Indian banks expected to maintain profitability amid margin pressure: Fitch Ratings

New Delhi [India], March 27 : Fitch Ratings has projected that Indian banks will sustain their profitability despite facing margin pressure in the medium term.
According to Fitch, while net interest margins (NIMs) are anticipated to narrow by 10 to 20 basis points over the next two years from the current cyclical peak of 3.6 per cent in the nine months of the financial year ending March 2024 (9MFY24), the sector's earnings resilience will persist.
The narrowing of NIMs is primarily attributed to increasing funding costs, driven by intensified competition for deposits amidst normalizing liquidity conditions and robust loan growth.
Fitch underscores that despite the banking sector's heavy reliance on net interest income, which contributed 75 per cent of total operating income in 9MFY24, profitability is expected to remain intact.
The credit rating agency highlights that there is potential for banks to mitigate the impact of margin compression through cost control measures and enhanced efficiency derived from digitalization initiatives.
Furthermore, Fitch anticipates a further decline in impaired-loan ratios across most banks, which could contribute to lowering operating and credit costs.
However, Fitch warns that the aggressive funding of higher risk-weighted loans, such as consumer credit and loans to non-bank financial institutions, could limit additional improvement in operating profit/risk-weighted assets (OP/RWAs).
To counter margin pressure, Indian banks are expected to redirect investments in government securities towards loan growth, thereby balancing growth objectives with margin considerations.
This shift is evident in the rising proportion of loans in the banking sector's assets, reaching approximately 63 per cent in 9MFY24 from 56 per cent in FY22.
While the transition from investments to loans aids in offsetting margin pressure, it also escalates risk density within banks' portfolios.
Nevertheless, Fitch reassures that banks have adequate headroom, as reflected in liquidity-coverage ratios remaining well above regulatory requirements.
Fitch acknowledges the necessity for banks to strike a balance between growth and margins, as evidenced by a moderated rise in loan-to-deposit ratios (LDRs) in 9MFY24 compared to the previous fiscal year.
The agency predicts a persistent gap between loan and deposit growth, favouring banks with a higher share of low-cost deposits.
Despite a decline in the share of low-cost deposits in the banking system, Fitch asserts that funding remains stable, supported by the predominance of local-currency deposits and the central bank's flexible liquidity management approach.
Customer deposits continue to constitute a significant portion of non-equity funding for Fitch-rated banks.
Fitch maintains a positive outlook on the earnings and profitability scores of most Indian banks, signalling an upward trajectory in profitability that could influence viability ratings in the future, contingent upon sustained improvements across key rating parameters.