Mumbai, April 7 Amid the ongoing conflict in West Asia, a consultancy firm on Tuesday urged banks to shift their exposure away from vulnerable small businesses and retail borrowers who may face the impact of layoffs.
Banks need to convert early warning signals into decisive action, EY said in a report.
"This could mean shifting exposure away from vulnerable MSME segments, import-intensive borrowers, and retail cohorts exposed to layoffs, while strengthening structurally stronger sectors and resilient secured portfolios," the report said.
The report recommended that banks focus on intervening early by resetting covenants, enforcing liquidity buffers, tightening collections, and using preemptive restructuring where cash flow timing is stressed.
The report said that multi-factor stress testing, capturing shocks from oil prices, foreign exchange movements, logistics disruptions, and demand volatility, should be used to assess rating migration risks and build expected credit loss (ECL) buffers.
Adopting this approach moves risk management from reactive containment to proactive control, strengthening asset quality and limiting credit costs across the cycle, it said.
The report said that the conflict's transmission to the domestic economy is increasingly visible in liquidity consumption across supply chains, and rising input costs and longer lead times are driving greater reliance on bank liquidity through elevated cash credit or overdraft utilisation, stretched receivables, inventory buildups, and short-tenor rollovers.
The report said lenders should embed sector-level diagnostics into underwriting and pricing, along with comprehensive borrower assessment based on key financial indicators such as Debt Service Coverage Ratio (DSCR), Interest Coverage Ratio (ICR), and working capital adequacy.
Export-oriented MSMEs (micro, small and medium enterprises), especially in the apparel, chemicals, logistics, and aviation sectors, are facing more acute margin and liquidity pressure, the report said.
In the near term, the biggest risk is rising liquidity use, which creates latent asset quality pressure as margins remain tight and cash cycles extend, it said.
A prolonged conflict could lead to job losses and economic disruption in the region, dampening remittance inflows over time and pressuring remittance-dependent households, particularly in states such as Kerala, Gujarat, and Maharashtra, the report said.
The first-order impact is typically treasury-led, reflected in volatility in foreign exchange, interest rates, and funding costs, which can quickly affect net interest margins. The second-order impact is borrower-led, seen in margin pressures, longer operating cycles, and rising working capital utilisation, while the third-order impact is demand-led, often emerging with a lag through weaker collections, retail loan slippages, and stress in the MSME segment.
The report further noted that banks should upgrade their Early Warning Systems (EWS) from static monitoring tools to predictive mechanisms capable of identifying stress 60-90 days ahead of special mention account (SMA) or non-performing asset (NPA) classification.