The rating agency ICRA has adjusted its outlook for the Indian banking sector, downgrading it from ‘positive’ to ‘stable.’ This revision comes in light of several factors impacting credit growth and profitability within the sector.
Credit Growth Projection
ICRA estimates a decline in credit growth for the Indian banking sector in the financial year 2024-25. The growth is expected to decrease to 11.7-12.5% from the previous year’s 16.3%. This translates to a projected credit expansion of Rs 19-20.5 lakh crore, down from the record high of Rs 22.2 lakh crore in 2023-24.
Challenges Ahead
During a virtual conference, Sachin Sachdeva, vice president and sector head at ICRA, highlighted challenges such as deposit mobilisation and regulatory measures. These challenges are expected to slow down credit growth, particularly for loans extended to consumer credit and non-banking finance companies (NBFCs).
Interest Margin Pressure
The recent compression in interest margins, driven by rising deposit costs over the last 18 months, is another factor noted by the rating agency. Expectations of a rate cut in the second half of 2024-25 could further pressure margins, potentially leading to downward re-pricing of advances.
Profitability and Return on Equity
Despite margin compression, ICRA anticipates steady operating profits driven by healthy earnings from the growing loan book. However, projections suggest a moderation in return on equity for both private and public sector banks. Private sector banks’ return on equity is estimated to decline to 12.2%, while public sector banks’ return on equity is expected to be 12% for the financial year 2024-25.
Asset Quality and Credit to Deposit Ratio
On the asset quality front, ICRA forecasts a further moderation in the gross non-performing assets (NPA) ratio, expecting it to reach 2.2% by March 2025, the lowest since September 2011. The credit to deposit ratio (CD ratio) for banks has increased to 78% as of March 2024, posing challenges for pursuing credit growth due to on-balance sheet liquidity deployment. The CD ratio is likely to remain elevated, possibly exceeding 80% at the sector level in FY2025.
Challenges Ahead
The elevated CD ratio implies fierce competition for deposit mobilisation, limiting banks’ ability to cut deposit and lending rates. This, combined with potential policy rate cuts, may pose significant challenges to banks’ net interest margins (NIMs) in the coming year.
The revised outlook to ‘stable’ reflects the complex landscape ahead for Indian banks, with various factors influencing growth, profitability, and asset quality. It remains to be seen how banks navigate these challenges in the upcoming financial year.
