SFBs to face high NPAs and slow credit growth in the financial year 2025

The Small Finance Banks (SFBs) in India are expected to see an increase in Non-performing Assets in the financial year 2025, as per the information given by ICRA, a credit rating agency. The rating agency further stated that the asset (credit) growth will observe a weak growth. This weakening growth is expected to be around 18 to 20 percent compared to the 24 percent growth in the financial year 2025. Previously, it has experienced a thriving growth in the last two financial years.

Increase in Gross NPAs ratio
The Small finance banks’ gross non-performing assets ratio surged to 2.8 in the month of September compared to the previous ratio of 0.5 percent. The reason for this increasing indebtedness is problems in the microfinance sector. It has affected the asset quality of the SFBs badly. ICRA underlines that these SFBs will face issues while maintaining their asset (loan) quality.

The microfinance sector in India is facing a number of challenges such as increase in overdue loans, operational challenges, and regulatory issues. Most of the small finance banks are active in the microfinance segment only. The growing concerns in the microfinance segment is also considered as the reason for the slow growth in credit creation in the small finance banks.

Diversification of asset class
For many years, the small finance banks segment has been working on diversifying their various services offerings. Currently, these products consist of many retail asset (loan) types such as business loans, gold loans, and loans against property. housing loans, and auto loans. This increase in the secured asset class has led to a fall in share of unsecured loans in the total asset class of these banks.

ICRA’s head for the financial sector rating, Manushree Saggar stated that the matter of concern in the microfinance industry indicates that the possible growth drivers in the financial year 2026 will be secured asset classes as many SFBs are moving towards diversification of portfolios. The SFBs are taking measures towards reducing their dependency on unsecured asset classes.

Issues with CASA
A significant proportion of current and savings account deposits (CASA) in banks is important in terms of banks’ financial health as well as its ability to generate credit availability. Currently, the share of CASA of the small finance banks recorded 28 percent of growth by the month of September, 2024. Despite this, the growth in CASAs of SFBs is considerably smaller compared to the CASA proportion of universal banks.

The small finance banks in India face the issue of increasing the share of low-cost CASA. In the month of September 2024, the credit-deposit ratio of SFBs fell to around 89 percent compared to the credit-deposit ratio of 97 percent in the month of March 2023. This challenge is expected to carry on in the upcoming term as well.

The rating agency also anticipates that the small finance banks will face the issue of increasing competition in deposit levels. This will lead to a shift of small finance banks in the direction of term deposits, which have high interest rates. This shift will lead to a hike in funding expenses.

Other issues of SFBs
The small finance banks are suffering from the issue of rising operating expenses. The reasons for higher operational cost is expansion of branches, increase in staff costs, and also the increasing measures taken for tackling the NPA debtors. These issues are largely leading to hikes in operations expenses of these banks.

Adverse impact on Profitability
The hike in asset cost is anticipated to slow down the total profitability ratio of the small finance banks in the financial year 2025. At the industry level, the ratio of return on assets is expected to fall at a range of 1.4 percent to 1.6 percent in the financial year 2025 compared to the return on asset ratio of 2.1 percent in the financial year 2024. Overall, these challenges will impact the margins of small finance banks adversely.

The future prospects for the small finance banks highlights an adjustment period. It has to go through these challenges of credit creation, high NPA, and operational costs. At the same time, the SFBs has to find better growth opportunities through the process of increasing the proportion of secured assets and also diversification of its portfolio.

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