Start-up financing. Banks need a tight framework, say experts

Prime Minister Narendra Modi’s vision for banks to support start-ups by investing in ideas needs to be backed by a comprehensive framework from the Reserve Bank of India (RBI), say banking and finance industry experts.

In the absence of such a framework that would, among other things, cover aspects such as NPA recognition and treatment of start-up failures, public sector banks — which are into mostly asset-based lending — would not venture into supporting start-ups, experts feel.

The framework should be tight and well-thought-out to encompass all aspects of venture funding so as not compromise and expose the bankers if such investee ventures were to fail due to market forces. No banker would want to risk depositors’ money in new start-ups without safeguards. PM Modi had, earlier this week, told bankers to invest in ideas thrown up by the start-ups and support their growth.

Funding start-ups

“Start-up finance is nothing but venture capital finance. Venture capital has never been part of banking. In VC, the person who takes the risk profits if the venture succeeds and suffers losses if it does not. The present regulatory framework does not allow banks the same privilege. They do not profit if the investee venture profits but if it makes losses, the bank loses money. There is a big difference and PSBs definitely are not looking at funding start-ups”, a former chief executive of a PSB told BusinessLine . In PSBs, the monies are that of the depositors and not that of the banker, this expert pointed out.

Venture funding

There has to be a mechanism where the PSBs’ commercial banking activities are ring-fenced from their venture funding efforts, say experts. One way is to encourage banks to float their venture funding entities.

PSBs are presently not allowed to do direct equity investments in start-ups. At the most, they can set up vehicles that will do debt funding. Even here, except for large banks like State Bank of India, there has been very little activity by other PSBs. However, private banks have in the recent years been taking equity exposure in fintechs and other start-ups that they would like to partner with.

“Typically, a venture capital fund spreads its bet among a portfolio of start-ups and if one or two among, say ten, becomes a successful enterprise, it is able to recoup the losses made in other investee companies in the portfolio. That is how the world of venture capital works and it will not be easy for banks to replicate this given their less-than-optimal skillsets in evaluating enterprises even if regulations permit them to take equity bets in start-ups,” said a banking industry observer.

Srinath Sridharan, Corporate Advisor and independent markets commentator, said “This would need the banking sector under RBI’s leadership to come up with requisite framework which encourages entrepreneurship, ideas and reaps benefit for all the stakeholders and also offers solutions to any hesitancy factors”, he said.

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