Banking return of assets (RoA) is expected to moderate to 1.1-1.2 per cent this fiscal after touching a 20-year high of approximately 1.3 per cent in fiscal 2024, stated a report by CRISIL Ratings, while adding that it will remain healthy as compared with the long term sectoral average of 0.75 per cent over 20 years (average of 0.5 per cent over the past 10 years).
Per the report, the expected moderation in profitability is because of higher cost of deposits given continued re-pricing at elevated rates. Deposit rates are expected to rise by 25-30 basis points (bps) this fiscal after having risen around 140 bos since the start of the rate tightening cycle. As a result, the net interest margin (NIM) is likely to compress 10-20 bps this fiscal to ~3.0-3.1 per cent.
The report also stated that improvement in credit costs, which has supported the rising profitability of the banking sector in recent years, is likely to bottom out this fiscal and will, therefore, provide only a partial offset.
“The interest rate on fresh term deposits has largely plateaued. But the impact is still flowing through to the outstanding deposits as they come up for renewal, resulting in re-pricing of existing deposits at higher rates. And this process should continue through the first half of this fiscal. While interest rates may come down in the second-half of this fiscal1, transmission of any rate cut on the deposit side would be slower given the competitive environment and the tight systemic liquidity,” said Ajit Velonie, Senior Director, CRISIL Ratings.
Meanwhile, on the assets side, a rate cut would trigger faster repricing downwards as over 40 per cent of advances are linked to an external benchmark, primarily repo. Together, these factors indicate a compression in NIM in fiscal 2025. The transmission on the assets and liabilities sides will continue into fiscal 2026, stated the report.
Apart from interest rate, credit cost also impacts bank profitability. The overall profitability has benefitted from a secular improvement in credit cost to below 0.5 per cent in fiscal 2024 from a peak of 2.3 per cent in fiscal 2018.
“Gross non-performing assets should continue to decline further from ~2.7% as of March 2024. India Inc’s credit quality outlook remains positive on the back of stronger, deleveraged balance sheets. On the retail side, delinquencies are expected to be range bound. Early bucket delinquencies are also controlled, as evidenced by SMA3 trends. Consequently, credit cost will remain low, though it is close to bottoming out and is unlikely to decline by more than ~5 bps hereon. Therefore, with credit cost improvement unlikely to fully offset the impact of compression in NIM, banking sector RoAs are likely to compress by 10-20 bps in fiscal 2025,” said Subha Sri Narayanan, Director, CRISIL Ratings.