Rising credit stress slows retail and micro, small and medium enterprise loans

Mumbai: Despite supportive policy measures aimed at boosting credit growth, asset quality stress in retail and micro, small and medium enterprise (MSME) segments continues to constrain lending appetite among private banks and non-banking financial companies (NBFCs), according to ICRA’s latest credit outlook.

The report notes that loans to MSMEs and unsecured personal loans now account for 17% of the overall non-food credit of ₹184 trillion for banks as of July 2025. For NBFCs, these segments comprise approximately 34% of their total credit book of ₹35 trillion as of March 2025. This concentration has heightened lenders’ exposure to income shocks and demand-side vulnerabilities, particularly in sectors linked to exports and discretionary consumption.

Anil Gupta, senior vice president and co-group head at ICRA, said the stress in these segments has led to slower growth for private sector banks and NBFCs. “With improvement in economic activity post the Goods and Services Tax (GST) rate cuts, the growth appetite shall improve, which will support the credit growth,” Gupta added. However, ICRA remains cautious about the underlying asset quality risks, especially given the evolving geopolitical conditions and their second-order effects on borrower income and repayment capacity.

The report highlights that transport operators serving export-dependent industries such as apparel are facing lower capacity utilisation, which in turn affects their ability to service loans. Employees in these sectors are also vulnerable to liquidity pressures, impacting repayments on microfinance, personal and home loans. These dynamics are expected to manifest more visibly from the third quarter of FY2026, should growth remain subdued and tariff-related pressures persist.

Credit costs are projected to rise modestly in FY2026 – by up to 13 basis points for banks and 30 basis points for NBFCs compared to the previous fiscal. AM Karthik, senior vice president and co-group head at ICRA, noted that the impact would be more pronounced in non-housing segments. While lenders’ earnings may be cushioned by lower funding costs and adequate capital buffers, the outlook for microfinance institutions remains negative due to their heightened sensitivity to borrower income volatility.

The implications for the retail and MSME sectors are significant. Tighter credit conditions and cautious lending practices could limit access to working capital and personal finance, particularly for borrowers with limited formal income documentation. This may slow recovery in consumption and small business activity, even as broader economic indicators show signs of stabilisation.

Some mid-sized NBFCs are especially vulnerable, according to ICRA, due to low capital buffers and high borrower overdues. Their limited financial flexibility in raising equity or refinancing debt could amplify credit risk if stress persists. While larger institutions may absorb these pressures, smaller players could face earnings volatility and funding constraints.

While headline credit growth figures remain broadly positive, the underlying asset quality challenges in retail and MSME segments present a more nuanced picture. Policymakers and lenders alike will need to monitor these trends closely to ensure that credit expansion does not come at the cost of financial stability.