Banks’ exposure to micro, small and medium enterprises (MSMEs) remains an area of concern even as overall asset quality in the banking sector improves.

The twin causes for concern are the end of moratoria under the Reserve Bank of India’s (RBI) Covid restructuring schemes and the simultaneous increase in interest rates. Bankers say that some categories of small enterprises are still recovering from the Covid shock and they may struggle with repayments.

For now, banks are putting up a brave front, pointing to their capital buffers as adequate protection against likely stress. State Bank of India (SBI) chairman Dinesh Khara told FE earlier this month that while MSMEs had seen disruptions in their cash flows during the pandemic, the bank’s restructured book in the segment has behaved pretty well.

“SME is one area where we have some NPAs (non-performing assets), but part of it is coming from the restructured book and we have already adequately provided for the restructured book,” Khara said after SBI’s Q1FY23 results. The lender’s NPA ratio in the SME segment rose marginally to 6.57% in June from 6.55% at the end of March.

The size of SBI’s special mention accounts-I and II (SMA-I and SMA-II) book for accounts with exposures of `5 crore or more rose 97% between March and June to Rs 6,983 crore. These consist of accounts where repayments have been overdue for over 30 days and less than 90 days. The bank’s SME restructured book stood at Rs 7,317 crore at the end of June, down from Rs 7,606 crore in March.

Sanjiv Chadha, MD & chief executive officer, Bank of Baroda (BoB), said, “If we look at the prognosis for the credit portfolio and credit costs, the broad trend should be that the corporate credit cycle should continue to improve and there are some challenges on the MSME portfolio because of restructuring that had happened.”

Chadha said that the composition of BoB’s slippages reflected these concerns. In Q1FY23, the bank saw fresh bad loans to the tune of Rs 1,107 crore in the MSME segment, higher than in any other segment of loans. However, according to Chadha, the improvement in the corporate credit cycle far outweighs the deleterious impact of the vulnerabilities in the MSME portfolio. “If we were to look at things in terms of their break-up, yes, corporate NPAs will be coming down, MSME will be going up. But, in aggregation, the credit cost should be coming down,” he said.

In its financial stability report for June 2022, the RBI said that the aggregate gross NPA ratio of public sector banks and private banks in the MSME sector has moderated to 9.3% in March 2022 from 11.3% in September 2021. “They, however, remain relatively high. Moreover, restructuring of portfolios to the tune of Rs 46,186 crore constituting 2.5% of total advances under the May 2021 scheme has the potential to create stress in the sector,” the FSR said.

Analysts are relatively optimistic about the future trajectory of slippages, especially those from the restructured book. In a recent report, Kotak Institutional Equities (KIE) said that the phenomenon of the restructured book showing higher slippages than the non-restructured book was along expected lines. “We expect slippages from the restructured book to decline gradually as the stress gets recognised in the next few months. While gross slippages should look elevated for some of the mid-tier MSME-focused banks, recoveries and upgrades continue to be healthy, resulting in a simultaneous release of provisions as well,” KIE analysts said.