Mid-sized firms are apple of a banker’s eye as EMI-induced purchases slow

Highlights

• Bank credit growth has decelerated sharply in past two years, led by slow retail disbursements


• As high-yielding retail loan growth slowed due to regulatory caution, banks had to find other avenues to direct credit


• Banks are pursuing small business loans and short-term working capital to mid-sized firms


• Credit to medium enterprises has been growing at a fast pace for many months now

The banking system’s credit growth is at its slowest pace in three years and the deceleration, though it began with retail slowing, has become broad-based now. By March this year, non-food credit has slowed to 10.96 percent from 16.3 percent a year ago, with retail loan growth declining to 11.65 percent from 17.6 percent. But there is one cohort that has bucked the trend and banks are pursuing this segment with gusto.

Loans to medium-sized manufacturing enterprises grew by an eye-popping 18.6 percent in March this year, sharply higher than 13.3 percent a year before. The momentum is said to have sustained in the following months as well. Notably, loan disbursals to large companies and even small and micro firms have decelerated sharply. What explains this pursuit of banks for this specific segment?

Medium-sized enterprises are firms where the investment in plant and machinery or equipment does not exceed ₹50 crore and turnover does not exceed ₹250 crore. Given their size and scale, they are perceived as having a lower credit risk compared with micro or small enterprises. Medium enterprises tend to weather sudden economic shocks or slowdown better than small businesses---hence the lower risk perception among lenders. At the same time, banks can charge a higher risk premium spread over the loan rate compared with large companies that command aggressive lending rates. These two reasons make medium enterprises an ideal segment to lend.

Another factor is that typically, medium enterprises are small businesses that have grown in size and scale. In other words, banks that have lent to small businesses for a long period to see them grow, prefer to loosen their loan covenants as disclosures and access to information for credit risk assessment is high. Lenders aren’t lending blind but have partnered with these small businesses and helped them grow through loans. Also, such businesses tend to avail a basket of services from one lender which is not limited to only short-term loans. Deposits, current and savings accounts and other products are also part of the relationship. That means banks have a greater hold on the borrower’s finances.

Then there is the regulatory requirement of priority sector lending towards which loans to medium enterprises are counted. This gives enough motivations to banks to lend to such firms. Within banks, private sector lenders have become more aggressive and have grabbed market share in lending to such firms.

The MSME pulse report from Transunion CIBIL Ltd and SIDBI highlights that private sector banks prefer to lend large-ticket loans to the MSME sector, and loan sizes to medium enterprises are usually large ticket. Analysts at Motilal Oswal Financial Services Ltd note that Axis Bank has been actively pursuing medium enterprises as borrowers and has an edge over other lenders in pricing of such loans. Axis Bank has cut its lending rates well ahead of peers in response to policy rate cuts by the Reserve Bank of India (RBI).

Given the interest and push from lenders, it would be logical to expect another increase in loan growth to medium enterprises in the current financial year. But there is a factor that could prove a challenge to banks. Companies are less willing to borrow. “Promoters, especially in the mid and large corporate segments, are increasingly averse to aggressive leverage (partially due to insolvency and bankruptcy code), preferring internal accruals over bank borrowings,” the Motilal Oswal report said. Loan-to-value ratios have also dropped in this segment, the report added.

When companies are cautious, they tend to keep off large loans which is why growth in working capital and cash credit has been quick while term loans have shown a more sedate pace. This does not augur well for private capex and shows the reluctance of companies. But banks are willing to give loans, whatever be the requirement, to medium-sized enterprises in their search for a higher yield.