Does Indian Banks Getting under pressure?

 

The  NBFC-MFI (Non-Banking Financial Company-Microfinance Institution) sector is projected to face significant challenges in FY25 and potentially beyond. These challenges are expected to stem from asset quality issues, funding constraints, and structural shifts in business practices. On the other hand, Private banks are raising concerns over the ambitious targets under the Pradhan Mantri Mudra Yojana (PMMY), particularly in light of the sector's growing stress and rising risks in the micro, small, and medium enterprise (MSME) portfolio. This comes as the government increases its focus on lending to MSMEs to stimulate economic growth and job creation.

Private banks argue that the newly prescribed Mudra targets exceed their MSME lending capacity, with some claiming the targets are 10–15 times higher than in the previous fiscal year. This disproportionate increase, compounded by the new provision to lend up to ₹20 lakh under the Tarun Plus category, places considerable strain on banks' risk management frameworks. For smaller private banks, achieving these targets might necessitate restructuring their lending strategies, often at the expense of profitability and asset quality.

Key Highlights:

1. Growth Challenges:
• Loan book growth is expected to flatten or decline in FY25.
• Focus may shift from growth to managing asset quality, potentially shrinking loan books across the sector.
• Performance in FY26 is also likely to remain muted unless asset quality issues stabilize.
2. Asset Quality and Funding Risks:
• Elevated asset quality risks could lead to stricter covenants with debt lenders.
• Liquidity buffers may need to be strengthened to mitigate risks of debt recall.
• Any significant deterioration in asset quality for a single NBFC-MFI could create cascading risks for the entire sector.
3. Funding Constraints:
• Incremental funding is likely to remain tight due to concerns over collection efficiency and rising costs.
• Lenders may reassess their exposure to the sector, impacting disbursements, particularly in the typically strong second half of the financial year.
4. Regulatory and Structural Challenges:
• Recent regulatory actions on loan pricing and risk-weight adjustments have further constrained disbursements.
• Discussions around the practice of providing top-up loans in Joint Liability Groups (JLGs) could lead to business model disruptions, with potential asset quality implications.
5. Capital Raising Difficulties:
• Moderate leverage ratios and short-term liquidity buffers exist but could be insufficient without additional capital infusion.
• Rising borrower overleveraging and inflationary pressures, especially due to food inflation, may exacerbate repayment challenges.

Rising Risks in the MSME Sector

One of the key challenges to meeting these targets is the rising stress within the MSME loan portfolio. According to a Ficci-IBA survey, non-performing assets (NPAs) in MSME loans are expected to rise by 38% in the next six months, driven by high interest rates, inflationary pressures, and global economic uncertainties. While Mudra loans have shown a declining NPA trend among public sector banks—falling to 3.4% in FY24—private banks remain cautious, fearing that indiscriminate lending could lead to elevated risks.

The practice of setting uniform lending targets without accounting for differences in lender size, geography, and portfolio structure undermines the feasibility of achieving these goals. Private banks are pushing for a more nuanced approach, where targets are aligned with their total MSME portfolio or growth potential.

Additionally, the government's push for collateral-free loans under Mudra raises questions about risk mitigation. Alternative credit risk assessment models, such as cash-flow-based lending, while promising, are still evolving and may not provide immediate solutions to the systemic challenges of unsecured lending.

Conclusion

The government and private banks may need to engage in a dialogue to balance the ambitious Mudra targets with practical lending capacities while ensuring the broader financial health of the MSME sector. In the medium term, the sector’s ability to navigate these challenges will largely depend on support from promoters, regulatory clarity, and improvements in macroeconomic conditions, including inflation and borrower repayment capacity.