ICRA downgrades Indian banking sector outlook to ‘stable’ from ‘positive’

New Delhi: Rating agency ICRA on Wednesday revised downwards its outlook for the Indian banking sector to ‘stable’ from ‘positive’ citing moderation in credit growth and profitability due to decline in interest margins. 

Credit growth of the Indian banking sector is estimated to decline to 11.7-12.5% in the financial year 2024-25 from 16.3% recorded in the previous year. In absolute terms, the credit expansion in the current financial year is estimated to decline to Rs 19-20.5 lakh crore from a record high of Rs 22.2 lakh crore in 2023-24.

Addressing a virtual conference Sachin Sachdeva, vice president  and sector head at ICRA, said the challenges in deposit mobilisation, and regulatory measures would slow down credit growth towards loans extended to consumer credit and non-banking finance companies (NBFCs).

While the compression in the interest margins over the last 18 months has been driven by rising deposit cost, the expectations of a rate cut in the second half of 2024-25 could lead to margin pressure, driven by a likely downward re-pricing of advances, the rating agency said.

Notwithstanding the margin compression, the growth in loan book shall translate into steady operating profits, aided by benign credit costs. ICRA expects this to drive healthy earnings that will largely be sufficient for most banks to meet their regulatory as well as growth capital requirements.

The Indian banking sector’s return on equity is projected to moderate. For private sector banks the return on equity is estimated to decline to 12.2% in the current financial year from 14.3% in the year ended March 2024 and 16.1% recorded in 2022-23. For public sector banks, the return on equity is estimated to decline to 12% in 2024-25 from 13.9% and 15% recorded in the previous two years, respectively.

On the asset quality front, the rating agency expects a further moderation in the gross non-performing assets ratio for the banking system at 2.2% by March 2025 from 3% in March 2024. The gross NPA by the end of the current financial year will be the lowest since September 2011.

Credit to deposit ratio (CD ratio) for the banks is estimated to have increased to 78% (excluding the merger of HDFC Limited) as on March 22, 2024, sharply higher than 75.7% as on March 24, 2023, and 71.9% recorded on March 25, 2022.

“This will pose significant challenges for the banks to pursue credit growth as their on-balance sheet liquidity has been deployed towards strong credit growth during the last two years,” the rating agency said.

The CD ratio is likely to remain elevated at over 80% (including HDFC merger) at the sector level in FY2025, even though some of the private banks may see a decline, while some of the public banks may witness an increase in their CD ratio.

“With elevated CD ratio, the competition for deposit mobilisation is likely to remain high even during FY2025, which will limit the banks’ ability to cut their deposit and lending rates. Amid this, if the policy rates are cut, it will pose significant challenges to banks’ net interest margins (NIMs),” said Sachdeva.