Chief Economic Adviser V. Anantha Nageswaran has proposed moving away from the rigid 90-day loan classification rule for MSMEs to improve credit access. While this could support struggling small businesses, it also introduces concerns about potential hidden stress in bank balance sheets. Investors should monitor how regulators balance this flexibility with the need for accurate asset quality reporting.
Chief Economic Adviser V. Anantha Nageswaran has publicly challenged the current banking regulations that classify loans as non-performing assets (NPAs) once they are overdue by 90 days. During a recent industry conference, Nageswaran argued that this universal, rigid timeline does not reflect the operational realities of micro, small, and medium enterprises (MSMEs). Because these businesses often deal with irregular cash flow cycles and varying payment schedules, a strict 90-day limit can unfairly penalize viable companies, making it difficult for them to secure further credit.
A key part of his argument focuses on the Special Mention Account (SMA) framework, which acts as an early warning system for banks. When an account is tagged as an SMA—often after just 30 or 60 days of delay—it signals to other lenders that the borrower is facing stress. Nageswaran suggests that this tag often functions as a red flag, causing banks to prematurely stop lending to these businesses. This, in turn, can trap otherwise healthy companies in a cycle of cash flow problems, eventually pushing them toward actual default.
For investors in the banking sector, this proposal introduces a complex trade-off. On one hand, relaxing these norms could help MSMEs survive temporary demand or supply chain disruptions, potentially protecting banks from losing money on good loans that just need more time. On the other hand, the financial system relies on strict classification rules to identify and manage bad loans accurately. If the rules are loosened, there is a risk that banks could underreport financial stress or mask struggling loans—a practice sometimes referred to as 'evergreening.' Investors will need to closely track how regulators, particularly the Reserve Bank of India, decide to implement these suggestions without compromising the transparency of bank balance sheets.
Separately, Nageswaran also cautioned the microfinance sector regarding its lending practices. He pointed out that the industry has often prioritized credit expansion over essential financial habits like savings and insurance. He warned that this structure has historically led to cyclical crises in the sector. With the microfinance industry already facing concerns about over-leveraging, his comments highlight that lenders must balance growth with strict risk management. The next important step for the market will be to see if there is a formal policy change regarding MSME loan classification and how lenders adjust their risk assessment models in response to these regulatory discussions.