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In recent times, the banking and the financial sector in India has been plagued with a number of controversies. In November 2019, the Punjab and Maharashtra Co-operative Bank (PMC) came down due to corrupt lending. It was followed by the Yes Bank crisis. According to industry insiders, the following reasons can be ascribed to the major banking failures in recent times - inadequacy in detecting suspicious transactions, deceitful practices, dummy account operations, and violation of standard operating systems and procedures. The worst sufferers of the banking crisis in India have been the small and medium enterprises (SMEs).

Difficulties for small businesses

Global financial services firm, Normura has recently observed that a huge credit crunch has been created in the Indian economic system due to the shadow banking crisis. This has not only affected the financial economy, which remains heavily exposed to shadow banks, but also impacted sectors like real estate and micro, small and medium enterprises (MSMEs), which depended on cheap financing from shadow banks.

Regarding the difficulties faced by the SMEs, an executive at a private bank informed BE, “Small businesses have been competed out of the loanable funds market due to lower creditworthiness. Though there are some schemes in place for the SMEs, due to lower profitability, the banks have been somewhat reluctant in lending to the SMEs, often charging higher rates of interests or limiting the maximum amount to lent.”

The struggle of the SMEs can be described by citing a report published in The Economic TImes. A mid-sized SME in the business of chemical exports approached one of India’s largest lenders for a working capital loan. However, for the SME borrower, there was an increase in the interest outgo – which was raised to 15.5% from 14.2%. Moreover, it was also warned that the facilities could be withdrawn within three months. Though the SME turned out to be fortunate to secure a loan, albeit at a higher rate, requests of several other SMEs were turned down as the state-owned bank decided to withdraw banking facilities for small businesses due to higher perceived risks.

Despite the government’s push for credit to small businesses, most banks have witnessed a spike in bad loans in that segment. According to CIBIL data, in three months, there was a decline in commercial lending to the segment from Rs 65.5 lakh crore in March, 2019 to Rs 63.8 lakh crore in June, 2019. Since the beginning of FY20, loans to micro and small businesses shrank by 3.4% against a contraction of 2.7% for the same timeframe in the previous fiscal year. Addressing this issue, Sridhar Ramachandran, Chief Investment Officer (CIO), IndiaNivesh Renaissance Fund, that purchases distressed assets, informed media, “The decision-making has been passed on to the lowest level in the chain to avoid taking responsibility in the event of future defaults; people at lower levels of management are also not taking calls due to these concerns.”

A well-placed source recently informed the press, “In an environment of slowdown, where the overall credit growth of the industry is waning, most banks increase scrutiny standards while giving loans, especially to the corporate sector.” The source further added that banks are becoming more cautious while lending as there have been several instances where promoters of smaller companies tried to leverage more than what was on the block to get quick access to working capital.

Worsening the situation

Covid-19 and the subsequent lockdown have added more miseries to the MSMEs. The banking executive cited earlier informed, “Due to Covid-19, MSMEs are suffering from a lack of demand and hence, lower cash flow. This in turn will lead to missed payments. Since, the RBI is yet to come up with any considerable payment holiday or loan restructuring schemes for them, this sector is expected to suffer a massive blow.” Though the government’s relief package of  Rs 1.7 lakh crore promises some relief for the industries, none of the measures specifically address the demands of the MSMEs.  Since MSMEs are seen as the backbone of the Indian economy, financial support is of utmost importance for them in this trying situation.

Resolution

Experts are of the opinion that in order to ensure that there are no more bank failures in India, a robust legal framework for resolution of such cases is crucial. The lenders must maintain a balance between corporate and retail lending which will be a big step in administering bad loans. To avoid collapse, the banks must voluntarily refrain from drawing out to one or a few large borrowers to minimise the chances of potential defaults. The government must also guarantee that the consumers, taxpayers, and borrowers do not suffer and pay for such collapses. In order to do so, the government should see that new bank licences are given to those emerging public or private sector banks which are equipped with a mechanism to exit in case things get disturbed.