Credit Growth Expected to Slow as Provision Costs Rise

Recently, the credit rating agency ICRA, an affiliate of Moody’s Investor Services slashed credit growth rate outlook for the Indian banking sector. The newer revised outlook for credit growth predicts that the loan growth would witness a slight slowdown to 10.5% to 11% for the fiscal year ending March, 2025. The revision is a reduction from the previous forecast of 11.6% to 12.5%. Primarily, the cause behind this alteration includes a sharp decrease in the lending segment in particular sections such as unsecured retail borrowers and NBFCs. When it comes to NBFCs, the credit growth decelerated to 7.8% year-on-year when compared to 19% for the previous year. RBI in November, 2023, increased risk weights on bank credit to NBFCs, prompting these institutions to diversify the source of their funding. Therefore, as these specific segments carry higher yielding returns but at the same time carry even higher risks, banks have become increasingly cautious when it comes to their lending practices.

Lending or credit growth by Indian banks slowed for the fifth consecutive month in November, up 11.8% year-on-year from 16.5% in November 2023. Including the impact of the HDFC Bank merger, credit growth stood at 10.6% compared to around 21% for the previous year. This moderation in credit growth follows the actions of the Reserve Bank of India to curb excessive lending on unsecured loans. Credit growth had also slowed in the previous months (October, July, August and September). Despite this slowdown, banks continue to report double-digit growth, supported by high retail demand and urban infrastructure. Furthermore, banks are now focused on improving their already high credit-to-deposit (CD) ratio. ICRA has stated that the loan growth will further decrease to 9.7% to 10.3% in the fiscal year ending March, 2026. This reduction would be a result of trimming CD ratios by the banks and the alteration in the implementation of changes in the liquidity coverage ratio framework which would kick in next fiscal fiscal year.

Bank margins would take a hit with consistently higher interest rates and a gradual slowdown in credit growth, said Sachin Sachdev from ICRA. As the primary source of bank margins are through disbursing of personal loan and other unsecured loan products, a significant reduction in the volume of such loans would definitely impact overall profitability of the bank. Further if the interest rates continue to decline in the future, banks could suffer with stagnant profit figures as the range between the lending and borrowing rate would grow narrower.

ICRA further stated that bank margins would be impacted by rate cuts which accelerate yield transmission. On the other hand, banks’ return on asset (RoA) is expected to stay in good health lying in the range of 1.1% to 1.2% for FY2026 and 1.2% to 1.3% for FY2025 when compared with 1.3% for FY2024. Additionally, with slower credit growth, banks would witness enhancement in loss absorption capacity with bolstering growth needs. Thus, banks would lend less aggressively and improve their reverses and manage high risks associated with high risk lending segments.

Banks’ balance sheets would be further stretched by the impact of the implementation of expected credit loss (ECL) framework and increased provision for medium term project financing. The ECL framework would require banks to set aside provisions for bad loans way earlier than they currently do. This would significantly improve transparency and risk management but at the same time increases financial burden on banks for short-term. Additionally, banks would be required to set aside higher provisions for project finance, particularly in infrastructure and large-scale projects. As a result, these provisions put pressure on banks’ financial resources, affecting the overall profitability including bank margins.

To handle and offset these challenges in the banking space, Indian banks are turning to the bond market to raise funds. Sachdev further elaborated that due to difficulties in attracting deposits, banks are now shifting strategies for fundraising and are expected to issue bonds at an increasing rate in the near future. Sighting this, banks are expected to surpass their previous high and could touch Rs. 1.3 trillion for FY2025 when compared to Rs. 1.02 trillion for FY2024.

Coming to the retail space, with the increasing stress, the fresh slippages by banks are on the rise while recovering are expected to slow down. The gross fresh NPA generation by banks is expected to increase slightly to 1.6% in FY2025 from 1.5% in FY2024 which still remains way lower than previous years. Eyeing this situation, gross NPAs would rise and correlatively GNPA ratio would also rise in FY2026.

Lastly, ICRA emphasized that although NPA generation rate is set to pick up, credit costs would likely only rise slightly due to lower legacy net NPAs. To improve banks’ bottomline, with higher current provision coverage ratio (PCR), banks would have more room to lower incremental provisions. Coming to numbers, credit expenses account for upto 21% to 23% of the operating profit of the banking sector in FY2025 and 27% to 30% in FY2026

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