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Credit rating agency ICRA has revised the banking sector outlook to Stable from Positive on the expectation of moderation in credit growth and profitability metrics, though the same would continue to remain healthy. It said while the compression in the interest margins over the last 18 months has been driven by rising deposit cost, the expectations of a rate cut in H2 FY2025 could lead to margin pressure, driven by a likely downward repricing of advances. Notwithstanding the margin compression, it said the growth in loan book shall translate into steady operating profits, aided by benign credit costs. ICRA expects this to drive healthy earnings, that will largely be sufficient for most banks to meet their regulatory as well as growth capital requirements.

According to the report, the credit to deposit ratio (CD ratio) for the banks is estimated to have increased to 78% (excluding the merger of HDFC) as on March 22, 2024, the highest since December 21, 2018 (77.9%) and much higher compared to 75.7% as on March 24, 2023, and 71.9% as on March 25, 2022. This will pose significant challenges for the banks to pursue credit growth as their on-balance sheet liquidity has been deployed towards strong credit growth during the last two years. The CD ratio is likely to remain elevated at 77-78% (excluding HDFC merger) and over 80% (including HDFC merger) at the sector level in FY2025, even though some of the private banks may see a decline, while some of the public banks may see an increase in their CD ratio.

Rating agency expects the headline asset quality metrics of the banking sector to remain on an improving trajectory. Gross and net additions to non-performing advances (NPAs) are likely to increase amid seasoning of recently originated book and slower recoveries and upgrades as low hanging resolutions and recoveries are largely completed. However, continued growth in the loan book would lead to an improvement in the headline asset quality metrics. ICRA expects the gross NPAs (GNPAs) and net NPAs (NNPAs) to decline to 2.1-2.3% and 0.5-0.6%, respectively, by March 2025 from 3.0% and 0.7%, respectively, estimated for March 31, 2024, which would remain the best in more than a decade. Notwithstanding this, ICRA remains cautious about the impact of macro-economic shocks such as slowdown in credit growth, and high interest rates locally as well as in developed markets on the asset quality, if these were to materialise.