Interest rate hikes unlikely to have negative impact on earnings of banking sector: ICRA

• Incremental credit growth expected to remain robust at Rs. 16.5-18.0 trillion in FY2024, despite marginal slowdown.
• NIMs expected to compress by 20-25 bps, though benign credit costs and lower operating expenses to provide support.
• Asset quality is likely to remain benign as GNPAs and NNPAs are expected to decline further by March 2024.

Analysts may be worried about rising stress in the retail assets of banks, but ICRA is of the view that the sector is resilient and that credit growth is expected to remain strong. Given that deposits have been repriced after the Monetary Policy Committee of the Reserve Bank of India delivered six interest rates hikes. However, ICRA does not expect this to impact profitability of the sector negatively. In a note, the agency said: “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. The retail segment is likely to remain the key contributor to credit growth although the sustainability of asset quality hinges on macroeconomic conditions remaining favourable.

ICRA expects the headline metrics of the banking sector to remain on an improving trajectory on the back of controlled net additions (net of 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 2.8-3.0% and 0.8-0.9%, respectively, by March 2024 from 3.96% and 0.97%, respectively, as on March 31, 2023, which would remain the best in more than a decade. Notwithstanding this, ICRA remains cautious about the impact of macroeconomic shocks on asset quality, if these were to materialise.

Commenting further Anil Gupta, Senior Vice President & Co-Group Head, 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 Rs 16.5-18.0 trillion, next only to the record level of Rs 18.2 trillion (+15.4%) last year.”

Credit costs are estimated to remain at 1.0% 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 1.0% in FY2024 from 1.1% in FY2023. At these levels, the RoE would remain healthy at 13.0-13.1% in FY2024 against 13.8% in FY2023.

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% (14.4% as of March 2023) and an improvement in the solvency levels to 7% (8% as of March 2023) by March 2024.

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% as on March 31, 2023 from 18% 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 the borrowers’ repayment behaviour during the pandemic, lenders can take better decisions while 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.

Gupta added: “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.”