The Indian banking sector could record strong earnings in Q2FY27, but the picture behind this growth is not entirely straightforward. On one hand, loan growth, core banking income and lower provisioning are supporting profits. On the other hand, net interest margins could remain under pressure in the near term due to foreign currency deposits.
Both credit and deposit growth have strengthened across the banking system. However, external challenges such as crude oil prices, El Niño and drought conditions in some states could affect asset quality and borrowers’ repayment capacity going forward.
Let us understand banks’ earnings, margins and the outlook for Q2FY27 in detail.
What’s Happening?
According to Emkay Research, the net profit of Indian banks could rise 25.4% year-on-year in Q2FY27, which covers the July–September quarter. Strong loan growth, better income from core banking operations and lower provisioning are the key factors behind this growth.
Credit growth across the banking system stood at 18.1% as of 15 September. Meanwhile, deposit growth rose from 12% in June to 17.3%. This has also significantly reduced the gap between credit and deposit growth. In Q2FY27, the gap between non-food credit growth and deposit growth narrowed to nearly 50 basis points, compared with approximately 500 basis points in the previous quarter.
Net interest income is estimated to grow 12.5% YoY, while pre-provision operating profit could rise 17.2%. Meanwhile, provisioning could decline 8.7%, providing additional support to net profit.
Why Does Pressure Remain on Margins?
Despite strong profit growth, net interest margins, or NIMs, could remain under pressure in Q2FY27. According to the report, NIMs across the banks covered could decline by 1-32 basis points sequentially. Margins at large private banks are estimated to decline by 7-32 basis points, while the decline at public sector banks could be relatively lower, at around 1-9 basis points.
The primary reason is the sharp inflow of FCNR(B), or Foreign Currency Non-Resident (Bank) deposits. These deposits have improved funding and liquidity, but their cost could put pressure on lending margins in the near term. A portion of the additional funds is expected to be used first to repay high-cost liabilities, followed by deployment into other assets and, gradually, into loans.
Credit Growth Strong, but External Risks Also Present
FCNR(B) deposits have improved deposit mobilisation across the banking system and could also support the liquidity coverage ratio. The report expects these inflows to support net interest income (NII), pre-provision operating profit (PPOP), profit after tax (PAT), earnings per share (EPS) and return on equity (RoE).
Asset quality is expected to remain stable for now. There are signs of reduced fresh stress in unsecured retail loans, which include personal loans, credit cards and microfinance.
However, external risks have not been completely eliminated. High crude oil prices could increase the operating costs of businesses and households. Along with this, El Niño, an uneven monsoon and drought conditions in five states could put pressure on borrowers’ repayment capacity and the outlook for banks’ asset quality.
What Does This Mean for Investors?
The current picture of the banking sector reflects a mix of strong profit growth and temporary margin pressure. The potential 25.4% growth in net profit, 18.1% credit growth and lower provisioning are positive signals. However, the estimated 1–32 basis point decline in NIMs means that the quality of near-term earnings needs to be watched closely.
The report describes large private sector banks as being in a better position due to strong balance sheet growth, better operating profit, healthy return ratios and attractive valuations. Even so, investors need to focus not only on profit growth but also on margins, asset quality and management commentary.
What’s Next?
According to the report, an improvement in NIMs could gradually become visible in the second half of the financial year. Banks could take nearly two quarters to fully absorb the additional liquidity. A reduction in expensive liabilities, the deployment of additional funds into loans and the benefit of the recent rate hike for banks with floating-rate loans could support margins.
However, once FCNR(B) funding normalises, credit growth across the banking system in FY27 is estimated to moderate to around 16%. Despite this, organic loan growth is expected to remain healthy.
Going forward, the key factors to watch will be how banks manage risks linked to crude oil prices, an uneven monsoon and drought conditions, how stable asset quality remains, and whether the current earnings growth can be sustained alongside a recovery in margins.
Disclaimer: This article is for educational and informational purposes only and does not constitute investment advice or a recommendation to buy or sell any securities. The companies mentioned are cited as examples within the context of market developments. Investors are advised to conduct their own due diligence and consult their financial advisor before making any investment decisions.
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