Q1FY27 banks’ earnings review: Pressure of interest rate cuts on margins over, say analysts

The past few months have seen some of the macroeconomic conditions impacting India’s economy starting to alter. These include stabilising crude oil prices, a gradual reduction in foreign fund outflows from equities and inflationary pressures that might not escalate. This means there is a lower possibility of interest rates moving up too quickly.

In this backdrop, for banks, the Q1FY27 earnings could be the “last hurrah of margin headwinds”, says Santanu Chakrabarti, India analyst-BFSI of BNP Paribas. “Going forward, the pressure of interest rate cuts on margins is over. The earnings growth trajectory will start to look significantly different from here on,” he told Fortune India.

Benign margin tailwinds

Chakrabarti said the net interest margin (NIM) misses landed harder than usual (impacting the stocks) given reasonably healthy early disclosures by banks on aggregate credit/deposit and CASA. This created anticipation of nearly flat margins quarter-on-quarter.

Chakrabarti, in his note to clients said that with term-deposit repricing of 30-40 bps yet to come and loan repricing over, benign margin tailwinds are the likely outcome.

“With credit growth running strong and no major credit/operating cost inflation likely for these banks, mid-teens earnings growth expectations appear justified and a likely catalyst,” he said.

On July 20, the HDFC Bank stock slid 5% after reporting its lowest ever NIM of 3.26% in the June-ended quarter, after the mega merger with HDFC in 2023. Investors were spooked by fears of the bank’s return on assets (RoA) and Return on Equity (RoE) getting hurt due to the shrinking of its margins.

HDFC Bank, being a low-margin, low-cost lender, is unlikely to surge sharply, in a few quarters. But it is expected to keep inching up gradually—as its top management said at the August AGM—which could see its RoE improve.

As this could play out in coming quarters, the banking industry continues to be plagued by the fact that system credit growth is outpacing deposit growth. According to data from the Reserve Bank of India, the credit-to-deposit ratio is at a high of 82%. “That gap is the single biggest issue facing the sector,” Raj Gaikar, equity research analyst at SAMCO Securities, told Fortune India. He also said that while the margins have bottomed out, they are not recovering yet, because deposits reprice more slowly than loans after a rate-cut cycle.

FCNR(B) deposits grow, RBI shortens forex deposit swap window

The June-ended quarter was the one in which RBI announced the new special FCNR(B) deposits scheme. The central bank, on June 8, announced special swap windows for external commercial borrowings (ECBs) and FCNR(B) issues. It also said that authorised dealer banks planning to raise FCNR(B) deposits with maturities in the range of 3-5 years will be eligible to a facility where the RBI would bear the hedging costs, till September 30, 2026.

FCNR(B) deposits provide the RBI with an additional buffer to counter any fresh bout of currency weakness. The rupee has strengthened 1.01% against the dollar, to 95.6 on August 14 from a record intra-day low of 96.8 on July 23.

Rikin Shah, senior vice president and banking analyst at IIFL Capital, said total FCNR(B) deposits will reach $80 billion by September. This should add 3 percentage points to system deposits and 3.7 percentage points to loans, driving potential upside to FY27 loan growth estimates.

RBI, in its latest data released on August 14, said the total collection of forex inflows through FCNR (B) and ECB and Overseas Foreign Currency Borrowings (OFCBs), touched $56.3 billion, of which $52.3 was through FCNR(B) deposits.

“Based on the encouraging response to the Swap Facility for FCNR(B) deposits and the resultant forex inflows, the RBI has decided that the Swap facility for FCNR(B) deposits will be available only for deposits mobilised till August 31, 2026. The Swaps under this facility i.e. FCNR(B) deposits, may be availed with RBI till September 11, 2026. The Scheme for ECBs and OFCBs will continue to be open till December 31, 2026,” the RBI said.

Shah, along with analysts Heet Khimawat and Ryan Daniels of IIFL Capital, said that “Based on our bank-wise sensitivity analysis, while we expect loan-to-deposit ratio to rise by 0.2 to 1.6 percentage points and NIM to contract 3-15 basis points, it should drive net profit accretion of 1-9%.” The IIFL analysts added that the market’s isolated focus on NIM rather than EPS growth is “myopic”.

From FY27 onwards, India’s banking ecosystem could also start to see private sector banks overtake public sector banks in terms of earnings growth (profitability).

“On profitability per rupee of assets, private banks are already ahead and should stay ahead. Their margins are generally higher than those of public sector banks, and they earn considerably more from fees,” says SAMCO Securities’s Gaikar.

“On headline profit growth, though, the two have been growing well, and that may persist a while longer. Public sector banks have two supports right now: bad loans are still falling, and they are also significant beneficiaries of the cheap foreign-currency money arriving through the RBI’s swap window,” Gaikar said.

“Private sector banks retain the structural levers: a richer loan mix, better pricing power and stronger fee income. The gap widens in FY27, but gradually, rather than dramatically, as these structural advantages become more visible over time,” Gaikar told Fortune India.

Further into this year, with the cost of funds for banks coming largely under control, banks will start to become aggressive lenders in the SME, commercial banking and medium aggressive in retail banking, feel analysts.