Banking: Is Profitability At The Peak? CareEdge Analysis

CareEdge Research Report

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 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. 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 basis points which to a certain extent were passed on to the customers.

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-a-vis credit growth is increasing the cost of funding of banks thereby impacting the NIMs during Q3 FY24 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 Q3 FY24.

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, we expect the return on total asset to decline slightly during FY25.

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