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Will the RBI Granting Startups in India Priority Lending Sector Status Truly Boost Startup Funding?

Aug 8, 2020 2:40 PM 4 min read

As per Tracxn, funding activity in the startup ecosystem in India fell by nearly 29% to $4.2bn in the first six months of this year compared to $5.9bn in the same period last year, owing to the impact of the pandemic. Only 443 companies were funded in the January-June period this year against 725 in the corresponding period last year. 

According to a survey published by industry body Nasscom in late May, 70% of startups in India have less than three months of cash runway. Another 22% have enough to barely make it to the end of the year. Merely 8% said that they had enough money to survive for more than nine months.

However, with the Reserve Bank of India (RBI) now granting priority sector lending (PSL) status to startups, these companies will perhaps have one less thing to worry about - swifter access to bank credit - or at least that's what the Central Bank envisages.



What Does Priority Sector Lending (PSL) Really Mean?

Under PSL guidelines, banks have to set aside 40% of Adjusted Net Bank Credit for sectors deemed as priority by the RBI.

The underlying idea here is to ensure that adequate institutional credit reaches some of the rather vulnerable sectors of the economy, which otherwise may not be attractive for banks from a profitability point of view. The move is expected to propel inclusive development, boost the startup ecosystem in India, and in turn generate employment and spur overall economic growth.

Sectors that are currently under PSL are agriculture, MSMEs, education, housing, social infrastructure, renewable energy, export credit and others. 


How Can it Help Startups in India?

Startups in India obtain funding from venture capital firms, private equity companies and angel investors. Some well-funded startups also get credit from private sector banks such as Yes Bank, HDFC Bank and Axis Bank.

Small scale and bootstrapped startups, on the other hand, have not had easy access to debt due to the lack of a robust credit history and an uncertain cash flow generation profile . Founders have often had to turn to friends and family to raise funds. Many have even had to mortgage their houses and other personal possessions to secure credit for their working capital needs. Therefore, the optionality of raising low-cost debt w]could be of some help to a few cash-strapped startups, whose operations have been hit during the ongoing pandemic.

The startup ecosystem has embraced the move, hoping to see it get translated on ground as effectively as envisaged.  

“Many startups in India have had to raise equity in order to finance working capital and credit needs, leading to needless dilution. This single act will allow them to access alternate lines of cash, and will go a long way in creating larger and more resilient startups without leading to significant loss of control,” said Siddarth Pai of VC fund 3one4 Capital.

The move could also prove to be a game changer for the venture debt model. As per  Ankur Bansal, Co-Founder and Director, BlackSoil, a Venture Debt Firm, "This will be a positive development for the venture debt model since we will now see banks partnering with venture debt players in their funding rounds, enabling them to write bigger cheques.”


Roadblocks En Route Funding Startups

While the planning looks good on paper, it’s implementation is likely to face some roadblocks. 

The lack of collateral is likely to emerge as a significant point of concern for banks when they will consider lending to startups. Many startups are digital platforms, and therefore, have little or nothing in the form of physical assets nor do they have sufficient free cash flow generation to cover interest payments 

Traditional reliance on collaterals may sway banks towards asset-heavy businesses such as renewable energy.

Banks will also have to comprehend the high-growth business models of start ups and discern how to underwrite them - a gap that has been filled by venture debt players. And fact of the matter remains that traditional banks don’t have the requisite expertise to successfully navigate a startup funding round, which a VC or PE firms has.  

It is also relevant to note here that as per data released by the RBI last year, the banking sector had failed to meet the PSL targets overall. They had also failed to meet targets of specific sectors such as agriculture and micro, small and medium enterprises (MSMEs).

“Bank credit to agriculture decelerated during 2017-18, partly reflecting the pervasive risk aversion and debt waivers by various state governments, which may have dis-incentivised lending to the sector,” the RBI said. Will this risk-aversion also manifest itself in the case of startups?

While the move is indeed a much-needed step in the right direction, it goes without saying that forcing banks to lend merely based on regulatory targets without pricing in the risks will only further burden the NPA-afflicted banking system in India. Mindful execution will be key here.


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