Small business loans could cause big problems for banks this fiscal year

The situation during the current pandemic is perhaps even more dire and less visible than during previous disturbing episodes. The latest Financial Stability Report from the Reserve Bank of India (RBI) gives enough reason for banks to increase their vigilance over MSME lending. Stress among MSMEs was increasing even before the pandemic. Delinquencies remained high with a bad debt ratio at 16% for public sector banks in March.

It should be noted that the delinquency rate has increased despite support for abstention. Among the lenders, public sector banks and non-banking financial companies could hold a maximum of distressed loans. Analysts at ratings agency Icra Ltd said repayment collections for non-bank lenders fell in May due to restrictions following the second wave of the pandemic. A slight improvement was seen in June.

“Due to the absence of relief measures, such as the moratorium planned the previous year, business cash flows and the income-generating capacity of borrowers were significantly affected during the second wave, affecting thus their ability to repay across all asset classes,” ICRA analysts wrote in a note.

The rise in delinquencies was highest for unsecured loans to small and medium-sized businesses in May, they added. The history of Special Mention Accounts (SMA) also remains the same. These accounts are showing early signs of trouble on the banks’ loan books, where repayments have been overdue for more than a month. Public sector banks saw a large increase in these accounts in FY21. In more than 12% of public sector lenders’ MSME loan portfolio, repayments were more than a month past due. For private sector banks, this ratio was 3.2%, compared to 2.6% a year ago.

The RBI report also warned that these companies are leveraged and hold high levels of debt. The Emergency Line of Credit Guarantee Scheme (ECLGS) has also enabled small businesses to borrow more. Therefore, business interruptions, if any, could harm small businesses disproportionately.

In this light, the specter of a third wave becomes more threatening. Certainly, access to cheaper funds and even restructuring are reliefs for MSME borrowers. Analysts expect restructuring to intensify in the coming quarters. But the health of these companies depends mainly on the recovery of the economy thanks to increased demand. The second wave and a potential third wave cast a shadow of uncertainty over them. Indian small businesses are certainly not an exception compared to their counterparts in other countries.

The pandemic has hit small businesses, even in advanced economies. But India compares poorly to others when it comes to crime. The weighted average default rate of Indian corporate borrowers has become the highest compared to its European counterparts from pre-pandemic levels, according to the report. The likelihood of increased delinquencies is also high among Indian companies.

Government and central bank measures have supported small borrowers. But whether their balance sheets have strengthened or weakened further will be known several quarters later.