Small Finance Banks' growth to slow to 18-20% in FY2025; profitability under pressure: ICRA

The growth of Small Finance Banks (SFBs) is likely to moderate to 18-20% in FY2025 from 24% in FY2024, according to credit rating agency ICRA.

The agency attributed the deceleration to sector-wide headwinds, particularly in the microfinance segment.

However, the growth is projected to pick up to 20-23% in FY2026.

The growth trajectory of SFBs in FY2023 and FY2024 was fuelled by strong credit demand and diversification into secured lending products such as vehicle loans, gold loans, and housing finance.

“Considering the stress seen in the microfinance sector, a larger share of incremental business shall come from secured asset classes, which would be the likely growth drivers in FY2026,” said Manushree Saggar, Senior Vice President & Sector Head – Financial Sector Ratings, ICRA.

Despite an improvement in asset quality in FY2024, SFBs experienced a reversal in H1 FY2025 as gross non-performing assets (GNPAs) increased by 50 basis points to 2.8% as of September 2024. The increase was driven by slippages, particularly in microfinance loans, which are under stress. ICRA projects GNPAs to remain elevated in the range of 2.6-2.8% by the end of FY2025.

"Elevated risk of the stress spillover to other asset classes would keep asset quality volatile," the agency said.

Profitability metrics for SFBs are expected to decline in the near term due to higher credit costs and elevated funding expenses. ICRA projects the return on assets (RoA) to decrease to 1.4-1.6% in FY2025, compared to 2.1% in FY2024. However, it is expected to improve slightly to 1.6-1.8% in FY2026.

SFBs have been gradually boosting their current account and savings account (CASA) deposits, which stood at around 28% as of September 2024, but much lower than those of universal banks.

"The CD ratio stood at ~89% as of September 2024 (reduced from 97% in March 2023), which at present is comparable to the private sector bank average; it, however, is expected to reduce further," the report said.

Operating expenses have also weighed on profitability, driven by branch expansions and efforts to recover loans.

“ICRA expects profitability for the SFBs to remain under pressure in H2 FY2025 as these entities would need to provide/write off delinquent loans to keep the reported GNPA/NNPA under the threshold levels required for universal bank licence application,” Saggar added.