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The deposit lag, coupled with the repricing of deposits and a liquidity deficit in the market, is likely to elevate the cost of funds in the near term exerting pressure on banks’ net interest margins, potentially leading to a moderation in overall profitability.

The credit-deposit ratios of the banks are likely to remain elevated due to a persistent shortfall in deposit growth compared to the pace of credit expansion, aligned with the overall positive growth outlook for the economy, according to a CareEdge report.

While the asset quality of banks is anticipated to remain largely stable, with no significant signs of stress evident, the asset quality within the newly originated retail portfolio warrants close monitoring.

The profitability squeeze

With the central bank removing the accommodative stance, there is a tightening of the money supply in the economy. The tightening of liquidity along with a lag in the deposit growth vis-à-vis credit growth is increasing the cost of funding of banks thereby impacting the NIMs during Q3FY24 and is likely to keep the margin under pressure over the next two to three quarters.

Additionally, banks have spent heavily on technology and branch expansion and have seen an increase in employee expenses, especially public sector banks due to the wage revision and pension liability which has led to an increase in the cost-to-income ratio of the overall private and public sector banks from 48.4% in FY20 to 50.6% in Q3FY24.

Thus, with the increasing cost of funds, elevated cost-to-income ratio and continued lag of deposit growth visa-vis the pace of credit expansion, CareEdge Ratings expects the ROTA to decline slightly during FY25.Following the RBI guidelines requiring higher risk weights on unsecured personal loans and higher-rated NBFCs, the growth rate in personal loans declined in Q3FY24 after growing sequentially by 13.3% in Q2FY24 to 7.2% in Q3FY24; however, it continues to grow at a decent pace.

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The golden period

Over the last two years, there has been a pick-up in economic growth and banks have witnessed credit growth at a Compound Annual Growth Rate (CAGR) of 18.2% from March 2022 to December 2023.

Banks had surplus liquidity generated through deposits at a relatively lower cost during the Covid period, which were utilised to fund the credit growth thus enabling banks to improve net interest margin (NIM). This, along with low credit costs, helped banks to report strong profitability during FY23.

RBI had increased interest rates from May 2022 to till date by 250 bps which to a certain extent were passed on to the customers.

The advances grew by 15.0% in FY23 and continued to grow at 19.9% (y-o-y) during 9MFY24. The growth was largely driven by personal loans followed by the services sector. Personal loans grew at the highest CAGR of 27.7% from March 2022 to December 2023 while the services sector has grown at a CAGR of 23.7% for the same period with NBFC and trade being the major contributors.

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  • Published On Apr 4, 2024 at 01:00 PM IST

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