Pressure on banks’ NIMs is expected to continue in FY25: ICRA

Pressure on banks’ net interest margins (NIMs) is expected to continue in FY25, driven by rising deposit costs in FY24 and thereafter by likely cut in repo rates, according to ICRA.

The credit rating agency said it remains cautious over any material weakening in asset quality levels amid higher interest rates or an unanticipated impact from regulatory changes on banks, in addition to a slowing global growth, which can have a spillover effect on certain export-oriented sectors of the economy and a tighter liquidity environment, which might exert higher-than-expected moderation in profitability margins.

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However, ICRA has maintained its positive outlook on the banking sector, driven by comfortable asset quality levels, with both corporate and retail portfolios performing well in terms of delinquencies, resulting in limited net-NPA (non-performing asset) additions.

Healthy credit growth

Furthermore, credit growth is expected to remain healthy at 12-13 per cent in FY25 (16.5 per cent y-o-y /year-on-year as on December 1, 2023 and 15.4 per cent in FY2023), driven by strong demand in the services and the retail segments.

“These factors are likely to be offset by the continued upward repricing of the deposit base in H2 (October-March) FY2024, leading to compression in interest margins. While this repricing is likely to mostly happen by the end of FY2024, the expectations of a rate cut from August 2024 could start a downward pressure on lending yields and hence pressure on interest margins may continue during FY2025,” ICRA said.

Aashay Choksey, Vice President, ICRA, said, “Incremental credit expansion has been robust so far at ₹15.5-lakh crore (for FY2024 till December 1, 2023), against ₹18.2-lakh crore in FY2023. However, as we look beyond this year, credit growth is likely to come off as tight liquidity conditions would eventually weigh down on growth.

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“Besides this, factors including weaker credit demand in the agriculture segment, subdued export demand as well as the recent increase in risk-weights to the unsecured consumer lending and the NBFC segments would also collectively temper credit traction”.

Further, the gross-fresh NPA generation for the banking system is expected to witness a mild increase in FY2025 as portfolios gradually season, although the corporate book asset quality is expected to hold up and slippages are likely to remain granular.

Despite the increase, the agency expects the headline metrics of the banking sector to maintain an improving trajectory on steady recoverability and credit growth.

GNPA, NNPA to decline

Accordingly, ICRA expects the gross NPAs (GNPAs) and the net NPAs (NNPAs) to decline to 2.1-2.5 per cent and 0.5-0.6 per cent, respectively, by March 2025 from 2.8-3.1 per cent and 0.7 per cent, respectively, expected as on March 31, 2024 (GNPA and NNPA at 4 per cent and 1 per cent respectively as on March 31, 2023).

Accordingly, credit costs are estimated to remain benign at 0.7-0.8 per cent of advances in FY2024-FY2025, in line with FY2023. This should allow banks to comfortably maintain their return on assets (RoAs) at 1-1.2 per cent in FY2024-FY2025 (1.1 per cent in FY2023).

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While the RoE (return on equity) is projected to moderate, it is likely to remain healthy at 11.5-12.7 per cent in FY2025 (13.7-14.6 per cent in FY2024E, 13.8 per cent in FY2023), thus meeting a meaningful share of banks’ growth capital requirements in FY25.

Comfortable capital position

While recent regulatory actions like an increase in risk weights for exposure towards unsecured loans and non-banking financial companies and an eventual transition to the estimated credit loss (ECL)-based framework could have a negative impact on the reported capitalisation levels, the capital position for most constituent banks remains comfortable and well placed to absorb these impacts while continuing to grow their respective portfolios at a reasonable pace, per the agency’s assessment.

Choksey said, “As a result of healthy profitability levels and controlled net-NPA additions, the capitalisation and solvency profile for private and public sector banks continued to improve in H1 FY2024.”

ICRA estimates that despite recent regulatory changes around increase in risk weights for exposure/lending to unsecured consumer credit and the NBFC segments, capitalisation levels would remain comfortable with tier-I capital of the banking sector at 14.5-14.9 per cent as on March 2025 (14.4-14.6 per cent/ Estimated as of March 2024, 14.4 per cent as on March 2023), while improvement in solvency levels would flatten out to 4-6 per cent in F2024-FY2025 (8 per cent as of March 2023).

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