MSME Lending a New Driver of Credit Growth?

Credit growth to small and medium enterprises is outpacing all other sectors, but the test of asset quality lies ahead

- TT RAM MOHAN

India's banking sector is in rude health. By a variety of measures — capital adequacy, provision coverage ratio, liquidity coverage ratio, return on assets, and gross non-performing assets (GNPAs) as a proportion of loans — the sector demonstrates strengths that would have been unthinkable five years ago.

Capital adequacy in the system as a whole is 17.3 per cent, with public sector banks' (PSBs') capital adequacy at 16.2 per cent. Being over five percentage points above the regulatory minimum is prudent and a source of stability. Return on assets (ROA) for all banks is 1.4 per cent. PSBs have an ROA of 1.1 per cent, which is above the benchmark of 1 per cent in banking.

When a bank produces an ROA of 1 per cent or more, it can be reasonably sure of access to capital from the market. In other words, PSBs do not have to turn to the government for capital support. The question is often asked: How do PSBs compete with private banks that produce higher returns? The answer is that they can compete on their own terms as long as they can raise capital from the market.

The banking sector will walk on two legs. We will have private banks that are focused on maximizing returns by catering to the mass affluent. And PSBs that will marry larger social objectives with profitability while catering to the wider market. The model as a whole remains viable as long as the benchmark of profitability is met.

So far, so reassuring. Banking is safe and sound. That apart, a few points emerge clearly from the latest edition of the Reserve Bank of India's Financial Stability Report (June 2025).

Firstly, credit growth slowed noticeably to 11 per cent in 2024-25 from 16 per cent in 2023-24 and 15.4 per cent in 2022-23. In 2024-25, PSBs have shown higher credit growth than private banks, which means their market share has risen after years of decline.