Regulatory measures and tighter funding conditions could result in a slowdown in credit growth: ICRA

The slew of regulatory measures and tighter funding conditions in the domestic markets could result in a steady slowdown in credit growth, especially in the unsecured retail and microfinance segments, for lenders -- banks and non-bank financial companies (NBFCs), posing a risk to their asset quality, according to ICRA.

The credit rating agency estimated the incremental bank credit growth to slow down to ₹ 19.0-20.5 lakh crore (includes the impact of merger of HDFC and HDFC Bank) in FY2025, which will translate into a year-on-year (y-o-y) growth of around 12 per cent, compared to ₹22.3 lakh crore (excludes the impact of merger of HDFC and HDFC Bank) in FY2024 (y-o-y growth of 16.3 per cent).

For the NBFCs (including housing finance companies), the growth in assets under management (AUMs) is expected to slow down sharply to 16-18 per cent in FY2025 from 25 per cent in FY2024, per the agency’s assessment.

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ICRA officials opined that the recent regulatory actions on certain entities are expected to push others to adjust their business practices and models, which will also have a bearing on near-term growth.

Slowdown in credit to retail segment

ICRA noted that the share of the retail segment and the NBFCs in the incremental credit flow of banks declined to 42.9 per cent in 12 months ending August 2024 from 48.9 per cent for the corresponding period of the previous year, driven by slower flow of credit to the NBFCs.

The agency opined that as a sizeable portion of bank credit flow to the NBFCs is towards on-lending to the retail segments, overall credit to the retail segment may slow down in the next 12-18 months.

While ICRA believes that the demand for retail credit remains strong, the regulatory nudge to prevent overheating in certain segments in the retail space is the key factor driving slower growth.

“The latter shall moderate the NBFC sector’s funding requirement as well, which shall ensure adequate funding available to the players in the space. However, NBFC’s cost of funds is expected to remain elevated, considering the high dependence on bank credit,” the agency said.

Delayed transmission

Anil Gupta, Senior Vice President & Co-Group Head – Financial Sector Ratings, ICRA, observed that the regulatory measures to slow down bank credit growth will be crucial for banks to cut their deposit rates, once the rate cut cycle starts.

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“This will especially be important for maintaining the margins, as the cut in policy rates expected in H1 Calendra Year (CY) 2025 will exert a downward pressure on lending rates.

“However, the proposed changes in guidelines for liquidity coverage ratio could mean that the immediate cut in deposit rates may not be very substantial, resulting in delayed transmission,” he said.

Asset quality pressure

The agency observed that the high credit growth during the last two years in the retail segment, across the lenders, has potentially resulted in over leveraging in some asset segments, and a slower credit growth can impair the refinancing ability of some these borrowers, as the lenders become risk averse.

“Such tightening often results in weaker borrowers falling behind in their repayments schedule, thereby increasing the asset quality pressure for the lenders. Loan segments, which have high lending rates or marginal borrower profiles, like microfinance, personal loans, credit cards or unsecured business loans, are already showing rise in delinquencies,” ICRA said.

The agency expects these segments, which are largely unsecured, to continue to be a source of stress in the near term, and the spillover to secured asset classes, like micro and small mortgage loans, used vehicles and other small-ticket loans remains a near-”term monitorable.

A M Karthik, Senior Vice President & Co-Group Head – Financial Sector Ratings, ICRA, observed that as bank funds constitute a larger share in the overall funding of NBFCs, a slower credit flow from banks to the NBFCs will also compress their AUM growth.

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He opined that NBFCs in unsecured and digital lending businesses shall face higher squeeze in funding compared to others.

Amid concerns on overleveraging, ICRA expects the AUM growth in microfinance loans and unsecured (personal and business) loans by the NBFCs to moderate to 10-12 per cent and 19-21 per cent, respectively, in FY2025 compared to 30 per cent and 38 per cent, respectively, in FY2024.

Gold loans to shine

The agency said given the risk aversion of lenders in the unsecured space, the credit demand of the borrowers seems to have shifted towards gold loans, thereby resulting in a higher 18 per cent y-o-y growth (Q1 FY2025 and FY2024) in gold loans vis-a-vis 12 per cent in FY2023. This growth is also aided by the rise in gold prices, and ICRA expects a similar strong growth in bank AUMs.

Karthik observed that the RBI’s recent notification of the deficiencies observed in the gold loans by regulated entities is a push for all the players to tighten their governance practices and processes, with a possible expectation that gold loan demand shall increase as unsecured loans become scarcer.