For Small Finance Banks, RoA To Dip 40 Bps This Fiscal

The profitability of small finance banks (SFBs), measured in terms of return of assets (RoA), will moderate around 40 basis points (bps) to 1.7 per cent this fiscal from 2.1 per cent for fiscal 2024 due to lower net interest margins (NIM) and higher credit costs, according to the Crisil Ratings.

That said, RoA for SFBs will still be higher than that for the overall banking system by 50-60 bps on account of the relatively higher-yielding nature of their loan book. The agency stated that the NIM for SFBs is expected to contract 15 bps as they continue diversifying to secured asset classes, which have relatively lower yields.

Credit cost, meanwhile, may rise 40 bps because of rising delinquencies, primarily in the microfinance and other unsecured segments. An uptick in delinquencies, albeit more controlled, is also likely in sub-segments of secured asset classes catering to a similar customer segment.

Notably, SFBs have been focusing on segmental diversification as a core growth strategy. With many having started out as microfinance lenders, the diversification has largely been towards secured asset classes (primarily loans against property, housing loans and vehicle loans), to curtail potential volatility in asset quality and earnings.

Subha Sri Narayanan, Director, Crisil Ratings said, “The share of secured asset classes, which come at a lower yield of 6 to 7 percentage points on average, is set to rise to almost 65 per cent of overall SFB advances by end of fiscal 2025 from 62 per cent in March 2024."

Narayanan added that while deposit costs will remain structurally higher than universal banks, diversification into alternate funding avenues should support stability in funding costs. "All said NIMs are likely to compress 15 bps to 7.2 per cent for the fiscal," said Narayanan.

With operating expenses estimated to remain flat, this would translate into a reduction in pre-provisioning operating profitability to 3.5 per cent in fiscal 2025 from 3.6 per cent last fiscal. The overall profitability will continue to be significantly influenced by credit costs. Given the relatively vulnerable customer segment catered to by SFBs, periods of economic stress tend to result in higher delinquencies and credit costs, as seen most recently during the pandemic.

In fiscal 2025, microfinance loans and unsecured personal loans, where early signs of stress are visible on account of a rise in borrower indebtedness, will see a moderation in portfolio quality. Sub-segments within secured asset classes, catering in part to a similar customer segment, could also see higher delinquencies.

Vani Ojasvi, Associate Director, Crisil Ratings stated, “The gross NPA of SFBs is expected to move up to 2.9 per cent by the end of fiscal 2025 from 2.3 per cent as on 31 March 2024. As a result, credit cost is set to rise ~40 bps to 1.4 per cent. The impact of the expected delinquency trends will not be uniform, though. The extent of the rise in gross NPAs and credit costs across SFBs will vary based on the extent of their exposure to the vulnerable segments.”

As witnessed in the aftermath of the pandemic, SFBs with a more diverse and secured portfolio will be more resilient. Ultimately, as organic transition to newer asset classes continues, the ability of SFBs to maintain sound asset quality and profitably scale up the newer portfolio will bear watching over the long term, Crisil added.