The small finance banks (SFBs) are expected to post a moderation in profitability by around 40 basis points (bps) to approximately 1.7 per cent this fiscal from around 2.1 per cent for fiscal 2024 due to lower net interest margins (NIM) and higher credit costs, stated a report by CRISIL Ratings. Profitability is measured in terms of return of assets (RoA). That said, it added, RoA for SFBs will still be higher than that for the overall banking system by 50-60 bps on account of the relatively higher yielding nature of their loan book.
NIM for SFBs is expected to contract by around 15 bps as they continue diversifying to secured asset classes, which have relatively lower yields.
Credit cost, meanwhile, may rise around 40 bps because of rising delinquencies, primarily in the microfinance and other unsecured segments. An uptick in delinquencies, albeit more controlled, is also likely in sub-segments of secured asset classes catering to a similar customer segment.
SFBs have been focusing on segmental diversification as a core growth strategy. The diversification has largely been towards secured asset classes, primarily loans against property, housing loans and vehicle loans, to curtail potential volatility in asset quality and earnings, with many of the SFBs having started out as microfinance lenders.
Subha Sri Narayanan, Director, CRISIL Ratings, said, “The share of secured asset classes, which come at a lower yield of 6-7 percentage points on average, is set to rise to almost 65 er cent of overall SFB advances by end of fiscal 2025 from ~62 per cent in March 2024. While deposit costs will remain structurally higher than universal banks, diversification into alternate funding avenues should support stability in funding costs. All said, NIMs are likely to compress 15 bps to ~7.2 per cent for the fiscal.”
With operating expenses estimated to remain flat, this would translate into a reduction in pre-provisioning operating profitability to approximately 3.5 per cent in fiscal 2025 from 3.6 per cent last fiscal.
According to CRISIL Ratings, the overall profitability will continue to be significantly influenced by credit costs. Given the relatively vulnerable customer segment catered to by SFBs, periods of economic stress tend to result in higher delinquencies and credit costs, as seen most recently during the pandemic.
In fiscal 2025, microfinance loans and unsecured personal loans will see a moderation in portfolio quality. Sub-segments within secured asset classes, catering in part to a similar customer segment, could also see higher delinquencies.
Vani Ojasvi, Associate Director, CRISIL Ratings, said, “The gross NPA of SFBs is expected to move up to ~2.9% by the end of fiscal 2025 from 2.3 per cent as on March 31, 2024. As a result, credit cost is set to rise ~40 bps to ~1.4 per cent. The impact of the expected delinquency trends will not be uniform, though. The extent of rise in gross NPAs and credit costs across SFBs will vary based on the extent of their exposure to the vulnerable segments.”
Furthermore, CRISIL said that SFBs with a more diverse and secured portfolio will be more resilient, as witnessed in the aftermath of the pandemic.
With organic transition to newer asset classes continuing, the ability of SFBs to maintain sound asset quality and profitably scale up the newer portfolio will bear watching over the long term, said CRISIL.