Banking and finance: Lenders healthier, credit tap opens wider

Credit flow in the Indian economy is on a steady improvement as the outlook for banks as well as non-banking financial companies (NBFCs) brightens. This is good augury for India, considering a healthy financial sector — especially credit markets — is an important enabler for the economy to grow at a reasonable clip

Credit flow in the Indian economy is on a steady improvement, as the outlook for banks as well as non-banking financial companies (NBFCs) brightens. Not only are balance sheets of lenders looking better compared with the past few fiscals, but also the credit growth is expected to spurt even as asset quality remains stable.

This is a good augury for India, considering a healthy financial sector — especially credit markets, which is an important enabler for the economy to grow at a reasonable clip.

Banks seeing improvement in the key performance metrics

The Indian banking sector is at an inflection point, slowly overcoming vulnerabilities and making a comeback after a period of sharp increase in the gross non-performing assets (GNPAs), fall in profits, and subdued credit growth.

Credit growth for the banking sector is expected to increase to about 15% this fiscal, from the previous 12%. However, growth in deposits has lagged in recent months, and with the surplus liquidity situation now normalising, the bank’s ability to garner deposits for meeting credit demand will remain a key monitorable. From a segmental perspective, growth in corporate credit, which constitutes ~45% of total bank credit, is expected to pick up on the back of higher demand from the infrastructure sector, additional working capital requirement, and shift from the bond markets given the sharper interest rate hikes.

The upside of private capex on credit growth remains to be seen. From an asset quality perspective, the GNPA of banks is expected to improve 90 bps (basis points) on-year to ~5% this fiscal, riding on the post-pandemic economic recovery and higher credit growth. The biggest improvement will be in the corporate segment, where GNPA is expected to fall below 2% next fiscal (from a peak of ~16% as on March 31, 2018). This is a result of significant clean-up by banks in recent years and strengthened risk management and underwriting.

The improvement in asset quality and the already high provisioning cover ratio of 73% as on March 31, 2022, should help reduce credit cost, thereby supporting profitability.

Despite lower treasury profit, the rising interest rate regime is likely to improve return on assets to ~1.0% in fiscal 2023 from 0.9% the previous fiscal, which will help increase margins and lower credit cost. Even from a capitalisation perspective, the banking sector has improved and has adequate buffers. It is, therefore, well placed to support economic growth over the medium term. Overall, the banking sector is on a relatively stronger footing today. However, to avoid a repeat of past asset quality challenges, it is important that banks do not relax their credit underwriting standards, while focusing on higher growth.

NBFCs to see a 4-year-high growth in AUM

Non-banks – comprising NBFCs and housing finance companies (HFCs), excluding government-owned NBFCs – are expected to see their AUM grow 11-12% in fiscal 2023 after three years of single-digit growth. This growth is expected to be relatively broad-based, across the retail segments. However, the overall growth will be lower than the pre-pandemic level, because of the intense competition from banks and the rising interest rate scenario, which will lead non-banks to focus on segments with higher yield. Home loans and vehicle finance, which have the largest share in the AUM pie of non-banks, are expected to grow in double-digits this fiscal, thereby supporting the entire sector.

The digital lending norms announced in August, 2022 will impact the way NBFCs operate in an online space. The guidelines aim to usher in orderly growth and financial stability, check malpractices, strengthen transparency and protect customer interests. The GNPA levels for NBFCs and HFCs were impacted following the Reserve Bank of India’s clarification on Prudential Norms on Income Recognition, Asset Classification, and Provisioning regarding NPA recognition norms, as announced in November, 2021.

Subsequently, there was a deferment in implementation of the upgrade criteria to September 30, 2022, providing reasonable transition time for non-banks to recalibrate their processes, revamp collection infrastructure and teams, and persuade borrowers to align with the new dispensation. GNPAs for NBFCs and HFCs are expected to be ~3%, as on March 31, 2023, as against 3.5% as on March 31, 2022.

A key monitorable for the profitability of non-banks this fiscal is the rising interest rate environment. We expect borrowing cost for non-banks to rise 85-105 bps this fiscal. The profitability metrics for non-banks are contingent upon not just rising rates but also ability to pass on the increase in rates. We expect non-bank profitability to be steady this fiscal due to an interplay of these two factors, in the backdrop of lower credit costs.

There could be a reduction in interest spreads as non-banks may not be able to pass on the entire increase in borrowing costs to their customers. However, this impact will be offset by lower incremental credit cost on account of the substantial provisioning buffers built over the past two fiscal. That said, geopolitical issues, sharper-than-expected increase in interest rates, and inflation will bear watching.

Author: Krishnan Sitaraman, Senior Director and Deputy Chief Ratings Officer, CRISIL Ratings

Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of the Economic Times – ET Edge Insights, its management, or its members

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