Synopsis: Small finance banks' RoA is expected to fall to 1.7% in FY25, down from 2.1% in the previous year. The reduction is due to shrinking net interest margins and higher credit costs, particularly in the microfinance and unsecured segments.
The profitability of small finance banks (SFBs) is projected to decline in FY25, with their return on assets (RoA) expected to drop to 1.7% from 2.1% in the previous financial year.
This decrease is attributed to narrowing net interest margins (NIM) and rising credit costs, as per a recent report by Crisil.
Despite the decline, SFBs are expected to continue outperforming the broader banking sector, owing to the higher-yielding nature of their loan portfolios.
Profitability Pressures:
The report highlights that small finance banks will see a 40 basis point reduction in their RoA in FY25.
This decline is primarily driven by a 15 basis point contraction in net interest margins.
As these banks diversify into secured asset classes such as loans against property, housing loans, and vehicle loans, they are dealing with lower yields on these secured loans, which is contributing to the overall compression of margins.
Additionally, rising delinquencies in the microfinance and unsecured lending segments are expected to push credit costs up by around 40 basis points.
The report also points to potential increases in delinquencies in sub-segments of secured asset classes that cater to the same customer base, though these are anticipated to be more controlled.
Maintaining a Competitive Edge:
Despite the expected dip in profitability, small finance banks are expected to maintain an advantage over the broader banking system.
Their RoA will still exceed the overall banking sector’s by 50-60 basis points due to their higher-yielding loan books, which include segments like microfinance that offer better returns than traditional secured loans.
In response to these challenges, small finance banks are focusing on diversification strategies to strengthen their long-term growth prospects.
Initially founded as microfinance lenders, many of these institutions have expanded into more secured asset classes.
This shift is intended to mitigate potential risks to asset quality and earnings, especially during periods of economic volatility.
Regulatory and Risk Management Focus:
Recently, Reserve Bank of India (RBI) Deputy Governor Swaminathan J urged small finance banks to be vigilant and manage risks effectively.
He emphasized the need for sustainable business models and highlighted the importance of strengthening cybersecurity measures to protect against digital threats.
The report underscores these points, emphasizing that as SFBs continue to grow and diversify, risk management and cybersecurity will remain critical to their stability.
In conclusion, the upcoming fiscal year poses profitability challenges for small finance banks, with shrinking margins and higher credit costs expected to weigh on their performance.
However, through prudent diversification and maintaining a focus on higher-yielding loans, SFBs are likely to continue outperforming the broader banking sector in profitability.
To navigate these challenges effectively, a strong focus on risk management, as emphasized by regulatory authorities, will be essential.
Investors should keep a close watch on these developments, particularly in the microfinance and unsecured segments, which are key drivers of profitability trends.
Disclaimer: This article is for informational purposes only and should not be taken as investment advice. Please consult a certified financial advisor before making any investment decisions.
