McKinsey expects return on assets of banks to fall in 24-30 months
2 min read 02 Aug 2023, 06:56 PM ISTReturn on assets of the banking system, a measure of profitability in relation to assets, stood at 1.1% in FY23, up from -0.2% in FY18 and 0.9% in FY22.
PremiumMumbai: Indian banks are likely to post a lower return on assets, between 0.85 and 1%, in the next 24-30 months as net interest margins (NIMs) contract due to repricing of deposits, showed an analysis by McKinsey & Co.
Return on assets (RoA) of the banking system, a measure of profitability in relation to assets, stood at 1.1% in FY23, up from -0.2% in FY18 and 0.9% in FY22.
“If we take a 12-18 month view, we expect RoAs to fall. If you look at all banks’ quarterly results and their forward looking projections as well, everyone has made the same commentary that we will see pressure on net interest margins (NIMs) going forward," Peeyush Dalmia, senior partner, McKinsey & Co.
This, Dalmia said, automatically translates into RoA and it will be very difficult for other factors to compensate for the drop in NIMs. Dalmia said that RoAs, at an average, was about 1% in FY13, then came down to -0.2% and has again gone up to 1.1%.
“We are at a 10-year high from a profitability perspective as far as the banking industry is concerned," he said.
This is predominantly driven by two factors. The NIMs have come back to its historical highs because retail loans have grown faster. Dalmia said that the share of retail loans in total banking advances has gone up quite significantly and corporate loans have grown the slowest.
“Retail does give you the maximum amount of NIM," he said.
That apart, even as rates moved up, cost of deposits did not go up at the same rate but lenders were able to pass the new rate to the borrowers. Dalmia said this was largely because almost 70-75% of the lending today is on floating rates so the transmission of rates to borrowers happens much faster than on deposits.
Historically, about 30-40% of the loans were floating rate, he said.
“This is also one of the factors why we think we will see a compression as we go forward as the lag in cost of deposits catches up," said Dalmia.
That apart, McKinsey said in its report on Wednesday that over the past five years, and even more so through the recent global banking turmoil, Indian banks have remained strong and outperformed their global peers on growth and profitability.
A large portion of the banking system remains profitable, primarily driven by strong growth in the retail and micro, small, and medium enterprises (MSME) lending segments, it said. Consolidation across public sector banks (PSBs), the report said, has also yielded larger, healthier institutions.
