Mumbai: Small borrowers, whose default rates have traditionally been among the lowest in India, are increasingly missing loan repayments as rising unemployment and stagnant-to-declining wages put pressure on finances of small companies as well as households.

One of the categories of borrowers that have been the worst hit are those that have availed small loans under the government’s Mudra scheme designed to encourage micro-entrepreneurship. So much so, the central bank Tuesday asked bankers to monitor defaults in Mudra loans closely.

At the Sidbi National Microfinance Congress 2019 on Tuesday, Reserve Bank of India deputy governor M.K. Jain said banks need to focus on repayment capacity of borrowers at the appraisal stage and monitor the loans through their lifecycle much more closely.

“Mudra is a case in point. While such a massive push would have lifted many beneficiaries out of poverty, there has been some concerns at the growing level of non-performing assets among these borrowers," said Jain.

Indian banks, which hold the dubious distinction of having the world’s worst bad loan ratio, have so far seen most of its asset-quality troubles originate in the corporate sector. With the economy slowing down sharply, smaller borrowers are also finding it difficult to repay loans.

According to data from credit bureau Cibil, bad loan rates in micro enterprises and small and medium-sized enterprises were at 8.7% and 10.6%, respectively in June this year.

The reasons for the rising defaults are multifold. Experts said the slowdown in economic growth is hampering the loan-servicing capability of small businesses. For small retail borrowers, slackening growth in rural income has been a pain point.

“Whenever there is an economic downturn, one can expect small businesses to be affected the most, since their activities are linked to other larger companies. When the index of industrial production (IIP) has grown at a negative rate in September, it actually means that the overall performance of these businesses have been affected along with their ability to service loans," said Madan Sabnavis, chief economist, CARE Ratings.

(Graphic: Sarvesh Kumar Sharma/Mint)
(Graphic: Sarvesh Kumar Sharma/Mint)

Under the Pradhan Mantri Mudra Yojana launched in April 2015 banks provide loans up to 10 lakh to non-corporate, non-farm small/micro enterprises. There are three categories of Mudra loans, depending on size. While loans up to 50,000 are termed Shishu, loans of 50,000-5 lakh and those of 5-10 lakh are called Kishore and Tarun, respectively.

Data from Mudra’s annual report showed that non-performing assets (NPA) ratio or bad loans as a percentage of total loans were at 5.38% as on 31 March 2018. The FY19 annual report is not available.

Jindal Haria, director, banking and financial institutions, India Ratings, said asset quality of small firms is likely to deteriorate further in fiscal 2021 after the existing forbearance on restructuring of loans to small businesses expires.

“As working capital cycles of large and mid-corporates stretch, the SMEs bear the brunt of the same. With banks hesitating to lend to them incrementally if there are even marginal cash flow issues, the defaults in SME could materially increase even from 10-11% seen currently for public sector banks (PSBs)," said Haria.

Jain also cautioned against systemic risks arising from unsustainable credit growth, increased interconnectedness and financial risk manifested by lower profitability of the small businesses.

Small businesses, contributing to 29% of the gross domestic product (GDP), are not isolated from the slowdown. The latest in a series of bad news came in earlier last month as India’s factory output shrank for the second straight month at 4.3% in September. In the June quarter, India reported its weakest growth in more than six years at 5%. The latest GDP estimates by banks indicate that the economy may slow down further. Nomura, for instance, has projected September quarter growth to decelerate to 4.2%.

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