Whalesbook
Banks Push for MSME Loan Moratorium
Indian banks, through the Indian Banks' Association (IBA), have formally asked the Reserve Bank of India (RBI) to allow a loan repayment moratorium for micro, small, and medium enterprises (MSMEs). Banks cite the ongoing US-Iran war as the main reason, fearing it will disrupt demand for MSME goods and hurt their ability to repay loans. The proposed relief would be optional, available only to MSMEs that ask for it. The RBI has already extended export credit relief measures until June 30, 2026, acknowledging supply chain delays and logistics issues from the wider geopolitical crisis.
MSME Sector Shows Strong Growth and Low Defaults
Despite external pressures and bank concerns, the MSME credit segment has shown considerable strength. By December 2025, MSME loans outstanding hit ₹67.6 lakh crore, up 16% year-on-year. This marks a five-year compound annual growth rate (CAGR) of 17%. This growth was driven by strong demand for secured business and property loans. Crucially, asset quality improved. Serious delinquencies (loans 90-720 days overdue) fell to 1.87%, the lowest in five years. This shows the sector remains operationally strong despite external pressures.
War's Impact on Trade and Costs
The US-Iran conflict is casting a shadow over India's economy, affecting key industries. Disruptions in key shipping lanes like the Strait of Hormuz have raised freight costs and delivery times, squeezing exporter margins, including for MSMEs. Manufacturing activity has slowed, with the Purchasing Managers' Index (PMI) dropping to a four-and-a-half-year low in March 2026 due to uncertainty. Rising crude oil prices from the tensions also risk fueling inflation and straining repayment abilities for consumers and businesses. This mix of supply chain issues, higher input costs, and lower global demand creates significant risk for MSMEs.
COVID-19 Moratorium Offers Precedent
The IBA's moratorium proposal draws heavily on the COVID-19 pandemic experience. During COVID-19, the RBI allowed a loan moratorium that did not lead to the feared spike in non-performing assets (NPAs) for banks. Later, policy measures and economic recovery improved overall asset quality. Bankers argue the current geopolitical situation calls for similar financial buffers for vulnerable businesses, seeing it as a precedent for regulatory flexibility during major shocks.
The Bear Case: Banking Sector Strain
While MSMEs show resilience, banks face escalating geopolitical risks. Fitch Ratings warned of margin pressure for Indian banks, projecting a 20-30 basis point drop from its FY2027 forecast of 3.1% for sector margins, if funding costs rise due to ongoing tensions. Liquidity has tightened, with the banking system surplus recently declining. Prolonged geopolitical instability could also lead to increased stress in MSME and unsecured retail segments, though overall stress remains low. Banks are using more expensive short-term funding as deposit growth lags lending, potentially impacting net interest margins.
RBI Faces Balancing Act on Moratorium Decision
The RBI must balance supporting MSMEs with the risks of moral hazard and potential strain on bank finances. Analysts suggest recent asset quality gains could be tested by persistent tensions, with early stress signs potentially appearing in export-linked and cost-sensitive sectors. The government is reportedly looking at regulatory relaxations, like on Special Mention Account (SMA) and NPA timelines, to further support MSMEs affected by the conflict. The RBI's decision will depend on its assessment of the immediate threat versus long-term financial stability and MSME ecosystem resilience.