Credit for small businesses may be central to the government’s strategy of providing employment, but these small loans come at a cost to banks.

Data from the latest issue of MSME Pulse, a jointly authored report by credit rating scorer TransUnion CIBIL and SIDBI, shows that delinquency rates are the highest for loans below 10 lakh, typically taken by mom-and-pop stores.

Chart 1 shows how size makes a big difference. Nearly 16% of the new borrowers who took loans up to 10 lakh between January and June 2016 have defaulted since then. This delinquency rate falls sharply to about 4% for loans above 10 lakh. What this means is that ultra-small businesses haven’t been able to scale up their business or even generate revenue to cover costs.

This is the segment with the highest loan growth rate within the micro, small and medium enterprises (MSMEs) sector, and is expected to grow by 24% in the first half of 2018-19, according to the report. Clearly, growth is coming at the cost of asset quality for lenders. The government and the Reserve Bank of India are trying to support MSMEs through making available more subsidized credit. That explains the 22% growth in loans to ultra-small businesses and the 13% rise in loans to SMEs in fiscal year 2018. Loans to large companies grew at a sedate pace of 6%.

So who is taking the most risky MSME loans on their books? Not surprisingly public sector banks have lent 75% of the new loans under 10 lakh. As Chart 2 details, private sector banks have avoided this segment while non-banking financial companies (NBFCs) have tried to balance it out by lending to almost all the segments equally.

What is more significant is that nationalised lenders also account for a larger share of MSME borrowers tagged as high-risk by CIBIL. Chart 3 shows that of the total new high-risk borrowers, 16% is with public sector banks and 14% with finance companies. Large private sector lenders have only 9% of these borrowers on their books.

Private sector banks seem to have cracked the code in lending to this segment. Lenders such as HDFC Bank, IndusInd Bank, Kotak Mahindra Bank and Yes Bank appear to have chosen to cater to only those small businesses that have a need to borrow at least 1 crore and above. Secondly, they choose borrowers with a reasonable risk profile. Large private sector banks got 47% of new banking customers with a credit score of CMR1 to CMR3, while public sector banks and NBFCs got hold of 37% and 34% share of these categories, respectively.

The government’s push to public sector banks to finance its job-creation programme by lending to the proverbial tea or pakoda (fritters) stall owners is likely to lead to even more non-performing assets for these banks a few years down the road.