Indian banks’ profitability seen rising in FY23: Moody’s

The correlation between rising interest rates and profitability is strongest for India, the agency said.

Bank sector moody's
Other than India, banks in Saudi Arabia and South Africa are also expected to see an increase in their NIMs in FY23. (File)

Net interest margins (NIM) of Indian banks are expected to increase at a faster pace compared to its peers in the emerging markets in the current financial year on account of rising policy rate cycle, credit ratings agency Moody’s Investor Service said in a report. Typically, interest rate increases lead to a widening of banks’ interest margins, providing a boost to their profitability.

Along with widening of margins, banks will also witness an increase in their return on assets (ROA) as there will not be a likely increase in their credit costs as the lenders have made significant increases during the pandemic. The correlation between rising interest rates and profitability is strongest for India, the agency said.

Despite the increase in profitability of banks in a rising interest rate cycle, the banks also face higher credit costs due to weakening of loan quality and rising provisions. However, the Indian banks will be able to retain their profitability as the recognition of bad loans in India comes with a lag. 

“In the case of India, the historic relationship between credit costs and inflation is distorted because of significantly delayed recognition of NPLs and bank restructurings that took place in 2016-18 when inflation was slowing. We expect Indian banks’ asset quality will improve in 2022-23 because of recoveries and write-offs of legacy NPLs,” according to analysts at Moody’s.

The ratings agency focused on banks of 10 emerging economies, including Argentina, Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa and Turkey. In 9 out of the 10 emerging markets, banks’ margins have historically widened in tandem with rises in inflation, the agency observed. 

Other than India, banks in Saudi Arabia and South Africa are also expected to see an increase in their NIMs in FY23. 

While most central banks have already increased interest rates, the ratings agency expects more rate hikes in 2022 especially by those central banks that are still early in the rate increase cycle or haven’t started yet.

The Reserve Bank of India (RBI) has increased the policy repo rate by 90 basis points (bps), once by 40 bps in an off-cycle meeting in April, and another by 50 bps in scheduled meeting in June. Analysts are expecting more rate hikes, closer to the pre-pandemic levels as the inflation is still above the upper tolerance limit.

The retail inflation abated in May to 7.04% compared to 7.79% in the previous month due to the unscheduled rate hike, but still remains at an elevated level. In its June policy meeting, RBI has set the retail inflation expectation for FY23 at 6.7% with the inflation expected to go below the tolerance level in the last quarter.

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