Banking Central| Slower loan growth, rising stress: What do bank earnings tell us about state of economy?

Banks may report poor numbers in the third quarter

Earnings numbers reported so far by some banks, such as Axis Bank, for the third quarter of FY25 clearly suggest that the banking sector, often a bellwether for the economy, is bracing for a subdued third quarter as slower credit growth, higher provisioning, and rising funding costs weigh on profitability. Analysts largely expect muted earnings for banks in the October-December period, driven by several headwinds.

Axis Bank's gross non-performing asset (GNPA) ratio, a key gauge of lenders' asset quality, was at 1.46 percent at December-end, compared to 1.44 percent three months earlier. Axis Bank's loans grew 9 percent year on year (YoY) in the three months to December-end, slower than the 11 percent rise in the previous quarter.

Its total deposits also grew by 9 percent. Net interest margin (NIM), a key gauge of profitability, narrowed to 3.93 percent from 4.01 percent a year earlier, and 3.99 percent in the previous quarter.

RBL Bank, too, reported poor numbers. Its GNPA ratio was 2.92 percent, as on December 31, 2024, compared to 2.88 percent as on September 30, 2024, and 3.12 percent on December 31, 2023.

Other private sector banks (PVBs), too, are expected to face slower credit growth, margin compression, elevated operating expenses, and increased loan-loss provisioning, according to Emkay Global.

Public sector banks (PSBs) are going to be no different either. They are likely to see earnings moderation, impacted by lower treasury gains stemming from a resurgence in government security (G-Sec) yields, reduced recovery of NPAs, and softer margins.

Margins under pressure

Elara Capital highlights three factors that will impact NIMs: repricing pressures from the deposit book, rising incremental deposit costs, and interest income reversals from higher slippages. Additionally, penal interest charges on select accounts are expected to contribute to margin softness.

The strain on deposit mobilisation, as seen by the persistent rise in deposit rates, is likely to sustain funding cost challenges in the near term. Large banks, such as Axis Bank, IndusInd Bank, and Canara Bank, raised rates in the 1-3 year bucket in December, with the impact expected to manifest in the coming months.

Emkay Global predicts a 5-25 basis points (bps) contraction in NIMs for the quarter. Slower advances growth, absence of treasury gains (notably for PSBs), and sustained cost pressures are expected to moderate net interest income (NII).

Despite the Reserve Bank of India’s (RBI) recent 50 bps cut in cash reserve ratio (CRR) to address systemic liquidity, banks have refrained from cutting deposit rates, aiming to sustain deposit momentum.

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Liquidity tightness persists

To ease liquidity constraints, the RBI initiated daily Variable Rate Repo (VRR) auctions, starting with Rs 50,000 crore on January 16. The move comes amidst a liquidity deficit of approximately Rs 2 lakh crore, driven by the RBI’s interventions in the forex market to manage rupee depreciation.

Though the CRR cut infused Rs 1.16 lakh crore in liquidity in December, it was insufficient to offset heavy outflows from advance tax and goods and services tax (GST) payments, totalling over Rs 3 lakh crore. As a result, the banking system currently faces a deficit of Rs 2.1 lakh crore.

Slower credit growth

Quarterly business updates from major banks suggest muted credit growth during the quarter. HDFC Bank reported a mere 3 percent YoY growth in loans, with advances rising less than 1 percent on QoQ basis. Deposit growth, however, outpaced credit growth, rising 2.5 percent QoQ and 15.8 percent YoY. The bank’s credit-deposit ratio dropped to 99.18 percent, down from 100.76 percent in Q2.

Union Bank of India reported  a modest deposit growth of 4 percent YoY in Q3, while advances grew by 6 percent. Bandhan Bank also showed muted growth, with collection efficiency slipping and advances rising by just 2 percent QoQ . Similarly, Ujjivan Small Finance Bank’s deposits grew by 16 percent YoY , while loans increased by only 10 percent.

Strategic or cyclical?

The slowdown in credit growth raises questions about its cause. One possibility is that banks are deliberately tempering credit expansion to lower their credit-deposit (CD) ratios, which the RBI has advised against due to associated risks. A high CD ratio could indicate over-leveraging and potential difficulties in meeting obligations.

Alternatively, the slowdown may reflect reduced credit demand in specific segments. Data from the previous year reveals significant declines in credit growth for personal and service loans, suggesting that economic activity in these areas may be slowing.

The full impact on banking sector earnings will become clearer when final numbers are announced. Investors will closely watch whether these trends are temporary or indicative of  a deeper structural challenges in the sector.

(Banking Central is a weekly column that keeps a close watch on and connects the dots regarding the sector's most important events for readers.)