Indian Banks' earnings growth forecast halved amid economic caution and high deposit costs

Synopsis

Indian banks are facing a significant slowdown in earnings growth, potentially halving to 6.5% in FY26 due to a cautious economy and reduced core profits. Muted credit demand, high deposit costs, and RBI's measures to control unsecured lending contribute to this deceleration. However, a rebound to 16.1% is expected in FY27 with anticipated rate cuts and improved demand.

Mumbai: The pace of earnings growth could halve at Indian banks, which together make up about a third of the Nifty's weighting, with experts attributing the foreign funds-heavy sector's deceleration in FY26 to a circumspect economy, narrower core profits, muted credit demand, and persistently high deposit costs.

"The banking sector's earnings growth has witnessed successive moderation-from 39.3% in FY23 to 12.8% in FY25," said Nitin Aggarwal, head, BFSI, Motilal Oswal Securities. "In FY26, we estimate earnings growth to moderate to 6.5%, with the first half being more muted. We also estimate FY27 earnings growth to recover to 16.1%."

Some analysts have pencilled in aggregate growth at 2%, with policy rates dropping a full percentage point in four months, prompting an immediately lower pricing for a majority of loans tied to the external gauge. Most analysts, however, expect earnings growth in the lending sector to rebound in FY27.

Agencies

"We expect earnings growth for our covered banks to remain subdued at 2% on year in FY26 and improve to 16% on year in FY27," Ankit Bihani, associate, Nomura Financial Advisory and Securities (India), said. "Earnings cuts have been sharper for MFI lenders like Bandhan and IndusInd Bank. FY26-27 EPS cuts for large private banks have been 0-8% and PSU banks 6-10%, led by moderation of NIMs amid the rate cut cycle."

The recent deceleration in credit growth and the downgrade in earnings growth is the result of RBI's calibrated actions to rein in unsecured consumer credit which has triggered a slowdown in personal and services credit, which together account for over 70% of the total growth slowdown. Credit growth has dropped sharply from 16% a year ago to under 10% now.

While bank credit to NBFCs, down to 3% on year, has driven much of the decline in services credit, a drop in unsecured credit growth has also weighed on the expansion in personal loans. Tight liquidity in the system, due to persistent forex outflows, continued well into March 2025, further constraining banks' lending capacity.

A weakened risk appetite among banks, driven by emerging asset quality concerns in microfinance and credit card book, prompted banks to pull back on credit growth toward the latter half of FY25. "We forecast a rebound to 13% in FY26, around 100 bps ahead of consensus, supported by a favorable base, improving demand from consumers, NBFCs, and the agri segment, and aided by both rate cuts, liquidity surplus, CRR easing and fiscal measures like budget tax cut stimuli," said Pranav Gundlapalle, head of India financials at Bernstein.

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