Domestic rating agency Icra on Monday upped its banking sector outlook to 'positive' on healthy asset growth, improving asset quality and stronger capital buffers.

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The agency expects asset quality to improve to a decadal best of 4 per cent from a gross non-performing assets (NPAs) perspective by the end of FY24.

The banking system's credit growth will slow down to 11-11.6 per cent in FY24, after a very healthy growth of 15.2-16.1 per cent expected in FY23, the rating agency said.

A bulk of the credit growth story will be led by state-owned lenders which are in far better shape now having recognised and provided for loan losses and also after some capital infusions, it said, adding that the market share gains for private sector lenders will slow down.

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Public sector lenders will witness a credit growth of 13.4-14.1 per cent in FY23 and 9.5-10.1 per cent in FY24, the agency estimated, adding that the same for private sector banks will be 14.5-15.5 per cent and 12.6-13.5 per cent.

From an asset quality perspective, the system's GNPAs (Gross Non-Performing Assets) will come down to 4 per cent and net NPAs will be under 1 per cent, the agency's vice president Aashay Choksey told reporters.

The system's GNPAs were at 6 per cent in FY22, while the net NPAs were at 1.7 per cent.

The state-owned banks' net NPAs will come down to 1.3-1.6 per cent by FY24-end, while the same for private sector lenders will be 0.8-0.9 per cent, it said.

The restructured assets will be under 1 per cent by FY24, Choksey said.

Even as asset growth is happening at a faster pace, the agency is also more sanguine about the asset quality prospects given the granularity in the stressed assets and the dud assets not masked as restructured assets, its executives said.

On the capital adequacy front, the agency said, there will not be any significant fund infusion requirement to attain a 10-12 per cent asset growth in FY24. It expects the core tier-I buffers to be at 13.8-14.1 per cent in FY23 as against 14.3 per cent in FY22.

Net interest margins made by banks will narrow down in FY24 on the deposit rate hikes, but higher loan volumes will ensure that banks book healthy growth on interest to make healthy profits, it said.

The agency said it expects banks to generate their own growth capital through healthy profitability, and the government will not have to infuse any money in the lenders it runs.

However, it did point to a few risks for the sector, which include higher than expected compression of spreads because of the inability to pass on the rising deposit costs, economic slump leading to higher slippages in asset quality, and the pay scale and pension revisions for state-run lenders, which are currently under negotiation.

There are also a few segments, like the small businesses area, which need closer monitoring, the agency said, adding that they are most at risk in a rising interest scenario and added that some of them dependent on exports will be in more difficulty.

Given the overall positive conditions, the agency said the next two years will be opportune time for a transition to the IND-AS system of accounting, which focuses on the provisions from an expected loan loss basis, and may lead banks to set aside higher amounts while transitioning itself.

One or two more banks can be classified as systemically important, which can lead to an increase in capital buffers for them, it said.

The BSE's sectoral index Bankex was trading 0.51 per cent up at 49,355.63 points at 1518 hrs on Monday.

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