Crisil Ratings expects healthy bank credit growth in fiscal 2025, but moderate at about 14 per cent, compared to about 16 per cent in fiscal 2024 and 15.9 per cent in fiscal 2023.

In fiscal 2024, broad-based economic growth and strong retail demand had driven bank credit growth.

In fiscal 2025, however, it is set to moderate due to four factors — slower growth in gross domestic product (GDP) at 6.8 per cent, compared with about 7.6 per cent in fiscal 2024; the high-base effect of fiscal 2024; decreased growth in unsecured retail loans; and deposit growth lagging credit growth.

To be sure, larger capital expenditure would provide some tailwind.

But the Reserve Bank of India’s move in November to increase risk weights on unsecured consumer credit and bank lending to higher-rated non-banking financial companies (NBFCs) remains an overhang.

These two segments were among the fastest growing for banks in recent years. While the revised norms have already impacted bank credit to NBFCs, growth in unsecured credit will temper over the next few months.

Benign outlook

Asset quality trends are benign, with gross non-performing assets (NPAs) expected to decline from 3.9 per cent, as on March 31, 2023, to about 2.5 per cent in 2025. Continued improvement is likely in the corporate segment, as gross NPAs may fall below 2 per cent from a peak of about 16 per cent, as on March 31, 2018, thanks to clean-ups and tougher norms for risk management and underwriting.

Fundamentally, corporate India is on stronger footing, given the secular deleveraging over the past few fiscals — the median gearing will likely remain benign at about 0.5 times for this fiscal. Asset quality in the micro, small and medium enterprises (MSME) segment has also improved with formalisation and data availability enabling improved underwriting. However, the segment remains vulnerable to economic cycles.

Retail loan NPAs are seen rangebound while there could be uptick in unsecured loan NPAs. That said, lending to the unsecured segment is largely through cross-selling to existing customers, which benefits credit quality assessment. Hence, a significant deterioration in asset quality is unlikely.

Capital adequacy

The banking sector has adequate buffers in terms of capitalisation and is set for medium-term growth. The increased risk weights may marginally impact capital adequacy. Public sector banks have benefited from capital infusion by the government, as well as improved internal accrual. Private banks have traditionally maintained comfortable buffers, but many also benefit from capital raised in the past few fiscals.

It is important to ensure deposit growth does not greatly lag credit growth, with the differential narrowing to 300 basis points (bps) in fiscal 2024 from 500 bps in fiscal 2023, given the hike in deposit rates.

The shift from lower-cost current and savings account (CASA) deposits to term deposits happens during rising interest rates, as the opportunity cost of maintaining funds in CASA is higher.

Improved asset quality due to lower slippages and healthy recoveries, and the high provisioning cover ratio (PCR), have cut incremental credit costs. Return on assets improved to about 1.2 per cent in fiscal 2024 from 1.1 per cent the previous fiscal, despite relatively flat net interest margins (NIMs). Crisil Ratings expects NIMs to compress 10-20 bps this fiscal due to deposit rate hikes.

Faster transmission of rate cut on the assets side as well as lower growth of high-yield unsecured loans could impact NIMs. While lower credit costs could provide some offset due to benign asset quality and strong PCR, they are likely bottoming out. Hence, return on assets could moderate to 1.1 per cent.

Going forward, banks are likely to walk a tightrope between growing their deposit base cost-effectively and protecting profitability.

Overall, the sector is better placed today than a few years ago, but banks must maintain their credit underwriting standards to avoid asset quality challenges.

(The writer is Senior Director, Crisil Ratings Ltd)