The profitability of small finance banks (SFBs) is anticipated to be negatively impacted in the fiscal year 2025 (FY25) by the growing cost of funds and increased credit expenses, particularly for microfinance loans because of increased delinquencies.
Their return on assets (RoA) could therefore drop from 2.1% in FY24 to 1.4% to 1.6% in FY25. ICRA, a rating agency, predicts that it would slightly increase to 1.6% to 1.8% in FY26.
According to Manushree Saggar, Sector Head-Financial Sector Ratings at ICRA, the SFBs' profitability will continue to be strained in the second half of FY25 (H2 FY25) as a result of their obligation to provide or write off past-due loans. This is done in order to maintain reported gross non-performing assets (NPAs) and net NPAs below the threshold amounts needed to apply for a universal bank license.
The industry reported better-than-expected asset quality indicators in FY23 and FY24 thanks to significant write-offs and a slow improvement in borrowers' cash flows that resulted in recoveries. However, this tendency was reversed in April-September 2024 (H1 FY25), as the headline asset quality metrics were impacted by stress in SFBs' microfinance loan books. During this time, the reported GNPA percentage rose by over 50 basis points. Gross non-performing assets (NPAs) decreased from 2.8% in FY23 to 2.3% in FY24.
According to ICRA, the margins of SFBs are anticipated to be compressed as the share of secured loans increases and the cost of financing stays high. Additionally, branch development, increased staff costs, and increased efforts to collect from past-due clients caused operating expenses to increase in FY24 relative to average assets.
The current fiscal year's expansion will be more calibrated, which will increase the efficiency of the operating ratios. However, higher credit charges will cause the total profitability in FY25 to moderate.
According to ICRA, the growth in SFB assets under management could slow to 18–20% in FY25, drop to 24% in FY24, and then increase to 22%–23% in FY26.
