Small Finance Banks' bottom-line to take hit on rising fund, credit costs

Manushree Saggar, Sector Head - Financial Sector Ratings, ICRA said the profitability for the SFBs to remain under pressure in H2 FY2025

The rising cost of funds and higher credit costs -- especially for microfinance loans due to higher delinquencies -- is likely to make a dent into the profitability of small finance banks (SFBs) in the financial year 2025 (FY25).

 

As a consequence, their return on assets (RoA) may decline to 1.4-1.6 per cent in FY25 from 2.1 per cent in FY24. However, it is likely to improve marginally to 1.6-1.8 per cent in FY26, according to rating agency ICRA.

 

Manushree Saggar, Sector Head-Financial Sector Ratings, ICRA said the profitability for the SFBs will remain under pressure in the second half of FY25 (H2 FY25) as these entities would need to provide/write off delinquent loans. This is to keep the reported gross non-performing assets (NPAs) and net NPAs under the threshold levels required for universal bank licence application.

 

The gradual improvement in borrowers’ cash flows, which led to recoveries, and sizeable write-offs helped the industry report better-than-envisaged asset quality indicators in FY23 and FY24. This trend was, however, reversed in April-September 2024 (H1 FY25) with stress in the microfinance loan books of SFBs impacting the headline asset quality indicators. The reported GNPA percentage increased by almost 50-bps during this period. The gross NPAs had declined to 2.3 per cent in FY24 from 2.8 per cent in FY23.

 

ICRA said the SFBs’ margins are expected to witness compression as the cost of funds remains elevated and the share of secured loans goes up. Also, the operating expenses, in relation to average assets, rose in FY24 due to the branch expansion, higher employee expenses and increasing efforts towards recoveries from delinquent customers.

 

With a more calibrated expansion in the current financial year, the operating ratios shall benefit from higher efficiency. Higher credit costs, however, shall lead to a moderation in the overall profitability in FY25.

 

ICRA said the growth in the assets under management of SFBs may moderate to 18-20 per cent in FY25, lower than 24 per cent in FY24 and may move up to 22-23 per cent in FY26.