The Economic Survey 2016 was significant because for the first time it went to great lengths to talk about the problem of non-performing assets or bad loans in the banking segment. This is surprising since the economic survey for 2014-15 showed no signs of distress in the banking sector. However, the problem with the banking sector is not one that was created overnight, but has been created after years of mismanagement. Banks favoured larger corporate over smaller companies and disbursed large amounts of money based on earnings potential and credit ratings that these firms enjoyed. That the credit ratings for most of these corporates never mirrored the actual position is another story, but years of funding the unfeasible is finally beginning to show.

Stressed assets (nonperforming loans plus restructured assets) of banks are at 11.3%, one of the highest that has ever been. "Banks have responded by limiting the flow of credit to the real economy so as to conserve capital, while investors have responded by pushing down bank valuations, especially over the past year. The shares of many banks now trade well below their book value,” said the Economic Survey. 

So what does these NPA mean for you and me? The problem now is that with a paucity of funds, the banks would not be able to lend, with more corporate turning bad and smaller companies finding it even more difficult to borrow. This in turn leads to a further deterioration in asset quality for banks and the vicious cycle continues. It is well known that banks that have NPAs mostly focus on recovery of loans and their penchant to lend is severely curtailed.

For small business and anyone with a ‘thin file’ getting credit from a bank is not easy. It sometimes takes as much as 6-7 months for an SME to get any response to an application for credit from a bank. Banks consider the cost of lending to smaller firms, higher than lending to a corporate customer. It also does not help that SMEs often have riskier credit ratings, less glossy financial statements and peer group comparisons are often difficult. With rising NPAs, if getting credit from banks was difficult, it is worse now.

Relatively non-risky loans have become non-performing and that has led banks to tighten their purse. Banks at the moment do not want to take on the additional risk of lending to smaller companies and this can lead to loans for the SME sector seeing its slowest disbursals. The smaller firms have been dealt a second blow as the corporate they do business with are defaulting on their payments. Banks have tightened their purse because of high NPAs and at the same time fragile balance sheet of these corporate mean smaller vendors are not being paid.

It is, however, not the case that money is not available. There is still plenty of money in the system that can be mobilized to get around this shortfall. It is for this reason that India needs alternative sources of finance. The world has never recovered from the 2009 downturn, but alternative sources of finance have seen wide adoption throughout the world. Indian economy is the beacon of hope for the world as it continues to grow at over 7 %, but finance continues to be an important cog in that wheel. Banks will take time to emerge from their problems, so in the meantime, it is important to strengthen alternative sources of finance. This is particularly important as sources of finance like peer-to-peer lending can play a pivotal role in lending to smaller borrowers. Government and RBI through regulatory framweork need to go all out to ensure that P2P lending continues to be an alternative source of finance for the small and medium enterprise thereby ensuiring that the wheels of the economy keep running.