  • Monitoring of mismatches
  • Advance against orders
  • Supply bills & CC limit against book debts – declaration
  • Exclusion of drawee bills discounted 
  • Periodical visits for verification
  • Obtaining invoices/Relate to the activity
  • Debts pertaining to sister/associate concerns included?
  • Certified by the CA as per sanction terms?  
  • Monthly cash flow statement?
  • Certified by the CA as per sanction terms?  
  • Monthly cash flow statement?
    
• Identification of SMA Accounts
  • SMA-0:  P or I not overdue but signs of incipient sickness (MSME)/Overdue from 1 – 30 days (others)
  • SMA-1:  P or I overdue between 31 – 60 days
  • SMA-2:  P or I overdue between 61-90 days 
  • CRILC (Central Repository of Information on Large Credits)

FOLLOW UP

• Term Loan
  • Servicing of interest/installment
  • Sources of the repayment 
  • Compliance of terms of undertakings 
  • Obtaining copy of the Registration of Charge with ROC/ RTO 
  • Obtaining invoice and stamped receipt      
  • Copy of the insurance policy
  • Reporting overdue accounts, etc.     
• Cash credit 
  • Overdrawing within the sanctioned limit 
  • Overdrawing in excess of the sanctioned limits
  • Overdrawing owing to application of interest 
  • Diversion of funds  
  • Return of Outward/inward  clearing cheques 
  • Frequent overdrawing/payment against un-cleared effects, etc.

SUPPLY BILLS DISCOUNTING 

• Status reports 
• Fixing of sub-limits
• Irrevocable PoA by Drawer.  
• Acceptance by Drawee duly verified by their bankers
• Obtaining signature of drawee bills duly attested by their bankers 
• No bills on sister/group concerns to be discounted
• Insurance      
  • Joint names 
  • Adequate coverage – application of average clause 
  • Average clause formula: (IA x Actual Loss) ÷ Value of security
  • Timely renewal, etc.
  • Inspection
  • Significance 
  • Frequency of inspection 

INSPECTION

• Element of surprise
• Non-uniformity 

    Why inspection?

To ascertain:-

• Functioning of unit
• Maintenance of security created/charged
• End use of funds 
• Involvement  
• Records & Registers
• To realize irregularities, viz.
• Shortage of stock
• Stoppage of activity
• Presence of other bank’s name board
• Redundant stock
• Ascertain value
  • Storage in large storage vessels 
  • SIP
  • Production  - electricity consumption/bills
  • Cost of goods purchased and sold
  • No other bank on same security
  • Collateral Security     

     Assets to be inspected

• Fixed assets
• Current assets
• Records & Books 

Monitoring by Controlling Offices

Reports & Returns   

• Periodical reports from field functionaries/other agencies
  • Inspection reports    
  • Stock Audit Reports
  • Credit Portfolio Audit (Credit Audit)
  • Loan review mechanism (LRM)
  • Book debts inspection reports by branch officials
  • Consortium meeting minutes
  • Consortium inspection reports, etc.
  • Concurrent audit reports
  • Internal audit inspection reports
  • Statutory audit reports (LFAR, etc.)
  • RBI AFI Reports  
  • Credit reports from other banks
  • Media reports, etc.
  • Branch visits, etc. 
  • Stock & Receivables Audit Reports, etc.
    

REVIEW

Review gives an idea to the Bank of the action it has to take, if any, in respect of a borrower.

While the audited financials of the enterprise is desirable and should be scrutinized at the time of review, depending on the health of an enterprise and the exposure outstanding Banks may allow review up to certain limits on satisfactory conduct of account, without audited financials.

Usually in such cases the following parameters have to be satisfactory-:

• Satisfactory conduct and Turnover in the account 
• Fulfillment of repayment obligations (Interest/ Instalments) 
• Adequacy of securities, drawing power, insurance coverage etc. 
• Rectification of inspection irregularities (other than non-submission of financial statements) 
• Compliance of all terms and conditions of previous sanction. 
• Satisfactory trend in production and /or Sales as per projections 
• Documentations and mortgages in the account being complete, valid and enforceable 
• Prompt payment of bills under Letters of Credit, realization of Bills Purchased/ Bills Discounted etc. 
• Submission of Income Tax / Sales Tax returns filed with Statutory Authority as per time schedule prescribed, wherever applicable (which will also indicate about the sales and profitability of the operations). 

• Any adverse observations should be properly recorded in the report and steps taken for amelioration of the situation in consultation with the borrower.
• Post sanction inspections are an important source of information about the financial and general health of an enterprise and should be carried out periodically as stipulated in the sanction.

Loan Review Mechanism(LRM) 

• In LRM, large borrowers as well as the portfolio as a whole is constantly evaluated for the quality of the credit book and also to bring about qualitative improvements in credit administration. 
• Banks therefore have to put in place proper Loan Review Mechanism especially for large value accounts with responsibilities assigned in various areas such as, evaluating the effectiveness of loan administration, maintaining the integrity of credit grading process, assessing the loan loss provision, portfolio quality, etc. 
• The complexity and scope of LRM normally vary based on banks size, type of operations and management practices.

LOAN REVIEW MECHANISM(LRM) 

• The objectives of LRM in Banks are usually as follows-:
  • to identify promptly loans which develop credit weaknesses and initiate timely corrective action;
  • to evaluate portfolio quality and isolate potential problem areas;
  • to provide information for determining adequacy of loan loss provision;
  • to assess the adequacy of and adherence to, loan policies and procedures, and to monitor compliance with relevant laws and regulations; and
  • to provide top management with information on credit administration, including credit sanction process, risk evaluation and post-sanction follow-up.
• Banks are required by RBI to formulate Loan Review Policy and it should be reviewed annually by the Board.
• The policy should inter alia address the issue of identification of specific Loan Review officials.