Rating agency ICRA on Thursday said it continues to maintain a positive outlook on the banking sector on the expectation that credit growth would remain meaningfully strong, thereby driving earnings growth. 

While the upward repricing of the deposit base is likely to lead to a moderation in the interest margin, benign asset quality pressures would support lower credit costs and earnings. 

Accordingly, in ICRA’s view, the banking sector is expected to continue generating sufficient internal capital to largely meet its growth needs while improving the capital cushions. 

Role of retail segment

The retail segment is likely to remain the key contributor to credit growth although the sustainability of asset quality hinges on favourable macro-economic conditions.

Anil Gupta, Senior Vice-President & Co-Group Head—Financial Sector Ratings, ICRA, said, “Credit growth remains robust despite some moderation. Even at the anticipated pace of growth for FY2024, incremental credit expansion would be the second highest ever at ₹16.5-18 trillion, next only to the record level of ₹18.2 trillion (+15.4 per cent) last year.

“Even as the retail segment has performed well, the material weakening of macro-economic conditions could exert pressure on the debt-servicing abilities of borrowers and we remain watchful of its impact on the asset quality of lenders. Nonetheless, banks have strong operating profits and capital positions. Consequently, they are much better placed at present for navigating through such a scenario.”

Non-performing assets

ICRA expects the headline metrics of the banking sector to remain on an improving trajectory on the back of controlled net additions (recoveries and upgrades) to non-performing advances (NPAs) and reasonably strong credit growth. Accordingly, ICRA expects the gross NPAs (GNPAs) and net NPAs (NNPAs) to decline to 2.8-3 per cent and 0.8-0.9 per cent, respectively, by March 2024 from 3.96 per cent and 0.97 per cent, respectively, as on March 31, 2023 — the best in more than a decade.

Notwithstanding this, ICRA remains cautious about the impact of macro-economic shocks on the asset quality.

Credit costs are estimated to remain at 1 per cent of advances in FY2024, in line with  FY2023. 

This should allow banks to comfortably withstand a compression of 20-25 bps in the interest margins, which would lead to a mild moderation in the return on assets (RoA) to 1 per cent in FY2024 from 1.1 per cent in FY2023. 

At these levels, the return on equity (RoE) would remain healthy at 13-13.1 per cent in FY2024 against 13.8 per cent in FY2023, according to ICRA.

Furthermore, supported by internal capital generation and lower NNPA levels, the capitalisation and solvency profiles of private and public sector banks would remain comfortable. ICRA projects the Tier-I capital of the banking sector at 14.6-14.7 per cent (14.4 per cent as of March 2023) and an improvement in the solvency levels to 7 per cent (8 per cent as of March 2023) by March 2024.

Credit expansion

Over the last decade, credit growth in the retail segment remained buoyant and a key driver of overall credit expansion. 

As retail growth outpaced other segments, its share in bank credit rose to 32 per cent as on March 31, 2023, from 18 per cent in March 2013. Moreover, the corporate book witnessed underperformance in recent years, including weaker asset quality levels and muted expansion, resulting in slower growth trends relative to the retail segment.

The Covid-19 pandemic was a stress test event on the asset quality across segments, and defaults and losses were relatively higher in the unsecured segments. With more insight on borrowers’ repayment behaviour during the pandemic, lenders can take better decisions in growing unsecured retail loans. Moreover, the retail segment continued to report resilience despite volatile macro-economic conditions, including rising interest rates and surging inflation, which impacted disposable income. 

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