Key Takeaways
- We believe that credit growth for India's banking sector could slow to 12%-14% in fiscal 2025, similar levels to deposit growth.
- Funding metrics could continue to deteriorate if liquidity does not improve, and may further strain margins and hurt profitability.
- In our view, rated banks have sufficiently solid asset quality and steady capitalization to support credit profiles.
Liquidity is tightening for Indian banks. We believe the sector's strong credit growth could moderate in fiscal 2025 (ending March 31, 2025) if deposit growth remains tepid, compounded by higher deposit costs and competition for funds. Deposit growth continues to lag credit for the Indian banks we rate. Banks may be compelled to look for wholesale funding. And the higher costs of such funding could further strain margins and hurt profitability. That said, stable asset quality and steady capitalization should still support the banks' credit profiles.
Robust Credit Growth Could Moderate
Average deposit growth for rated banks of 11%-13% remains lower than credit growth of 15%-17%. This has led to a rise in loan-to-deposit ratios (LDR) compared with levels at the end of March 2023. Private sector banks have seen a particularly sharp deterioration because LDRs have risen to 90%-95%. HDFC Bank Ltd.'s LDR was higher at over 110% due to its merger with Housing Development Finance Corp. Ltd., a housing finance company that was predominantly wholesale funded. Public sector banks' LDRs are stronger at below 80% despite a slide in the last three quarters.
This deterioration in funding metrics could persist if sector liquidity, in the form of retail deposit flows, does not improve. Banks have had to rely on bulk or wholesale deposits to fund growth because of rising competition for deposits and the shift from low-yielding current and savings deposits to higher interest-bearing term deposits. Wholesale deposits often come at a higher cost than retail term deposits.
We believe that credit growth could slow to 12%-14% in fiscal 2025, levels that are similar to deposit growth. Otherwise, higher costs of wholesale funding will increase pressure on net interest margins and could affect profitability. In our view, Indian banks will have to strike a fine balance between maintaining strong loan growth and paying more for deposits to fund that growth.
Share Of Unsecured Loans Will Continue To Rise
The Reserve Bank of India's recent ruling on applying higher risk weights to unsecured personal loans has not yet hindered rapid growth in this segment. For credit cards and unsecured loans, growth declined slightly to 22.3% year on year as of Dec. 31, 2023, compared with 23.6% in November 2023. This is because the pricing for such loans has increased marginally by 20-30 basis points (bps) and could be absorbed by borrowers.
Unless pricing dynamics change significantly, we expect that the share of such loans in the banks' total loan book could continue to rise. This will also help banks to partly mitigate the downside risks to margins from tighter liquidity. Yields on unsecured retail loans are higher and their increasing share will be beneficial to net interest margins.
Many large banks are controlling credit risks in this segment by lending to existing and salaried customers, limiting the risk from job losses. (See "New Regulatory Risk Weights Will Hit Indian Banks' Capital Adequacy By 60 Basis Points," published on RatingsDirect on Nov. 17, 2023.) This could explain the diverging performance of large private banks and nonbank finance companies (NBFCs) in this segment. SBI Cards and Payment Services Ltd., a nonbank subsidiary of State Bank of India, saw elevated credit costs of 750 bps in the third quarter of fiscal 2024.
Margins Have Peaked
Rising cost of funds and potential rate cuts in fiscal 2025 will squeeze net interest margins to 3% in fiscal 2024 and 2.9% in fiscal 2025. This is because deposits typically get repriced with a lag while loan yields are more sensitive to policy rate movements.
We see higher downside risks to margins of NBFCs because of the central bank's decision to increase the risk weight on banks' lending to NBFCs by 25 percentage points in November 2023. During this quarter, NBFCs experienced a 10-20 bps surge in the cost of funds, though the full impact of this change will likely be seen in the following quarter. Some NBFCs maintained their NIMs by passing on higher funding costs to borrowers or increasing the share of higher yielding loans. Some banks have modified their incremental lending rates, while others have chosen to universally increase rates for all loans extended to NBFCs.
Asset Quality Should Remain Stable
For all the Indian banks we rate, gross nonperforming loan ratios and credit costs are declining. We forecast asset quality will generally remain stable, given the robust operating conditions in the country. Banks have had to make a one-off provision on their investments in alternative investment funds to comply with recent regulations. For the rated banks, this impact was under 5% of profit before tax for the quarter ending December 2023. Some NBFCs had higher exposure and hence saw a significant impact on earnings. For example, Piramal Enterprises Ltd. (unrated) reported a loss of US$286 million for the quarter.
Potential Increase In Capital Raising
Rated banks' capitalization has improved over the last two years, with private sector banks maintaining higher capital. Strong loan growth and higher regulatory risk weights on unsecured personal loans and loans to NBFCs resulted in sequential decline in the tier-1 capital ratio for the banks. Public sector banks, such as Indian Bank, leveraged the country's vibrant capital markets to raise additional capital. This provided them with growth capital. It also resulted in a reduction in government ownership to below 75% and met minimum public shareholding norms. This aligns with regulations set out by the Securities and Exchange Board of India for listed companies.
Favorable equity markets and operating conditions could spur other public sector banks with over 75% government shareholding also to raise funds in 2024. Some smaller public sector banks like Indian Overseas Bank, Punjab & Sind Bank, and UCO Bank are over 95% government owned. Strengthened capitalization should also help them offset a moderate decline in asset quality, although such a decline is not in our base case.
Table 1
| Gap Between Loan Growth And Deposit Growth Will Push LDRs Higher | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Rated Indian Banks: Summary of results as of Dec. 31, 2023 | ||||||||||||||||||
| Reported gross NPL ratio (+ over Mar. 23) | Credit costs (FY23) | Return on assets (FY23) | NIM (FY23) | Loan growth | Deposit growth | Loans to deposit ratio (FY23) | Tier 1 capital ratio (Sept. 30, 2023) | |||||||||||
|
State Bank of India |
2.4%(-35 bps) | 0.2% (0.6%) | 0.9% (1.0%) | 3.2% (-15 bps) | 12.8% | 10.2% | 75.3% (73.9%) | 10.8% (12.0%) | ||||||||||
|
HDFC Bank Ltd.* |
1.3% (+10 bps) | 0.6% (0.9%) | 2.0% (2.1%) | 3.6% (-70 bps) | 70.5% | 23.4% | 111.5% (85.7%) | 16.7% (17.7%) | ||||||||||
|
ICICI Bank Ltd. |
2.3% (-54 bps) | 0.4% (0.7%) | 2.4% (2.2%) | 4.4% (-5 bps) | 17.8% | 17.1% | 89.9% (89.5%) | 15.8% (16.7%) | ||||||||||
|
Axis Bank Ltd. |
1.6% (-48 bps) | 0.4% (0.3%) | 1.8% (1.8%)^ | 4.0% (-1 bp) | 13.7% | 8.1% | 92.8% (89.3%) | 12.5% (13.8%) | ||||||||||
|
Union Bank of India |
4.8% (-270 bps) | 0.9% (1.8%) | 1.1% (0.7%) | 3.1% (+1bp) | 14.1% | 6.5% | 76.4% (72.5%) | 13.1% (14.6%) | ||||||||||
|
Indian Bank |
4.5% (-98 bps) | 1.3% (2.1%) | 1.0% (0.8%) | 3.4% (+4 bps) | 9.1% | 4.7% | 75.4% (73.0%) | 13.2% (13.0%) | ||||||||||
|
Kotak Mahindra Bank |
1.7% (-8 bps) | 0.5% (0.1%) | 2.6% (2.6%) | 5.2% (-11 bps) | 16.5% | 16.7% | 88.0% (88.1%) | 19.0% (20.4%) | ||||||||||
| Credit costs, return on assets, loan growth, and deposit growth figures are annualized for the nine months ended Dec. 31, 2023. *For HDFC Bank Ltd., data may not be comparable with historical figures due to merger with HDFC Ltd. on July 1, 2023. FY23—Fiscal year ending March 31, 2023. ^Excluding one-off exceptional items related to acquisition of Citibank’s India portfolio. NPL—Nonperforming ratio. NIM—Net interest margin. Source – Bank financial statements, S&P Global Ratings. | ||||||||||||||||||
Related Research
- Bulletin: ICICI Bank's Profitability Is Solid Despite AIF Provisioning And Margin Pressure, Jan. 22, 2024
- Bulletin: Indian Bank's Capital Raising Enhances Its Financial Resilience, Dec. 22, 2023
- Banking Industry Country Risk Assessment: India, Aug. 3, 2023
- New Regulatory Risk Weights Will Hit Indian Banks' Capital Adequacy By 60 Basis Points, Nov. 17, 2023
This report does not constitute a rating action.
| Primary Credit Analyst: | Nikita Anand, Singapore + 65 6216 1050; nikita.anand@spglobal.com |
| Secondary Contacts: | Deepali V Seth Chhabria, Mumbai + 912233424186; deepali.seth@spglobal.com |
| Geeta Chugh, Mumbai + 912233421910; geeta.chugh@spglobal.com |
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