(April 2): Goldman Sachs Group Inc sees increasing headwinds for India’s banks and expects their returns on assets to decline in the coming quarters.

Indian banks were in a Goldilocks period over the last couple of years, during which lenders improved their top line and enjoyed a pickup in loan growth, according to Rahul Jain, co-head of Asia Pacific Financials Research at Goldman. That is now over. “We expect their ROAs (return on assets) to start moderating somewhat,” he said in an interview with Haslinda Amin on Bloomberg TV on Tuesday.

Jain said banks are facing tighter liquidity conditions and more scrutiny over their unsecured lending. They need to invest in expansion and build up their capacity in order to mobilise more deposits. "Clearly, all of this is not very conducive for the top line," he said, adding that investors will need to be selective when it comes to picking Indian financial stocks.

Goldman downgraded ICICI Bank Ltd, State Bank of India and Yes Bank Ltd in late February and has a “market weight” call on the country’s broader financial sector. Jain said the firm has lowered its earnings estimates for the banks by mid-single-digit percentage terms to below-consensus levels.

Jain said structural drivers are in place for loan growth in line with or higher than GDP growth in the longer term. But in the near term, “we see some consolidation happening in the consumer-retail space because we see that household balance sheets are getting leveraged,” he said.

Lenders are likely to experience slower growth due to potential asset-quality challenges as the credit cycle plays out, which would impact their revenue margins and fee income, Jain said. Worsening credit quality would also hit banks’ bottom lines, he added.

Around 70% to 80% of Indian banks’ assets are funded by deposits. “We’re sitting at the peak of the loan-to-deposit ratio for the banking system,” Jain said, adding that this also points to slower growth.

Goldman’s view on India’s banking sector contrasts with research analysts from JPMorgan Chase & Co, which said in a note this week that India’s corporate lenders are “the single largest opportunity” among Asia Pacific financial stocks.