Bank credit growth is expected to touch a new high, surpassing the Rs 19 trillion in the current fiscal, ICRA said.

System level asset quality is also set to improve to near 4%, the domestic rating agency added.

ICRA upgraded its outlook on the banking sector to ‘positive’ from ‘stable’ on the expectation that there would be healthy loan growth through the next fiscal, along with benign asset quality pressures. This will drive net interest margins, which may, however, be compressed due to rising cost of deposits. If banks fail to adequately pass on this cost, then it could emerge as a key risk factor.

“Incremental credit growth in FY2023 is expected to remain at an all-time high of Rs 18-19 trillion in FY2023, which will be significantly higher than the previous high of Rs 11.4 trillion in FY2019. Further, the growth momentum is expected to remain strong in FY2024 as well, even though rising interest rates and tight liquidity conditions could moderate the growth," said Anil Gupta, senior vice president & co-group head, ICRA.

While the retail, MSME and agriculture have been the key segments for credit growth in the recent past, rising yields for overseas borrowings and in domestic capital markets have created a conducive demand environment for wholesale funding from banking channels. As of November 18, 2022, credit expansion was impressive at Rs 10.6 trillion, representing a decadal high YoY growth of 17.6%.

 The Indian banking sector may see incremental credit growth of 15.2–16.1% year-on-year in FY23, followed by 11–11.6% credit growth in FY24, according to ICRA.

 Deposits, on the other hand, are expected to grow by 8.5–9.1% and 7.3–7.8% year-on-year in FY23 and FY24, respectively, it said.

 The gross slippage (or fresh NPA) rate also stood at a decadal low of 2.2% in H1 FY2023 (lowest since FY2012) and given the granular nature of the fresh slippages, the recoveries/upgrades have been better, leading to lower net slippages as well as credit losses.

 With the relatively better health of the corporate sector, the asset quality outlook also remains strong. According to ICRA estimates, gross NPAs (non-performing assets) will decline to 3.9-4.3% by March 2024 while net bad loans will decline to 1.1-1.3%. Sale of NPAs under the asset reconstruction companies (ARCs), including NARCL, could further moderate these headline metrics, compared to our estimates.

“Notwithstanding the ongoing rise in deposit cost and expected moderation in the interest margins, we expect better credit growth and the benign credit cost environment to support the overall profitability of banks. We estimate the return on assets (RoA) and the return on equity (RoE) to improve to 1.2-1.3% and 16.1-16.8% respectively by FY2024 against 0.9-1.0% and 12.9-13.9% respectively for FY2023," ICRA said.

 “As of September 30, 2022, the Tier I capital for public and private banks stood at 12.1% and 16% respectively which was comfortable in relation to the regulatory requirements of 9.5%. Driven by expectations of healthy internal capital generation, we expect banks to be largely self-sufficient in capital requirements, despite a strong credit growth outlook," it added.

While the outlook on the sector is positive, ICRA continues to remain cautious on the impact of the rising interest rates and the inflationary or economic shocks on the asset quality.

 “Banks’ ability to adequately pass on rising costs of deposits and the extent of scale-up in discretionary expenditure to expand their customer franchise, will drive their operating profits. Lastly, we are also watchful of any impact on banks’ profitability following regulatory changes like implementation of IND-AS or the revision in salaries and pensions in public banks," Gupta said.