ICRA upgrades outlook for banking sector in India

One of India’s top-3 credit rating agencies (CRAs), ICRA Ltd, revised its outlook for the banking sector to “Positive”. This positive re-rating of its outlook is predicated on some key factors including strong credit growth, relatively benign asset quality and one of the best capital and solvency position over the last decade. Not only that, despite the higher interest rates in the economy, ICRA expects the profitability of the banks to remain strong in the coming quarters. While the higher interest rates is likely to impact loan demand at some point in the future, for now the growth is healthy so higher costs should be sustainable.

One trend in the last few months has been the gradual reduction in system liquidity. That is largely because of the wide gap between credit growth and deposit growth. That trend has been visible for some time as the deposit growth has just failed to keep pace with the rapid growth in credit demand. However, despite these factors, ICRA does expect that the overall bank credit growth should taper to a range of 11-16% in the financial year FY24. This is compared a relatively healthier 15.2-16.1% credit growth expected in the current fiscal year, FY23. The fall in credit growth is likely to be much sharper for the public sector banks.

Here is how the numbers appear to stack up. ICRA expects that the credit growth for the public sector banks would likely be in the range of 13.4-14.1% in FY23. However, this is likely to taper sharply to around 9.5-10.1% in FY24. That is a likely fall of 400 basis points in credit growth for the PSBs in FY24 over FY23. What about the private sector banks? For the private sector banks, ICRA has pencilled in a credit growth of 14.5-15.5% in FY23. However, this is expected to taper by around 200 basis points to the range of 12.6-13.5% in FY24. In short, both private banks and PSBs will see contraction in credit growth in FY24 over FY23, although the extent of the fall will be sharper for the PSB than for the private banks.

On the subject of asset quality, ICRA has pointed out specifically that non-performing assets (NPAs) of the banking system overall are at multi-year lows. This is true for the public sector banks and also for the private sector banks. In addition, ICRA has also underlined that most of the Indian banks are better prepared and also better positioned to deal with any incremental stress arising out of the restructured book. Therefore, ICRA expects the gross NPAs and the net NPAs to trend lower in the coming quarters. Slippages would still be there, but the broad ICRA expectation is that such slippages would be less of bulky corporate slippages and more of granular client specific stress; that is easier to deal with.

One factor that will drive profitability in the banking system will be gross NPAs under 4% and net NPAs under 1%. However, there is likely to be more to the profitability story. Some impact on the profits is likely due to the rising costs of deposits, which is likely to limit the upside for banks. However, ICRA also expects that while the net interest margins (NIMs) may compress a bit in the coming quarters, the rapid credit growth should more than compensate for such margin compressions. In addition, due to mellowed down credit provisions, most of the banks are likely to see perceptible improvement in the return on equity (ROE) as well as an improvement in the return on assets (ROA).

Finally, let us move to what ICRA said about the capital adequacy and solvency conditions of the banks. Despite the banking capital and solvency position being best in the last decade, it is expected to improve further. Robust capital markets will permit easy raising of capital by banks, which should help the adequacy ratios in future also. Most of the private banks already have extremely comfortable levels of capita adequacy while the ratios for the PSBs has been rapidly improving. Overall, it looks like the banking sector overall is in an extremely sweet spot. The upside potential appears to far outweigh the downside risks.