They said fuel price hikes will erode disposable incomes of retail borrowers, while rising input costs risk compressing corporate margins.
While the books of banks remain clean for now, the inflationary lag effect makes the second quarter asset quality a critical monitorable for the sector.
“The impact of the West Asia crisis on fuel prices, inflation and rupee depreciation will certainly affect multiple industries-SMEs (small and medium enterprises), large corporates as well as small borrowers,” Paritosh Kashyap, executive director of Kotak Mahindra Bank, told ET. “In Q2, all of this impact will be visible in the financials of those companies.”
Kashyap flagged SMEs as the most vulnerable. “SMEs will be squeezed from both ends-they may not be able to pass on cost increases to their anchor corporates, while raw material, supply chain and input costs are all rising simultaneously,” he said.
The caution around MSMEs is not limited to Kotak. Yes Bank‘s managing director Vinay Tonse said the lender is pulling back from the segment until there is greater visibility on the conflict’s trajectory. “Over the next couple of months, we will not be aggressive in lending to micro, small and medium enterprises (MSMEs) until we derive greater comfort that the situation has stabilised and clarity emerges on the war,” Tonse said.
Rating agency ICRA projects system-wide gross non-performing assets (NPAs) at 2.0-2.1% in FY27, with deterioration concentrated in private bank portfolios, given their heavier exposure to unsecured retail and MSME credit.The agency pegs India’s real GDP growth at 6.5% in FY27, assuming crude at $85 per barrel, with credit growth moderating sharply to 11-11.7% from 15.9% in FY26.
Cracks Ahead Asset quality stress looms from Q2 as fuel prices hit retail borrowers and input costs squeeze cos’ margins
“The asset quality stress is likely to start reflecting from the second quarter results of lenders, as the inflationary impact of fuel price hikes will weigh on disposable incomes of retail borrowers, while higher input costs will potentially squeeze corporate margins,” Anil Gupta, senior vice president of ICRA, told ET.
He said credit guarantee scheme support could provide partial relief to both borrowers and lenders.
The macro indicators reinforce the concern. India’s wholesale price index surged to 8.3% in May 2026 on soaring fuel costs, while the merchandise trade deficit ballooned to $28.4 billion in April-among the highest monthly readings in recent years. The rupee has depreciated 7.04% in calendar year 2026, with the bulk of the fall – 5.01% – occurring between March 2 and May 21, directly coinciding with the oil price spike triggered by the conflict.
SBI chairman CS Setty, in his letter to shareholders in the bank’s 2026 annual report, warned that the West Asia conflict could drag on global growth and push inflation higher.
“The economic fallout of the conflict may lead to lower GDP growth and higher inflation in FY27,” he said, noting that RBI regulatory dispensation and fiscal measures were being deployed proactively to absorb the shock.