Special foreign-currency deposits raised under the RBI’s window weigh on quarterly net interest margins, but lenders expect improved profitability as funds are deployed into loans and expensive borrowings are replaced

India’s leading private sector banks reported sequential declines in net interest margins (NIMs) during the second quarter of FY27, as deposits mobilised under the Reserve Bank of India’s special Foreign Currency Non-Resident (Bank), or FCNR(B), window added to near-term funding costs. HDFC Bank, ICICI Bank and Axis Bank have indicated that the pressure could ease over the coming quarters as they deploy the funds into lending and replace higher-cost deposits.

The latest results highlight a challenge facing lenders: raising long-term foreign-currency deposits can strengthen funding stability, but the timing of deployment and the cost of those deposits can temporarily weigh on profitability. The impact is particularly important for banks because NIM, which measures the difference between interest earned on loans and investments and interest paid on funding, is a key driver of core banking earnings.

Despite the immediate pressure, bank managements have expressed confidence that margins can improve as funds are utilised more efficiently. The recovery will depend on loan growth, deposit costs, asset repricing and the broader interest-rate environment.

HDFC Bank’s NIM Declines to 3.16%

HDFC Bank, India’s largest private sector lender, reported a 10-basis-point sequential decline in its net interest margin to 3.16% in the September quarter, compared with 3.26% in the preceding quarter.

Managing Director and Chief Executive Officer Sashidhar Jagdishan said the bank had previously experienced margin pressure because lending assets repriced faster than funding costs adjusted during the declining interest-rate cycle. With the rate environment turning upwards, the bank expects the dynamics affecting margins to change.

The potential recovery will also depend on the composition of HDFC Bank’s loan portfolio. Management indicated that a shift towards retail and micro, small and medium enterprise (MSME) lending, relative to corporate loans and home loans, could support margins over time.

Retail and MSME lending can offer different yields and risk characteristics from large corporate loans. However, higher-yielding loans must be balanced against credit costs, operating expenses and the risk of borrower stress. The benefit to profitability will therefore depend on the bank's ability to expand these segments while maintaining underwriting discipline.

HDFC Bank mobilised approximately $11.5 billion through FCNR(B) deposits, making it one of the largest fundraisers among private lenders. Its overseas operations extended around $5.7 billion in loans against these deposits and issued approximately $3.1 billion in standby letters of credit.

The extent to which the bank can deploy the remaining funds productively, while managing its overall funding mix, will be important for its margin trajectory over the next several quarters.

ICICI Bank Reports the Sharpest Sequential NIM Decline

ICICI Bank, the country’s second-largest private sector lender, recorded an 18-basis-point decline in NIM to 4.18% in Q2 FY27 from 4.36% in the previous quarter.

Executive Director Sandeep Batra attributed much of the contraction to FCNR(B) deposits and indicated that the full impact would be reflected in the December quarter. The bank expects margins to begin improving after the third quarter, even if policy rates remain at their prevailing levels, provided the funds are deployed effectively.

The deposits provide ICICI Bank with a relatively stable source of funding for three to five years. During the September quarter, the bank used part of the funds to repay existing deposits and support loan growth. The remaining funds are expected to be deployed over the following two quarters.

ICICI Bank mobilised $17.88 billion in gross FCNR(B) deposits. Its international branches and subsidiaries extended approximately $9 billion in loans against these deposits and issued $3.63 billion in standby letters of credit.

The scale of the mobilisation gives the bank access to a substantial pool of foreign-currency funding, but the financial benefit will depend on how effectively it matches the cost, maturity and currency of those liabilities with corresponding assets and business requirements.

Investors will watch whether ICICI Bank can stabilise its NIM after the expected impact in the December quarter and subsequently translate its funding base into sustained loan growth and earnings.

Axis Bank Expects Benefits From Retiring High-Cost Deposits

Axis Bank, India’s third-largest private sector lender, reported a 10-basis-point sequential decline in NIM to 3.36% in Q2 FY27, compared with 3.46% in the previous quarter.

The bank attributed part of the pressure to FCNR(B) deposits but maintained that it remained on track to meet its NIM guidance of 3.8%.

Management said it had used a portion of the funds towards the end of the September quarter to retire higher-cost non-retail term deposits (NRTDs). Since the exercise was completed late in the quarter, the benefit was not fully reflected in the reported results.

The bank expects the reduction in expensive funding costs to support NIM improvement in the current quarter. This illustrates an important distinction between deposit mobilisation and actual profitability: the benefit from new funding depends not only on the amount raised but also on which existing liabilities it replaces and how quickly the resulting savings appear in earnings.

Axis Bank mobilised $10.62 billion through FCNR(B) deposits. It deployed approximately $4.57 billion to support lending through its overseas branches and used the remaining funds to help retire higher-cost non-retail term deposits.

The extent of the expected margin recovery will depend on the cost differential between the new funding and the deposits being replaced, alongside the bank’s ability to grow its loan book without compromising asset quality.

Why FCNR(B) Deposits Can Pressure Bank Margins

FCNR(B) deposits allow eligible non-resident Indians to place funds in foreign currencies with Indian banks. Unlike ordinary rupee-denominated deposits, these accounts are maintained in permitted foreign currencies, subject to applicable regulations.

For banks, such deposits can diversify funding sources and provide access to foreign-currency liabilities. The funding may support overseas lending, eligible foreign-currency requirements and other permitted uses. However, the economics depend on the interest rate paid to depositors, currency and interest-rate hedging costs, deployment opportunities and applicable regulatory conditions.

When a bank raises a large volume of deposits but cannot immediately deploy all the proceeds into assets that generate sufficient returns, the new funding may dilute its overall margins. If the deposits carry relatively high costs, the pressure can persist until the bank increases lending, replaces more expensive liabilities or benefits from changes in asset yields.

The timing also matters. Funds raised or deployed late in a quarter may contribute only partially to that quarter’s earnings, while their costs may be recognised over a different period. As a result, the full effect on NIM may emerge gradually rather than immediately.

Deployment of Funds Is Key to Margin Recovery

The three banks are following a combination of strategies to manage the impact of FCNR(B) mobilisation. These include expanding lending, using funds to replace expensive deposits and deploying resources through international operations.

The first route involves converting available funding into loans that generate interest income. However, loan growth must be accompanied by prudent credit assessment and adequate pricing. Aggressive expansion merely to improve margins could increase future provisions if borrower quality deteriorates.

The second route involves retiring high-cost deposits and other eligible liabilities. This can reduce interest expenses, provided the replacement funding is genuinely cheaper after accounting for currency-related costs and other expenses.

The third route involves deploying foreign-currency funding through overseas branches and subsidiaries. This can support international lending, although banks must manage currency, maturity and counterparty risks carefully.

The speed and effectiveness of these measures will determine whether the temporary margin pressure translates into a short-lived earnings setback or a more prolonged challenge.

What FCNR(B) Trends Mean for Bank Earnings

NIM movements are important because even a small change can affect a bank’s interest income when applied to a large asset base. A sustained decline may constrain earnings growth, while a recovery can improve profitability if loan growth and credit quality remain healthy.

However, investors should not evaluate bank performance on NIM alone. Deposit growth, the cost of funds, loan mix, credit costs, non-performing assets, fee income, operating expenses and capital adequacy all influence the quality and sustainability of earnings.

For HDFC Bank, the key monitorables include margin recovery, the contribution from retail and MSME lending, and the utilisation of FCNR(B) funds. For ICICI Bank, investors will focus on the expected December-quarter impact and the timing of subsequent improvement. For Axis Bank, the benefits from retiring higher-cost term deposits and progress towards its stated NIM guidance will be particularly important.

Comparisons between the three lenders also require caution because their loan mixes, funding structures, overseas operations and starting margin levels differ.

Key Risks to Watch

Several factors could delay the anticipated recovery in margins. Competition for deposits may keep funding costs elevated, while changes in lending rates could reduce yields on parts of the loan book. If credit demand weakens, banks may find it more difficult to deploy the funds at attractive returns.

Currency movements and hedging costs can also affect the economics of foreign-currency funding. In addition, rapid loan growth could increase asset-quality risks if underwriting standards weaken or economic conditions deteriorate.

Finally, management expectations about margin improvement are forward-looking. The timing and magnitude of any recovery will depend on actual deployment, funding costs and market conditions, and may differ from current projections.

Market Outlook

The Q2 FY27 results show that FCNR(B) deposit mobilisation has created near-term margin pressure for HDFC Bank, ICICI Bank and Axis Bank. Sequential NIM declines were reported across all three lenders, with ICICI Bank recording the largest fall at 18 basis points, while HDFC Bank and Axis Bank each reported declines of 10 basis points.

Nevertheless, the pressure may ease as banks deploy the funds into lending and replace higher-cost deposits. ICICI Bank expects margins to begin moving higher after the December quarter, while Axis Bank anticipates benefits from the retirement of expensive term deposits. HDFC Bank sees scope for improvement as the interest-rate cycle turns and its loan mix evolves.

For investors, the central issue is whether the banks can convert their enlarged funding bases into profitable, high-quality assets. The next few quarters should provide clearer evidence through NIM trends, loan growth, deposit costs and credit-quality indicators.

The outlook for margins is cautiously constructive based on management commentary, but a recovery should not be assumed until it is reflected in reported results. Investors should compare each bank’s valuation with its expected earnings trajectory, asset quality and funding profile rather than treating FCNR(B) mobilisation alone as a positive or negative signal.