EY India Warns of Liquidity Stress and Credit Risks Amid West Asia Conflict

The ongoing geopolitical tensions in West Asia are beginning to ripple through India’s financial ecosystem, raising concerns about liquidity, credit quality, and overall economic stability.

According to a recent analysis by EY India, the impact of the conflict is no longer confined to energy markets and trade flows but is now extending deeper into financial intermediation and banking operations.

The report highlights how rising crude oil volatility, increasing freight and insurance costs, and foreign exchange fluctuations are placing pressure on working capital cycles and borrower cash flows across sectors.

Transmission of Global Shock into India’s Financial System

Beyond Energy and Trade

EY India noted that the effects of the West Asia conflict are spreading beyond traditional channels such as oil prices and global trade disruptions. Financial systems are now experiencing second-order impacts, including tighter liquidity and rising funding needs.

Higher input costs and longer supply chain timelines are affecting business operations, particularly for sectors dependent on imports or global trade.

Rising Dependence on Bank Funding

The report pointed out that these pressures are pushing companies, especially MSMEs and trade-linked industries, to rely more heavily on bank financing.

“Rising input costs, longer transit times, and delayed receivables are driving higher utilisation of working capital limits and stretching cash conversion cycles,” EY India said.

This increased dependence on credit is adding stress to both borrowers and lenders.

Early Warning Signs in Credit Portfolios

Liquidity Stress Emerging First

EY India highlighted that the initial signs of financial strain are visible in liquidity indicators rather than outright loan defaults.

Key early warning signals include:

• Irregular cash flows
• Increase in receivable days
• Higher utilisation of CC/OD limits
• Delayed GST filings

These indicators suggest that borrowers are facing short-term cash flow challenges, which could escalate if conditions persist.

Potential Impact on Asset Quality

The report warns that these early stress signals could translate into deterioration in asset quality within one to two quarters.

“Cash-flow volatility is likely to precede formal delinquencies, challenging traditional risk models,” EY India said.

Sectors such as unsecured retail lending and small-ticket secured loans are particularly vulnerable to these emerging risks.

Sectoral Impact and Risk Transmission

Non-Linear Risk Build-Up

Banks are facing a complex chain of risk transmission, where initial margin pressures gradually evolve into broader financial stress.

The progression typically follows:

• Margin compression due to rising costs
• Working capital strain
• Reduced income and repayment capacity

Industries directly exposed to global disruptions—such as oil, aviation, logistics, and chemicals—are experiencing the highest levels of stress.

Trade Finance Disruptions Intensify Pressure

Delays and Increased Compliance

Trade finance operations are also being affected, adding to liquidity challenges. The report highlighted several operational bottlenecks:

• Longer settlement timelines
• Delays in letters of credit
• Stricter sanctions screening
• Selective de-risking by global banks

These factors are increasing the time and cost involved in international transactions, leading to working capital lock-ups.

MSMEs Bear the Brunt

Export-oriented MSMEs, particularly in sectors like apparel, chemicals, and logistics, are among the most impacted.

Rising freight charges, higher insurance premiums, and elevated input costs are squeezing margins and intensifying liquidity stress for these businesses.

Rising Insurance Costs Add to Burden

War Risk Premiums Surge

The insurance sector is also reacting to geopolitical risks, with significant repricing underway.

War risk premiums have increased sharply, especially in marine and aviation insurance segments. Trade credit insurance is also becoming more expensive as insurers account for higher default risks.

This trend is further increasing the cost of doing business, particularly for companies engaged in international trade.

Risks to Remittances and Payments

Exposure to GCC Region

EY India noted that approximately 35–40% of India’s inward remittances come from GCC countries, making them vulnerable to geopolitical disruptions.

While short-term inflows may remain stable, prolonged conflict could impact employment in the region, affecting remittance-dependent households in India.

Impact on Payment Systems

On the payments front, rising fuel costs and supply chain disruptions may initially increase transaction values. However, over time, weakening trade activity and consumption could reduce transaction volumes.

Need for Proactive Risk Management

Shift to Anticipatory Frameworks

In response to these challenges, EY India emphasized the need for banks to adopt forward-looking risk management strategies.

This includes:

• Sector-specific stress analysis
• Cash flow-based monitoring systems
• Multi-factor stress testing models

Portfolio Rebalancing

The report also suggests that lenders may need to rebalance their portfolios by focusing on:

• Resilient sectors with stable demand
• Borrowers with strong balance sheets
• Reduced exposure to import-heavy industries

Long-Term Risk Outlook

EY India cautioned that “Second- and third-order effects—spanning working capital strain, payment delays, and employment-linked stress—are likely to build over the coming quarters,” emphasizing the importance of early intervention.

Conclusion

The EY India analysis underscores the growing interconnectedness of global geopolitical events and domestic financial systems. As the West Asia conflict continues to unfold, its impact on India’s banking and financial sector is becoming increasingly evident through liquidity stress, credit risks, and operational disruptions.

While the current challenges are manageable, the situation demands proactive monitoring and timely policy responses. Strengthening risk management frameworks and supporting vulnerable sectors, particularly MSMEs, will be crucial in maintaining financial stability in the months ahead.