Large private banks set for revival as credit growth and earnings outlook improve: Motilal Oswal report

Banking and financial services (BFSI) stocks are poised for stronger performance in the coming years, supported by robust credit growth, improving earnings visibility and a more favourable macroeconomic environment, according to the latest BFSI Picks 4.0 report by Motilal Oswal Financial Services Ltd (MOFSL).

The brokerage remains constructive on the sector despite mixed stock market performance over the past year, arguing that healthy loan demand, easing pressure on margins, and improving management commentary could drive a rerating of banking stocks, particularly large private lenders.

According to the report, banking system credit growth remained strong at 17.6%, driven by broad-based momentum across corporate, retail, and MSME lending. Growth has been aided by healthy demand for working capital loans and a shift by corporates towards bank borrowings as bond yields rose, making debt market funding relatively expensive.

MOFSL expects banking system credit to maintain healthy momentum, projecting a compound annual growth rate (CAGR) of 14% between FY26 and FY28.

The report also forecasts a recovery in sector earnings. Banks under MOFSL's coverage universe are expected to deliver earnings growth of nearly 15% CAGR during FY26-28, following a relatively muted FY26 when earnings growth is estimated at 6.6%.

Private sector banks are likely to lead earnings recovery

Private sector banks are expected to lead the earnings recovery, with projected earnings CAGR of around 21% over FY26-28, significantly higher than the approximately 8% CAGR expected for public sector banks.

"Earnings growth across the sector is likely to gain momentum as loan growth remains healthy, net interest margin (NIM) pressures ease and asset quality stress in unsecured lending moderates," the report noted.

The brokerage highlighted that banks saw a modest decline in NIMs during FY26 as lending rates adjusted lower. However, declining cost of funds and sustained credit growth have helped offset some of the pressure on profitability. Additionally, improving asset quality trends, particularly in unsecured retail lending, are expected to lower credit costs for several mid-sized banks, providing a further boost to earnings.

While banking stocks have delivered mixed returns over the past 12 months, MOFSL believes the outlook is turning more favourable. Large private banks, which underperformed amid macroeconomic uncertainties, foreign institutional investor (FII) selling, and margin pressures, remain the brokerage's preferred investment segment due to their attractive valuations, strong balance sheets, and superior long-term growth prospects.

The report noted that the Nifty Private Bank Index remained largely flat over the past year as major lenders such as HDFC Bank , ICICI Bank , and Kotak Mahindra Bank posted negative returns. In contrast, mid-sized private banks significantly outperformed.

Among the strongest performers were RBL Bank , South Indian Bank , Federal Bank , City Union Bank , and Karur Vysya Bank , which generated substantial gains during the period and outpaced their larger peers.

Resilience of its BFSI model portfolio

MOFSL also highlighted the resilience of its BFSI model portfolio, which has navigated a challenging macroeconomic backdrop marked by tariff-related disruptions, geopolitical tensions, crude oil price volatility, and currency pressures.

These factors periodically weighed on banking stocks through pressure on net interest margins, treasury mark-to-market losses and shifts in investor sentiment. Despite the volatility, the brokerage said sector fundamentals remained stable.

Since inception, the BFSI model portfolio has generated market-cap weighted returns of around 25%, outperforming both the Nifty Financial Services Index, which returned 10%, and the Nifty 50, which gained 5% during the same period.

Maintaining a balanced but positive stance on the sector, MOFSL said improving earnings visibility, steady credit expansion, and supportive management commentary are likely to remain the key drivers of BFSI sector performance over the medium term.

The brokerage added that the combination of healthy loan growth, stabilising margins, and easing asset quality concerns could create a more favourable environment for banking stocks after a period of subdued performance, particularly among large-cap private sector lenders.