Banking year-ender: What’s in store for Indian banks in 2023?

Bank FDs

Indian banks, which saw an improvement in asset quality and recovery in credit growth in 2022, could face some headwinds in the new year, largely due to tight liquidity and rising interest rates, say experts. The year 2022 was largely a good one for banks, with steady improvement in asset quality, following a large-scale clean-up of stressed assets by the Reserve Bank of India (RBI) initiated in 2015.

The gross non-performing assets (GNPA) ratio of public and private banks dropped to a six-year low of 5.9 percent in March 2022, while net NPA eased to 1.7 percent. Public sector banks, which accounted for the largest chunk of bad loans, saw their GNPA ratio easing substantially from 14.6 percent to 7.4 percent between March 2018 and March 2022 and net NPA declining to 2 percent from 8 percent during the same period.

Besides, a massive loan write-off helped banks to take the burden off their books. Banks wrote off around Rs 10 lakh crore in the last five fiscal years, which helped to show cleaner balance sheets.

“With the reduction in scheduled commercial bank GNPAs to 5.9 percent as of March 2022 and as per RBI’s baseline projections, GNPA is expected to reduce to 5.3 percent as of March 2023,” Gaura Sen Gupta, Economist with IDFC First Bank, said.

Sakshi Gupta, Economist with HDFC Bank, emphasised on how government schemes like the Emergency Credit Line Guarantee Scheme (ECLGS) will continue to aid the Micro, Small and Medium Enterprises (MSME) sector to protect their asset quality.

What’s in store in 2023?

The outlook for 2023 for the banking sector is largely positive, with room for easing rates and continuing the growth cycle for banks’ credit growth and asset quality, experts said.

“After a regressive repo rate hike cycle by RBI, I expect RBI to not be aggressive in rate hike in 2023 other than a soft hike of 25 basis points (bps) after which RBI would take a longish pause,” Siddhartha Sanyal, Chief Economist with Bandhan Bank, said. Experts also expect the sector to see some supporting growth from other sectors.

“I expect credit growth to hold up, supported by urban growth with household leverage remaining moderate and company balance sheets in good shape,” Sen Gupta highlighted.

But challenges persist…

But, going ahead, rising interest rates could limit the ability of small borrowers — both companies and individuals — to repay their loans on time, feel experts.

"Expecting a softer stance by RBI towards interest rates will give borrowers hope to borrow more. Hence, this would result in stronger repayment than we have now," Sanyal said.

RBI hiked the key repo rate by over two percentage points since May to fight inflation. This could eventually impact the ability of small borrowers to pay back loans on time, particularly if economic recovery gets delayed, experts said.

Sanyal explained: "RBI will get harsh in controlling inflation, but at the same time it would encourage economic activity which will uplift borrowers to repay, if not in time but with a slight delay."

Secondly, a tightening liquidity condition too may impact banks, especially if the demand for credit picks up pace, said analysts. Over the last few months, the banking system has been witnessing tight liquidity, prompting the central bank to infuse liquidity into the system.

According to Sanyal, RBI may offer some sort of liquidity in the market, at least in the initial months to function smoothly after which it will take a softer and supporting stance on liquidity.

Joydeep Dutta Roy, Executive Director, Bank of Baroda said: "Assuming that we have one more rate hike and then a pause, the challenge is to garner deposits at a time when financial savings of households and those of corporates have ebbed. This is something which has helped in compressing surplus liquidity but banks have witnessed challenges as credit growth has been swift."

Interest rates to go up again?

Clearly, the interest rate hikes aren’t over yet, said economists. Gupta said that the RBI is likely to hike the repo rate to between 6.5 and 6.75 percent soon, and then stay on pause through 2023.

“During the end of 2022, we could see the currency (rupee) being a little range-bound, but post that, the pressure around it could ease with the RBI,” Sanyal explained.

Gupta said, adding overall pressure on the central bank to raise rates would be significantly less once inflation eases.

On December 7, RBI’s monetary policy committee (MPC) hiked the key repo rate by 35 bps to 6.25 percent in its continued effort to fight inflation. RBI has increased the repo rate, or short-term lending rate, by 225 bps since May.

On December 21, RBI Governor Shaktikanta Das said there is a very coordinated approach between the Union government and the central bank to fight inflation. "I must say that to check inflation, there has been a very coordinated approach between the central bank and the central government," Das said speaking at an event in Mumbai.

Inflation worries are clearly far from over. In November, the headline retail inflation declined to an 11-month low of 5.88 percent from 6.77 percent in the previous month, while core inflation continued to remain high at over 6 percent, data from the RBI showed.

Sen Gupta highlighted two major headwinds that will affect the overall inflation and gross domestic product (GDP) growth in 2023.

“Growth in FY24 will be facing two headwinds – slower global growth, which is likely to weaken export growth, and increased transmission of past rate hikes, as liquidity conditions tighten,” Sen Gupta said.

According to Gupta, the long end of the bond yield curve could see some moderation as inflation eases and markets price in lower growth, and likely turning into global tightening cycles by the end of 2023.

"We do see inflation plateauing probably in 2023-24, unemployment gradually coming down and interest rates getting steady. We could work on the assumption of the RBI looking at real repo rate of at least 75-100 bps once things stabilize," said Roy said.

On the other side, there are fears of a COVID resurgence related to the new Omicron sub-variant BF.7.

“While there is an optimistic environment for further growth in 2023, there has to be a word of caution, too. We will have to plan out things and keep a check on global economic turnouts due to the scare presented by the new Omicron variant,” Sanyal said.