Small Finance Banks’ credit growth to slow in FY25; profitability to face challenges

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Small finance banks’ (SFBs) credit growth is expected to moderate in FY25 to 18-20 per cent from 24 per cent in FY24 in view of the industry-wide headwinds, specifically in the microfinance segment, according to ICRA. Further, higher credit costs will lead to a moderation in SFBs overall profitability in FY25.

The credit rating agency sees credit growth to pick up in FY26 to 20-23 per cent.

The agency noted that SFBs had witnessed strong growth momentum in FY23 and FY24, with expansion driven by buoyant credit demand and improved product offerings.

Manushree Saggar, Senior Vice President & Sector Head – Financial Sector Ratings, ICRA said: “The SFBs have been diversifying their product offerings over the years to include other retail asset classes such as vehicle loans, business loans, LAP (loan against property), gold loans and housing finance. This has led to reduction in the share of unsecured loans in their overall pie.

“Considering the stress seen in the microfinance sector, a larger share of incremental business shall come from secured asset classes, which would be the likely growth drivers in FY26.”

GNPAs to increase

ICRA assessed that after registering an improvement in the asset quality indicators in FY24, the trend reversed in H1 (April-September) FY25, with the SFBs reporting a 50-basis points increase in GNPA percentage to 2.8 per cent as of September 2024, driven by slippages, primarily in the microfinance loans.

ICRA believes that the stress in the microfinance loans and seasoning will weigh upon asset quality indicators of the SFBs in FY25. Elevated risk of the stress spillover to other asset classes would keep asset quality volatile, it added.

Funding

ICRA noted that from a funding perspective, the SFBs have been gradually increasing their share of current account and savings account (CASA) deposits over the years, and the same stood at around 28 per cent as of the end of September 2024, albeit significantly lower than universal banks.

SFB’s CD (credit-deposit) ratio stood at 89 per cent as of September 2024 (reduced from 97 per cent in March 2023), which is comparable to the private sector bank average. However, this is expected to reduce further.

“In line with the trend seen in universal banks, there has been a move towards term deposits offering higher interest, thus leading to a drop in the share of CASA deposits across most SFBs in H1 FY25. Increasing the share of these deposits will be a challenge for the SFBs. The trend is likely to continue over the near term,” the agency said.

Margin compression

ICRA projects that the SFBs’ margins will compress as the cost of funds remains elevated and the share of secured loans increases.

Operating expenses rose in FY24 in relation to average assets because of the branch expansion, higher employee expenses, and increasing efforts to recover from delinquent customers.

The agency said that with a more calibrated expansion in the current fiscal year, the operating ratios will benefit from higher efficiency.

Profitability to be under pressure

Saggar said SFBs profitability is expected to remain under pressure in H2 (October-March) FY25 as these entities would need to provide/write off delinquent loans to keep the reported GNPA/NNPA under the threshold levels required for universal bank licence application.

Accordingly, ICRA estimates the industry’s RoA (return on assets) will decline to 1.4-1.6 per cent in FY25 and improve marginally in FY26 to 1.6-1.8 per cent, compared to the 2.1 per cent reported in FY24.