How will this affect MSMEs and small traders?
Earlier this week, YES Bank, a mid-sized private sector bank with assets worth over $ 40 billion, effectively imploded. The bank has been put under moratorium by the RBI and some of its senior executives are under investigation by police. Because YES Bank is the fourth largest private sector bank in India, its collapse had a major impact on millions of customers. Those most affected by the collapse are those who can least afford it: small traders and MSMEs.
As far as, this is not an isolated event, one of the main reasons for the long term slowdown in the Indian economy is a major issue with NPAs, both in public sector banks and in private banks like YES Bank, caused by stupendous loans to bad actors. While a bailout could save YES Bank, structural problems in the banking system mean small traders and MSMEs will continue to have tough times. Here are some ways in which the YES Bank debacle affected these two groups, both directly and indirectly.
A loss of confidence in digital transactions and the banking system as a whole
Despite demonetization and government efforts to promote alternative payment methods, cash remains a vital aspect of the Indian economy. About 85 to 90 percent of retail transactions are done in cash. And, contrary to expectations, Indians now keep more money at home than before demonetization. Much of this is due to trust and perceptions. The NPA problem, reports of mismanagement of banking and digital security incidents all contribute to a general feeling of mistrust of non-cash payment methods. The collapse of the YES bank is likely to make this situation worse. One of the main risks is that YES Bank’s cash withdrawal moratorium highlights that cash may not be available when needed.
This has a major impact on traders and MSMEs. This has an impact on the rate of adoption of digital transactions, MSMEs might be less comfortable accepting non-cash payments, just like their suppliers. This will come with a significant opportunity cost, as MSMEs continue to miss out on the benefits of digital transactions.
MSME working capital will likely be affected
Indian MSMEs are very vulnerable to cash flow problems, they are often highly indebted and have minimal cash reserves. This means that any negative externality that impacts day-to-day working capital levels can bring business operations to a halt. Merchants who have accounts with YES Bank will be hit hard by the moratorium on withdrawals, especially if they do not have accounts at other banks. While the withdrawal cap is likely to be lifted in a few weeks, many traders may simply not have cash reserves to deal with this disruption. They could resort to informal sources of credit at high interest rates. Alternatively, they might have to cut down on day-to-day working capital expenses by limiting purchases. This would negatively affect their customers as product availability would then be limited.
MSMEs lack cash but still have to make payments
While tightening daily spending can help to some extent, MSMEs and small traders face a much bigger challenge. They must find a way to do their minimum required purchases, make pending credit payments, as well as pay wages and file their GST returns. While collecting pending payments from customers is a possibility, they might not be able to do so if their customers have YES bank accounts. Without other options to meet these unavoidable costs, MSMEs could resort to loans from informal lenders at exorbitant interest rates.
The long-term survival of MSMEs is at stake
The malaise underlying India’s banking system is that it serves the interests of large-scale clients to the detriment of millions of small account holders, many of whom are MSMEs. Systematic problems in the banking system, and in particular the NPA crisis, are largely due to excessive lending to large entities. This reduces the amount of capital that banks have to lend to everyone. Indian MSMEs are more in need of credit than any other business entity. The collapse of YES Bank, the resulting loss of confidence and the general credit availability problems plaguing the banking sector have hit MSMEs the most. Instead of having access to formal credit channels at preferential rates, they are often forced to resort to predatory lenders. Extreme credit conditions erode the long-term viability of many MSMEs, greatly increasing their likelihood of failure. In the shorter term, many MSMEs that do business with YES Bank, especially the smaller, highly leveraged, and high working capital needs MSMEs are at real risk of failure even before the moratorium on withdrawal is lifted.
The YES Bank crisis should not be viewed in isolation. This is symptomatic of the larger issues currently affecting the Indian banking system and the Indian economy as a whole. The only long-term solution here is to revamp a banking system that makes accountability a key priority.
The author is the Co-founder of Biz Analyst