Small finance banks growth to moderate in FY2025 amid industry headwinds: ICRA Report

Small finance banks (SFBs) have experienced robust growth in recent years, propelled by strong credit demand and an expanded range of financial products. However, this growth is expected to moderate in FY2025 due to industry challenges, particularly in the microfinance segment, according to a report by ICRA. The credit rating agency projects SFB growth to slow to 18-20% in FY2025 from 24% in FY2024, before rebounding to 20-23% in FY2026.

Diversified Offerings and Growth Outlook

Manushree Saggar, Senior Vice President and Sector Head – Financial Sector Ratings at ICRA, highlighted the diversification efforts of SFBs into secured asset classes such as vehicle loans, business loans, loan against property (LAP), gold loans, and housing finance. This shift has reduced the proportion of unsecured loans in their portfolios. “Considering the stress in the microfinance sector, a larger share of incremental business is expected to come from secured asset classes, which will likely drive growth in FY2026,” Saggar said.

Asset Quality and Rising Risks

After improvements in asset quality in FY2024, Small Finance Banks saw a reversal in H1 FY2025, with gross non-performing assets (GNPA) rising by 50 basis points to 2.8% as of September 2024. The increase was driven primarily by slippages in microfinance loans. ICRA warned that the stress in microfinance could spill over to other asset classes, keeping asset quality volatile in FY2025.

Funding and Margins

On the funding front, SFBs have gradually increased their current account and savings account (CASA) deposits, which accounted for about 28% of total deposits as of September 2024. However, this is still significantly lower than the levels seen in universal banks. The credit-deposit (CD) ratio has improved to 89% from 97% in March 2023, aligning more closely with private sector banks. The shift towards term deposits offering higher interest rates has also reduced CASA shares across most SFBs, a trend expected to persist in the near term.

ICRA noted that margins for SFBs are likely to face compression as the cost of funds remains elevated and the share of secured loans increases. Operating expenses have risen due to branch expansions, higher employee costs, and intensified recovery efforts. However, a more measured expansion approach in the current fiscal year may improve operational efficiency.

Profitability Under Pressure

Profitability is expected to decline in FY2025 as SFBs write off delinquent loans to maintain gross and net NPA levels within thresholds required for universal bank license applications. ICRA estimates that return on assets (RoA) for the industry will drop to 1.4-1.6% in FY2025, down from 2.1% in FY2024, with a slight recovery to 1.6-1.8% projected in FY2026.

Future Challenges and Prospects

As SFBs navigate these challenges, the shift to secured loans and efficiency-focused operations will be critical for sustaining growth. While FY2025 may see moderated growth and profitability, the sector’s adaptability and resilience could set the stage for a recovery in FY2026.

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