Interest costs on loan against property (LAP) are set to rise due to hardening rates and will adversely affect small business, which are already reeling under the impact of the note-ban and GST, warns a report.

“Introduction of the goods and services tax (GST) in July 2017 and demonetisation have also placed stress on the SME (small and medium enterprises) sector, which with the rising interest rates will exacerbate,” rating agency Moody’s Investor Service said today.

A hike in interest rates by the Reserve Bank and hardening of yields since late-2017 have led to an increase in the cost of borrowing for non-banking lenders, which will prompt them to hike the rates at which LAP is extended to SMEs, it said.

“We consider that the expected rise in interest rates for LAP will reduce refinancing options for small business owners, adversely affecting existing borrowers,” Moody’s assistant vice-president and analyst, Dipanshu Rustagi, said in the report.

He further said the higher interest rates will lead to an increase in loan repayment for SME borrowers, who cannot extend loan terms. It can be noted that the LAP is one of the most sought-after routes by SME promoters for short-term finance as they can raise money through pledging of property, which serves as a collateral for lenders.

In the recent past, there have been multiple warnings on LAP portfolios issued by analysts, especially in the wake of an extra focus by lenders on the retail segment considered resilient.

Moody’s today said it expects delinquencies on LAP portfolios, but added this will not pinch hard as the loans have low loan-to-value ratios and are ‘secured’ with property as collateral.

It said the legislative amendments in 2016, which lets non-banking finance companies recover money under the Sarfaesi Act, will also help restrict losses.

Improvements in property registration systems also lower the administrative and legal hurdles lenders face in limiting their losses during default, it said. Apart from that, asset-backed securities (ABS) include structural features, non-amortising cash reserves, substantial excess spread and the possibility to extend the life of the loans, and consequently, the principal repayment schedule that can mitigate the risks posed by higher interest rates, it said.

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