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Lenders in India may need to brace for a resurgence in delinquencies from their vulnerable small business loans portfolio in FY22. Micro, small and medium enterprise (MSME) has been a segment rife with problems when it comes to asset quality. Small borrowers are also the most vulnerable to crises and economic shocks given their fragile balance sheets.

The situation during the current pandemic is perhaps even more dire and less visible than in the earlier troubling episodes. The Reserve Bank of India’s (RBI’s) latest financial stability report gives enough reasons for banks to increase their guard for MSME loans. Stress among MSMEs was increasing even before the pandemic. Delinquencies have remained elevated with the bad loan ratio at 16% for public sector banks as of March.

It should be noted that the delinquency ratio has risen despite forbearance support. Among lenders, public sector banks and non-bank financial companies could be holding maximum stressed loans. Analysts at rating agency Icra Ltd said repayment collections for non-bank lenders dipped in May owing to restrictions in the wake of the second wave of the pandemic. A slight improvement was witnessed in June.

Big troubles
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Big troubles

“Due to the absence of relief measures, such as the moratorium provided in the previous year, the cash flows of businesses and income-generation ability of borrowers has been impacted significantly during the second wave, thereby affecting their repayment capability across asset classes," the Icra analysts wrote in a note.

The rise in delinquencies has been the highest for unsecured small and medium enterprises loans as of May, they added. The story for special mention accounts (SMAs) also remains the same. These accounts show early signs of trouble on banks’ loan books, wherein repayments are overdue for more than a month. Public sector banks showed a sharp increase in such accounts in FY21. In more than 12% of the MSME loan book of public sector lenders, repayments were overdue beyond a month. For private sector banks, this ratio was 3.2%, an increase from 2.6% a year ago.

The RBI report also warned that these firms are leveraged, holding high levels of debt. The emergency credit line guarantee scheme (ECLGS) has also enabled small firms to borrow more. Ergo, business disruptions, if any, could hurt small firms disproportionately.

In this light, the spectre of a third wave becomes more threatening. To be sure, access to cheaper funds and even restructuring are reliefs to MSME borrowers. Analysts expect restructuring to increase in the coming quarters. But the health of these firms hinge mostly on the pick-up in the economy through increased demand. The second wave and a potential third wave have cast a shadow of uncertainty over them. India’s small firms are certainly not an outlier when compared to peers in other countries.

The pandemic has hit small business even in advanced economies. But India compared poorly with others when it comes to delinquencies. The weighted average default rate for Indian corporate borrowers has risen to be the highest when compared with European counterparts from pre-pandemic levels, the report showed. The probability of delinquencies rising is also high among Indian companies.

The government and the central bank’s measures have lent support to small borrowers. But whether their balance sheets have strengthened or weakened further would be known several quarters down the line.

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