After reaching peak, banking profitability to moderate on deposit challenge

With intense competition for deposits among Indian banks, the return on assets (ROAs) is expected to moderate from 1.1 per cent in FY23 to 0.8-1.0 per cent in 24-30 months, said a Mckinsey update on the banking sector.

Peeyush Dalmia, senior partner, banking practice in India, Mckinsey, said while banking ROAs have been healthy, multiple trends could exert downward pressure on profitability over three-five years.

The slower deposit growth, increasing proportion of credit-tested customers, fee income decline and rising operational expenses may impact ROAs.  

The structural re-allocation of savings away from deposit products may lead to muted growth in deposits. The high inflation combined with slow growth in deposits is expected to keep upward bias on rates.

According to Reserve Bank of India’s (RBI’s) analysis, the weighted average domestic term deposit rates (WADTDR) on fresh rupee deposits increased from 4.21 per cent in May 2022 to 6.34 per cent in June 2023.

Also, the gap between the growth rate for advances and deposits has been significant. While advances grew 20.2 per cent year-on-year (YoY), deposits grew by 13.2 per cent as on July 14, 2023, according to RBI data.  

Over the last decade, net interest margins (NIMs) have remained high. They rose to around 2.9 per cent in March 2022 from around 2.5 per cent in FY18.

This is on increased penetration of retail lending and a significant proportion of floating rate loans driving faster transmission of rate changes.

As a consequence, ROAs rose to touch around 1.1 per cent in March 2023 from - 0.1 per cent in FY18, according to an update on Mckinsey’s last report ‘Indian Banks: Building Resilient Leadership’ published in 2017.

Referring to growth opportunities, Dalmia said capital expenditure is growing.

The pace of corporate lending will accelerate to 10-12 per cent in the medium term from the current 7 per cent now. Public sector lenders would continue to play a key role in this space.

Near-term opportunities to drive value creation include expanding into under-penetrated rural and agriculture segments. They also include tapping into the fast-growing digital commerce, which has shown a 30-35 per cent compound annual growth rate (CAGR).

Building capabilities to serve the mass affluent customers (13-15 per cent CAGR), optimising, and driving holistic societal impact across national priorities would also open business opportunities, it said.

Mckinsey said optimising operating expenditure by building digital capabilities, future-proof operations across the tech stack, data and infrastructure is crucial for competitive edge.

Banks will need to hike technology spending from 5-7 per cent now to 9-10 per cent to provide thrust to digital and analytics, Mckinsey added.