Risk Aversion: How failed bank loans have led to a credit crisis for India’s small biz

Less than a year into his first term as Prime Minister, Narendra Modi came to Mumbai to address India’s financiers to mark the 80th anniversary of the establishment of the central bank. The central theme of Modi’s emotional speech was financial inclusion. “I come as a representative of the poor, underprivileged, marginalised and tribals; I am one among them; I seek on their behalf, and trust you will not disappoint me.”

Four summers have passed since, and India has made some progress on bringing banking to those hitherto excluded from formal financing. Jan Dhan accounts and the Mudra scheme have sought to enhance financial inclusion at the individual level, gains that can’t be denied by the staunchest critics. But a credit crisis and question marks over debt-service cover have restricted fund access to a majority of Indian businesses below the top tier, despite abundant liquidity with high-street lenders. And that has raised the weighted average cost of capital for innumerable businesses now battling with the cost of working capital debt running into high teens.

The problem appears to affect small and medium businesses across industries. A mid-sized SME in the business of chemical exports approached one of India’s largest lenders for a working capital loan. But little did the SME borrower know that this will increase the interest outgo to 15.5% from 14.2%, with a warning that the facilities could be withdrawn within three months. While the SME was lucky to even secure a loan, albeit at much higher rates, several of its other counterparts had their requests turned down as the state-owned bank has decided to withdraw the banking facilities for lower-rated businesses due to higher perceived risks.

Risk aversion is the new guiding principle in Indian banking today, reflecting the decline in credit growth numbers. Loan growth remained tepid in the fortnight ended October 11, signaling that the loan melas that kicked off this month are yet to translate into significant disbursals.

“A lot of contraction in credit is related to the fact that mutual funds have withdrawn, non-banking lenders have withdrawn … there is a huge contraction … because some have burnt their fingers. You are seeing withdrawal of credit from the system. The problem is that most corporates are also not borrowing as much as they did in the past,” said Amitabh Chaudhry, CEO of Axis Bank.

Credit increased 8.8% compared with 14.4% in the same period a year ago. The latest monetary policy report by the Reserve Bank of India (RBI) also revealed that overall financial flows to the commercial sector have declined sharply, by around 88%, in the first six months of FY20.

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