The West Asia conflict, now stretching beyond a month, has begun to worry banks about the vulnerability of small borrowers, particularly SMEs and MSMEs. Banks have shifted to a more structured and cautious lending mode as early signs of stress among small borrowers intensify, prompting lenders to reassess their exposure even before the full impact of the war plays out.
Borrowers are now being evaluated through four distinct lenses – temporary damage with recovery ability, permanent damage but backed by strong corporate or industrial groups, permanent damage with weak balance sheets, and temporary damage with low resilience.
“Every segment and industry would be put into these categories, and accordingly, action will be taken,” said a senior private sector banker, adding that while the overall balance sheet remains stable, the stress is most visible among smaller enterprises.
“The concern is with smaller borrowers. Cost of raw material, cost of fund, input cost will all go up, and they may not have the ability to withstand that.” If the conflict continues for another few months (till May 2026), the pressure could intensify, with the banker warning that “it certainly will have major challenges on a lot of corporate as well as a lot of banks.”
Stress in MSME lending
The stress in MSME lending, however, did not begin with the geopolitical crisis. It had already been building through FY24, particularly in the small-ticket segment. According to a BCG report, while headline delinquency rates suggested improving portfolio health, vintage data told a different story of mounting stress in recent originations. Loans under Rs 10 lakh saw a sharp spike in FY24 vintage delinquency to over 10%, reversing earlier stability and signalling weakening repayment capacity.
Even mid-ticket loans showed a mild uptick, breaking a multi-year improvement trend. This divergence between headline metrics and underlying vintage performance indicates that MSME credit pressures were rising domestically, independent of external shocks.
The war has now added a fresh layer of vulnerability. “No one thought that the conflict would prolong this far…” said another senior banker, stating that the uncertainty is beginning to reshape risk assessments across industries. The most immediate pressure point is energy.
With India heavily dependent on oil and gas imports from the region, banks fear a cascading impact on sectors linked to petrochemicals. “If we don’t have supply of gas, we will struggle big time; everything as a byproduct of oil will get impacted,” the banker said.
Fertilisers, sulphur linked industries, and battery manufacturers are already facing supply disruptions, while freight and input costs are rising across the board.
What do bankers say?
A senior public sector banker said the system is in a heightened monitoring mode. “Yes, it’s a tough time. Right now, we are largely monitoring. Some package is under discussion with the government and the RBI which should support.” Bankers expect any relief to mirror Covid-era interventions targeted at MSMEs.
The broader macroeconomic environment is compounding the stress. India is importing oil at elevated prices while simultaneously grappling with a weaker rupee, a combination the banker describes as a “double whammy on all input costs for everyone”. Higher freight charges, costlier imports, and currency-driven inflation are eroding competitiveness for several industries, especially those dependent on global supply chains.
For now, banks are not pulling back from lending, but they are operating with heightened vigilance. With geopolitical uncertainty showing no signs of easing, the financial sector is preparing for a prolonged period of careful monitoring, selective support, and calibrated risk-taking, particularly for vulnerable borrowers.