PSBs' asset quality challenges to pull down FY23 banking outlook

Global rating agency Standard and Poor’s on Thursday said polarisation in the performance of Indian banks may persist in FY23 as many large public-sector banks are still saddled with weak assets, high credit costs, and poor earnings.

State Bank of India and leading private-sector banks have largely addressed their asset quality challenges, and their profitability is improving more sharply than the system's, S&P added.

Similarly, finance companies (fincos) in India are expected to show a mixed performance. The asset quality of these fincos is often weaker than that of major private-sector banks in the country.

The economic recovery in India was driving credit costs to cyclical low levels. Stronger balance sheets and higher demand should boost bank loan growth, but deposit growth would lag, the Rating agency said in a report, "Global Bank Country-By-Country 2023 Outlook: Greater Divergence Ahead."

Reserve Bank of India’s data showed a wide gap in the pace of credit offtake and deposit mobilisation. While the bank credit expanded at 17.9 per cent Year-on-Year (YOY) till late October 21, 2022 (6.8 per cent a year ago), deposits' growth was 9.5 per cent (9.9 per cent in October 2021)  

It said asset quality of the Indian banking sector will continue to improve. The banking sector's weak loans will decline 4.5-5 per cent of gross loans by March 31, 2024. Likewise, the credit costs are expected to normalise to 1.2 per cent for FY23 and stabilise at about 1.1-1.2 per cent for the next couple of years. This makes credit costs comparable to those of other emerging markets and to India's 15-year average.

Flagging sources of risk to credit profiles of banks, S&P said the small and mid-size enterprise sector and low-income households are vulnerable to rising interest rates and high inflation. But, in the base case scenario of moderate interest rate hikes, the risks from these sources are limited.

On the deposit and credit growth dynamics, the agency said that in the next few years, loan growth is expected to stay somewhat in line with the trajectory of nominal Gross Domestic Product (GDP), and loan growth to the retail sector would continue to exceed that of the corporate sector.

Corporate borrowing is also picking up momentum, but the uncertain environment may delay capital expenditure-related growth. A shift to bank funding from capital market funding is also driving a pickup in corporate loan growth.

Deposits may find it hard to keep pace, leading to a weakening in the credit-to-deposit ratio (C\D ratio). But the ratio has improved in the past few years. Banks' funding profiles to remain sound, supported by strong deposit franchises. The C\D ratio was at 74.92 per cent as of October 21, 2022 up from 70.30 per cent a year ago.