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mckinsey: Bank RoA at peak, need investment in tech, talent says McKinsey

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Slower deposit growth, likely decline in fee income, rising operational expenses and increasing number of so called credit tested customers is likely to impact bank profitability in the next couple of years, consultancy firm McKinsey & Co said. It expects banks’ return on asset (RoA) to drop to 0.80% to 1% range in the next two years from 1.1% at the end of fiscal 2023.

McKinsey expects the structural re-allocation of household savings away from deposits to hit deposit growth which together with high inflation will keep banks’ cost of funds on a upward bias. Increasing attrition, competition for skilled talent will continue to drive high personnel costs. This together with rise cost of compliance on data security and privacy issues will keep banks’ operational expenses elevated, McKinsey said.

The report titled ‘Indian Banks: Building Resilient Leadership’ examines the performance of 80 banks over the last five years. It pointed out that Indian banks’ profitability is highest in a decade with resilient net interest margins (NIMs) and declining credit costs contributing to healthy margins.

Indian banks have clocked higher ROA than global peers, resulting in a valuation premium with higher price-to-book (P/B) multiples. The top three banks in India have a P/B multiple of 2.5, compared to 0.5-1.5 for banks in other major geographies, as of March 2023.

However, banks in India face challenges reduced fee potential particularly because of increased competition from fintechs for fee income. Rising attrition and competition for skilled talent will also increase costs.

“To improve performance, the industry will require investment in digital capabilities to service the growing midand mass-affluent; focus on new opportunities such as digital commerce and financial inclusion in the rural sector; and build on tech resilience and digital & analytics capabilities,” Peeyush Dalmia, senior partner, McKinsey said.Dalmia said Indian banks will have to increase their spending in technology to 9% to 10% of total income from 5% to 7% of income currently. Banks will also have to expand into under-penetrated rural and agriculture segments and improve wealth management capabilities especially for mid and mass-affluent segments through investments in digital capabilities.Though McKinsey expects banking credit growth to remain healthy at compounded annual rate 12% to 14%, lenders will increasingly have to look to Tier 2 and smaller cities to drive their growth. The consultancy firm estimates that around 80% of the customers for personal loans are from Tier 2 and smaller towns up from around 70% in fiscal 2018.

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