An idea to pursue

Prime Minister Narendra Modi has exhorted banks to support startups and ideas, in a bid to channelise the returns from this fast-growing segment into India’s economy. Addressing chief executives of the country’s public and private sector banks last week, Modi said banks, which are flush with liquidity, should now shift focus from their balance sheets towards “building the country’s wealth sheet”. The suggestion has evoked unease among bankers steeped in a culture of recourse financing and asset-backed lending. However, the signals may be of a piece with the recently issued Staff Accountability Framework that exempts bankers from vigilance action for default on small ticket loans. Bankers say that the Reserve Bank of India (RBI) should come up with an entirely new regulatory framework if banks are to diversify their commercial lending into financing start-ups, which is a high risk activity. This is a justifiable demand.

While there is no denying the bankers’ genuine concerns and the need for a suitable policy response, what the PM has said also needs careful consideration. The fact is that India’s startup ecosystem is mostly funded by global investors largely from the US or, till the early part of the last fiscal, by Chinese investors whose share has since decreased owing to political factors. While domestic corporates and high networth Indians have slowly started coming on board to fund homegrown firms, the reality still is that out of an estimated $11 billion that has been pumped into the Indian tech startups in over 600 deals, the leading investors are those such as Tiger Global, Sequoia Capital et al who are US-based investment firms. It follows that the returns would trickle outwards. For instance, major beneficiaries of money pouring into India’s fintech sector are global investors. There is a vast space that Indian banks can tap into by diversifying from their traditional operations but it needs to be approached in a considered manner.

The Government has taken small steps towards supporting startups by setting up a ₹10,000-crore Fund of Funds operated by the Small Industries Development Bank of India (Sidbi). As of December 1, 2020, Sidbi had committed ₹4,327 crore to 60 SEBI Registered Alternative Investment Funds (AIFs). These funds have raised a corpus of ₹31,598 crore, drawn ₹1,270 crore from the Fund of Funds for startups and invested ₹4,509 crore into 384 startups. Still, this is only a drop in the ocean considering the speed with which the sector is growing. The RBI should endeavour to draw up a framework for banks to enter start-up financing. Care should be taken to ring-fence the traditional lending activity. Banks should be encouraged to look beyond their in-house talent to recruit professionals who understand start-up financing, and obviously this can be done only by offering market-linked compensation. Of course, the idea may sound ridiculous in a context where bankers are shying away from conventional lending backed by collateral securities. But clearly, building an indigenous financial system to back startups is an idea whose time has come.

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