Icra Reports Increase in SFB NPAs and Slowdown in Loan Growth to 18-20% for FY25

Small finance banks (SFBs) are expected to face an increase in delinquencies in the financial year 2025, according to a report by Icra. Asset growth is predicted to slow down to 18-20%, a decrease from the 24% growth seen in FY24. This slowdown is largely due to industry-wide issues in the microfinance sector, where many SFBs are involved.

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The gross non-performing assets (NPA) ratio for SFBs rose by 0.5% to reach 2.8% as of September. This increase was primarily driven by slippages in the microfinance institution (MFI) segment, leading to volatile asset quality. The agency highlighted that maintaining asset quality will remain a challenge for these banks.

Asset Diversification and Growth Drivers

Manushree Saggar, head of financial sector ratings at Icra, noted that SFBs have been diversifying their product offerings over the years. They now include various retail asset classes such as vehicle loans, business loans, loan against property (LAP), gold loans, and housing finance. As a result, the share of unsecured loans has decreased in their overall portfolio.

Given the stress in the microfinance sector, future growth is expected to come from secured asset classes. These are likely to be the main drivers of growth in FY26 as SFBs continue to diversify their portfolios and reduce reliance on unsecured loans.

Challenges with Deposits and Profitability

Increasing the proportion of low-cost current and savings account deposits remains a significant challenge for SFBs. This trend is anticipated to persist in the near term, affecting their ability to maintain profitability levels. The cost of funds remains high, which will compress margins as the share of secured loans increases.

SFBs are also facing higher operating expenses due to branch expansions, increased employee costs, and intensified efforts towards recovering from delinquent customers. These factors contribute to rising operational costs for these banks.

Impact on Profitability

Higher credit costs are expected to moderate overall profitability for SFBs in FY25. The return on assets at the industry level is projected to decline from 2.1% in FY24 to between 1.4% and 1.6% in FY25. This decline reflects the challenges faced by SFBs in managing costs and maintaining asset quality amidst a challenging economic environment.

The outlook for small finance banks indicates a period of adjustment as they navigate through these challenges while seeking new growth opportunities through diversification and secured lending.