Non-bank lenders have a big problem in small business loans

Industry executives said demand is slowing also because small businesses are facing delayed payments from central and state governments, and shrinking profit margins amid a broader economic slowdown.

While Bajaj Finance has pointed out a sudden buildup of stress, Shriram Finance has seen challenges in some states. Bajaj Finance has an MSME (micro, small and medium enterprise) loan book of ₹52,428 crore, and reported a gross bad loan ratio of 1.76% in Q1 in the segment, up 28 basis points (bps) from the previous quarter. A basis point is one-hundredth of a percentage point.

In the analyst call post Q1 earnings, the consumer loan behemoth flagged unexpected rise in delinquencies in the business banking and professional or self-employed borrower segments such as loans to doctors, which had not seen stress even during the pandemic period.

Meanwhile, in states such as Telangana, Tamil Nadu, Andhra Pradesh, and Karnataka, reduced state government spending has hit small businesses—particularly in manufacturing—leading to weaker demand for small business loans. For instance, Tamil Nadu spent 19.2% of its budgeted estimates in the April-June period, as against 22.1% in the previous fiscal, according to data from the Comptroller and Auditor General (CAG) of India. Similarly, for Karnataka, the spending was at 17.6% against 18.7% in Q1 of FY25.

Both Shriram Finance and Bajaj Finance have flagged rising stress in these states. Shriram, which has significant exposure in the region, reported MSME gross non-performing assets (NPAs) of 4.12% in Q1 in the segment, up 4 bps from the previous quarter.

“In some of our core markets, there is a slowdown in credit demand. Government spending has come to a standstill, and whatever money is being raised is being used for subsidies and pensions,” Y.S. Chakravarti, managing director and chief executive officer of Shriram Finance toldMint. “Money is not going into any developmental activity or creating positive cash flow. So, business has slowed down in those markets.”

Rajeev Jain, vice chairman and managing director of Bajaj Finance, pointed out that Karnataka’s contribution is 11% of its total balance sheet, and even higher for Maharashtra and Tamil Nadu.

“So, any of the large southern states see a change like this, it does have an unintended impact on the portfolio,” Jain said. “For the first time, we are experiencing what I would call political risk, which we don’t know how to navigate. We can’t stop business, but we can’t also continue business. So, it’s a little tricky.”

The NBFC has cut business in Karnataka by 40-50%, according to Jain.

Meanwhile, over-leverage of customers across product segments remains a pain point, Jain said, adding that the company was taking several actions across product lines to reduce the contribution of customers with multiple loans.

“The credit supply has got choked. So, it’s virtually a perfect storm in a way, and it’s come a little too suddenly,” he said. Thirteen of the 17 key MSME industries tracked by the NBFC are exhibiting signs of slowdown, and three are showing contraction.

Expert views

Experts said since loan growth is a factor of demand, when a business runs into problems because of cash flow challenges, it is because they have inventory but they are not seeing enough demand.

“We understand that unsecured business loans are a problem as borrowers are prioritising repayment of secured loans,” said Siddharth Goel, director, APAC for non-bank financial institutions at Fitch Ratings.

Goel said the MSME stress and demand problem is cyclical and not a structural thing right now, unlike the microfinance problem, and is hopeful that with the onset of the festive season, small businesses will recover. “The government is also pushing for more and easier credit access to MSMEs, which should help these businesses,” said Goel.

What lenders are doing about it

While Bajaj Finance has resorted to restructuring some small business loans to allow borrowers more time to repay, Shriram Finance said it is instead supporting borrowers to focus on incremental repayments while allowing them more time to pay the overdue or missed payments.

“An NPA account doesn’t always mean he’s a defaulter. It means you need to support him so that he comes out of that cycle,” Chakravarti said. “Most of the time, (in) manufacturing, what I’ve seen is that people suffer because either their bank lines are not getting renewed or their credit lines are not extended or enhanced, and they need more working capital.”

Shriram Finance, Chakravarti said, is looking to diversify to grow faster in other geographies such as Maharashtra, Madhya Pradesh, Uttar Pradesh and Rajasthan.

In Bank of Baroda’s Q1 media earnings call, managing director and chief executive officer Debadatta Chand said that within MSME, the bank is focusing on segments such as supply chain finance and cash management services, adding that growth is being supported by government schemes and increased focus on digital loan processing.

“We’re focusing on a relationship-based business, and on digital loan processing within the MSME segment. And also a couple of government schemes which are focused towards MSME, the bank is doing its best to have significant lending in those government schemes,” he said.

Segments that have been hit

Lenders with higher exposure to manufacturing-focused MSMEs seem to have been hit harder than service-related MSMEs given that margins are shrinking in trade businesses and opex cost is also higher.

A July report by CRIF High Mark showed that individual MSME loans–those taken by self-employed borrowers–saw an 11.4% on-year drop in origination volumes in FY25 even as the value of loan originations rose 4.5%. On the other hand, entity MSME loans–availed by enterprises–saw a 7.4% fall in origination value but 17.1% increase in origination volume.

Volumes are likely being driven by banks, especially PSU banks, which continue to remain optimistic on MSMEs amid persistently muted growth in corporate loans, slowing growth in retail loans, and a push from the Centre to lend under government schemes.