Rising stress on micro, small and medium enterprises (MSMEs) from the ongoing West Asia conflict and elevated borrowing costs could weaken the profitability buffers of MSME-focused non-bank finance companies (NBFCs), even as their solvency positions remain resilient, according to a report by India Ratings and Research (Ind-Ra).
The rating agency said its stress test on rated MSME financiers assumed peak credit costs seen since FY20, along with margin compression caused by elevated funding costs and inflation-driven operating pressures.
“With rising pressure on MSME cash flows from the ongoing West Asia conflict and rising interest rates, we conducted a stress test on our MSME financiers,” Karan Gupta, Head of Financial Institution Ratings at India Ratings and Research, said in the report.
The agency said the combined effect of higher fuel prices, supply chain disruptions and moderation in export demand due to the geopolitical conflict could intensify pressure on MSME cash flows, particularly in vulnerable business segments.
At the same time, persistently high effective lending rates are expected to elongate working capital cycles and raise near-term delinquencies for smaller borrowers, especially those already operating with stretched balance sheets.
India Ratings said unsecured business loan-focused NBFCs were likely to witness the sharpest depletion in pre-provision operating profit (PPOP) buffers under stressed conditions. However, it added that capital adequacy levels for rated entities were expected to remain above regulatory thresholds, with leverage staying under control.
The report said sponsor equity support and long-term promoter commitment would continue to anchor solvency across rated platforms, reducing the likelihood of any solvency breach despite worsening operating conditions.
Early signs of stress have already emerged in micro loan-against-property portfolios, where the agency observed an increase in soft bucket delinquencies even before the recent escalation in geopolitical tensions. According to the report, borrower over-leveraging and overlap with microfinance institution customers partly contributed to this trend.
India Ratings said pressure on unsecured business loans was expected to persist into FY27, with delinquency trends already elevated heading into the fiscal year.
The report also flagged the impact of input cost inflation on MSMEs, particularly in sectors such as restaurants, plastic granules and textiles, where lenders typically have exposure ranging between 2 per cent and 10 per cent of assets under management.
It said rising fuel prices and intermittent LPG availability linked to the West Asia conflict were already affecting these sectors directly, while broader second-order effects were likely to emerge through higher raw material costs and logistics inflation.
The agency warned that a weak monsoon linked to possible El Niño conditions could further soften demand in rural and semi-urban markets, amplifying stress for MSMEs already grappling with inflationary pressures.
“Ind-Ra believes this combination could result in cyclical asset quality deterioration,” the report said, although it added that most rated NBFCs retained adequate stress absorption capacity based on their experience through previous volatility cycles.
To assess resilience, India Ratings applied a stress scenario assuming peak credit costs for MSME-focused NBFCs. It said losses in secured portfolios would likely remain contained due to collateral cover, although recoveries in micro loan-against-property assets could take longer because of liquidation challenges.
In unsecured lending portfolios, guarantee schemes such as the Credit Guarantee Fund Trust for Micro and Small Enterprises and the Credit Guarantee Fund for Micro Units were expected to limit ultimate loss severity.
The report said stronger NBFCs with diversified funding profiles, robust PPOP generation and sponsor backing were likely to navigate the current environment with limited ratings impact.
However, it cautioned that lower-rated entities with weaker capital structures and limited pricing flexibility could face heightened rating sensitivity if stress conditions persisted beyond near-term expectations. |
