Strong Credit Demand, Healthy Asset Quality and Expected Recovery in Funding Costs Could Support Banking Stocks Through FY27, Says Brokerage

India's banking sector is expected to deliver another quarter of resilient earnings despite facing temporary pressure on profitability, according to the latest banking sector preview by Emkay Global Financial Services. The brokerage forecasts that banks under its coverage will report 12.2% year-on-year growth in net profit during the April–June quarter (Q1 FY27), supported by healthy loan growth, improving asset quality and robust core banking operations.

While elevated funding costs, margin compression and weaker treasury income may limit sequential earnings growth, analysts believe these challenges are likely to ease from the second quarter of FY27 as liquidity conditions improve and deposit costs begin to moderate.

The report highlights that India's banking industry continues to benefit from strong economic activity, rising credit demand and disciplined risk management, providing a favourable backdrop for earnings growth despite near-term headwinds.

Healthy Start Expected for FY27

Emkay Global believes the banking sector will begin the new financial year on a solid footing, reflecting the resilience of India's financial system.

Q1 FY27 Earnings Forecast

The expected year-on-year growth reflects strong operational performance across lending businesses.

However, profits may decline marginally compared to the previous quarter due to:

• Higher funding costs

• Pressure on Net Interest Margins (NIMs)

• Lower treasury gains

• Seasonal agricultural interest reversals

Despite these short-term factors, analysts believe the overall earnings trajectory remains positive.

Credit Growth Continues to Drive Banking Performance

One of the strongest positives highlighted in the report is the continued momentum in bank lending.

According to Emkay Global, banking system credit expanded by 17.7% year-on-year as of mid-June 2026.

The growth has been supported by multiple lending segments:

• Corporate loans

• Infrastructure financing

• NBFC lending

• MSME credit

• Vehicle finance

• Gold loans

• Select retail lending categories

Healthy credit growth indicates continued confidence among businesses and consumers while reflecting sustained economic activity across sectors.

Deposit Growth Remains the Biggest Challenge

Although lending activity remains strong, deposit mobilisation continues to lag behind credit expansion.

The report estimates that deposits grew by only 12% year-on-year, creating a widening gap between loans and deposits.

As a result, the banking system's Loan-to-Deposit (LDR) ratio has increased to nearly 83%.

This higher ratio has forced banks to rely more heavily on:

• High-cost fixed deposits

• Wholesale funding

• Bulk deposits

These funding sources carry higher interest costs, putting pressure on profitability during the quarter.

Why Net Interest Margins Are Under Pressure

Net Interest Margin (NIM), one of the most closely watched profitability indicators for banks, is expected to remain under pressure during Q1 FY27.

Several factors have contributed to weaker margins.

Elevated Deposit Rates

Competition for deposits has forced banks to offer higher interest rates to attract customers.

Seasonal Agricultural Impact

Interest reversals associated with agricultural loans and Kisan Credit Card (KCC) portfolios have reduced interest income during the quarter.

Corporate Loan Mix

A larger share of corporate lending, which generally earns lower spreads than retail lending, has also impacted margins.

Despite these pressures, Emkay expects margins to stabilise and gradually improve from the second quarter of FY27.

Funding Costs May Ease from Q2

The brokerage expects liquidity conditions to improve in the coming months.

One of the major factors supporting this view is the anticipated increase in Foreign Currency Non-Resident (FCNR) deposits.

Higher FCNR inflows could:

• Improve banking system liquidity

• Reduce dependence on expensive wholesale borrowings

• Lower funding costs

• Improve deposit availability

• Support margin recovery

If funding costs decline as expected, banks could witness stronger profitability during the remainder of FY27.

Asset Quality Continues to Improve

India's banking sector has made significant progress in improving asset quality over the past several years.

Emkay expects this trend to continue.

Positive Trends Expected

• Declining Gross Non-Performing Assets (GNPA)

• Lower Net Non-Performing Assets (NNPA)

• Stable credit costs

• Controlled provisioning requirements

Although seasonal stress may emerge within agricultural and KCC loan portfolios, analysts believe the overall asset quality outlook remains healthy.

Improved underwriting standards and stronger recovery mechanisms continue to support balance sheet quality.

Private Banks Expected to Lead Earnings Growth

The brokerage expects private sector lenders to outperform public sector banks during the June quarter.

Private banks are expected to benefit from:

• Strong retail loan growth

• Better operating efficiency

• Higher fee income

• Stable asset quality

• Healthy profitability

Private Banks Likely to Perform Well

• HDFC Bank

• Axis Bank

• IndusInd Bank

• IDFC First Bank

These institutions are expected to maintain healthy earnings despite temporary pressure on margins.

PSU Banks Likely to Deliver Stable Performance

Public sector banks are also expected to report healthy year-on-year earnings growth.

However, sequential growth could remain relatively softer because of:

• Lower treasury income

• Slightly higher provisioning

• Funding cost pressures

Expected PSU Bank Performance

Likely Outperformers

• Canara Bank

• Indian Bank

Moderate Performance Expected

• State Bank of India (SBI)

Comparatively Softer Quarter

• Bank of Baroda

Nevertheless, analysts believe PSU banks remain fundamentally stronger than in previous years due to improved capital adequacy, lower NPAs and stronger profitability.

Key Themes Investors Should Watch During Earnings Season

Management commentary will remain crucial during the ongoing earnings season.

Investors are expected to focus on:

Deposit Growth

Whether banks are witnessing improvement in low-cost CASA deposits.

Margin Outlook

Expected trajectory of NIM recovery over the next few quarters.

Credit Demand

Sustainability of retail and corporate lending growth.

Asset Quality

Potential stress in agricultural and MSME portfolios.

Treasury Income

Impact of bond market movements on investment portfolios.

Geopolitical Risks

Possible implications of developments in West Asia.

Weather Conditions

Impact of the El Niño phenomenon on rural credit quality.

These factors will influence investor sentiment and future earnings expectations.

Structural Growth Drivers Remain Intact

Despite near-term challenges, India's banking sector continues to benefit from several long-term growth drivers.

Economic Expansion

Sustained GDP growth continues to support credit demand across sectors.

Infrastructure Investment

Government capital expenditure is boosting lending opportunities.

Digital Banking

Technology adoption continues to improve customer acquisition and operating efficiency.

Financial Inclusion

Expansion of banking services into rural and semi-urban regions continues to broaden the customer base.

Retail Credit Growth

Demand for housing, automobile and consumer loans remains healthy.

These structural factors are expected to underpin long-term earnings growth for Indian banks.

Potential Risks to Monitor

Although the sector outlook remains favourable, investors should continue monitoring several risks.

These include:

• Persistent pressure on funding costs.

• Slower-than-expected deposit mobilisation.

• Global economic uncertainty.

• Geopolitical tensions affecting financial markets.

• Weather-related agricultural stress.

• Any deterioration in asset quality.

Managing these risks effectively will remain critical for sustaining profitability.

Investment Outlook

India's banking sector appears well-positioned to deliver another quarter of healthy earnings despite facing temporary pressure on margins. Strong credit growth, resilient asset quality and improving operational efficiency continue to support the industry's long-term fundamentals. While elevated funding costs have compressed profitability in the short term, expectations of improving liquidity and lower deposit costs from the second quarter provide optimism for a gradual recovery in margins.

Private sector banks are expected to maintain their leadership in profitability, although select public sector lenders are also likely to report encouraging financial performance. As India's economy continues to expand and credit demand remains robust, the banking sector is expected to remain one of the key drivers of corporate earnings and market performance during FY27. Investors will closely monitor management commentary on deposit growth, funding costs and asset quality to assess the sustainability of the sector's positive momentum.