In a world beset by uncertainty, a 14% plus year-on-year growth in bank credit during December 2025 to February 2026 is reason for cheer. To be sure, part of this reflects a normalization of the credit cycle which saw brief disruption in mid-2025 triggered by US President Donald Trump’s tariff announcements. But the more important shift is that the drivers of this credit expansion are not the same as in the 2022-24 phase.
About 12% of incremental bank credit is being driven by lending to micro, small and medium enterprises (MSMEs), double the sector’s 6-7% contribution in 2023. This surge is likely the outcome of a series of measures aimed at widening MSME access to credit.
A significant hike in MSME investment and turnover thresholds in 2025 allowed a larger set of firms to qualify for sectoral benefits. At the same time, the increase in the credit guarantee ceiling, from ₹5 crore to ₹10 crore, enabled larger loans to come under guarantee coverage. Concurrently, reduced guarantee fees lowered borrowing costs. In 2026, the Reserve Bank of India (RBI) added another layer of support by allowing banks to extend collateral-free loans of up to ₹20 lakh to MSMEs.
Promising rebound
Lending to non-bank financial companies (NBFCs) accounted for 11-13% of incremental bank credit growth in January and February 2026, the highest in 33 months. The improvement reflects a combination of lower interest rates, reduced risk weights for low-risk NBFCs, and the finalization of a co-lending framework between banks and NBFCs. Together, these measures have expanded credit reach while allowing risk-sharing and operational efficiency.
Loans against gold jewellery are also booming, as consumers take advantage of high gold prices to monetize their gold holdings: in recent months, gold loans have accounted for 10% of the growth in bank credit.
Indeed, gold loans now form over 2% of the total bank credit outstanding, up from 0.6% five years ago. Vehicle loans account for 4% of incremental credit; their higher contribution is the result of a combination of factors including lower borrowing rates, a cut in goods and services tax (GST) rates, and shifting preferences towards vehicle ownership. Housing loans, meanwhile, have seen their share in fresh credit moderate to about 12%, from about 15% a year ago, though they remain a core component of retail lending.
In summary, the recent uptick in credit is driven by lending to MSMEs, NBFCs and retail customers. By itself, this makes for an excellent loan book composition. MSMEs are crucial to India’s economy, accounting for approximately 35.4% of manufacturing, 48.58% of exports, and 31.1% of GDP; in addition, the sector is the country’s second-largest employer. Clearly, meeting MSME financing needs is equivalent to strengthening overall economic growth and incomes. Retail lending funds domestic household consumption, which is the mainstay of India’s economy. NBFCs act as critical intermediaries, complementing banks by extending reach, speeding up processing, and deepening credit penetration across both households and small businesses.
War woes
But the war in West Asia has hit precisely those sectors that have been driving credit growth. With the Strait of Hormuz disrupted, three broad channels of risk are emerging.
First, war-related disruptions have created operational and financial difficulties for MSMEs. Working capital conditions are under strain. Industry associations reported in April that over ₹8 trillion was locked up in overdue and delayed payments to MSMEs.
The government has responded with proactive support schemes, such as the Emergency Credit Line Guarantee Scheme (ECLGS) 5.0 announced last week, which provides a 100% government guarantee to MSME credit, capped at 20% of peak working capital utilization. This will likely ease liquidity pressures while containing potential non-performing assets (NPAs) in the banking system. However, credit guarantees cannot offset the impact of higher production costs stemming from logistical disruptions, elevated transport costs, rising insurance fees, and high prices of industrial use fuels.
Second, rupee depreciation is especially damaging to MSMEs in manufacturing, which depend on imports of crude, machinery, electronics and chemicals. Rising input costs could erode whatever export competitiveness has been gained via a weaker rupee. Not surprisingly, the MSME business confidence index for manufacturing firms decreased significantly in the January-March quarter.
Third, retail slippages may show up as second-order effects of industrial distress and higher prices. Even large corporations are feeling the impact of higher input costs. Bajaj Auto, for instance, recently warned that more than a third of the two-wheeler demand boost from GST cuts had been offset by price increases. A prolonged conflict could weigh on vehicle demand, slowing growth in vehicle loans.
As inflation bites and consumers tighten spending, discretionary retail borrowing is likely to soften, while delinquencies could edge up. Indeed, some banks have already made precautionary provisions in the January-March quarter to offset credit-related risks, and top banks have announced that they are cautiously monitoring the situation. If disruptions in the Strait of Hormuz persist, provisioning requirements are likely to increase across the system.
While overall asset quality is unlikely to deteriorate materially given healthy balance sheets of the banks, return on assets could see some moderation. The longer the Iran conflict drags on, the greater the risk that this nascent credit recovery loses momentum.
The author is an independent writer in economics and finance.