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We view 2QFY27 as a one-off quarter, with significant FCNR(B) mobilization driving system loan growth of 18% yoy through leverage, while deposit growth accelerated to 17% yoy as of 15-Sep-26. We expect overall system growth to trend down to ~16% in FY27. Excluding FCNR(B) leverage, organic loan growth is trending better across banks. Our discussions suggest that incremental FCNR(B) funds will be used to retire high-cost liabilities and be partly deployed into investments and gradually into loans, with banks likely to take 2 quarters to fully absorb the liquidity. NIMs may remain compressed in 2Q due to the FCNR(B)- led inflow but should gradually recover in 2H as banks retire high-cost liabilities, deploy liquidity into loans, and benefit from the recent rate hike (particularly banks with high floating-rate loans). Asset quality remains benign, though we remain watchful of external risks, including El Niño and drought. We expect our banking coverage universe to report 25.4% yoy profit growth, led by 24.6% growth for PVBs and 26.2% for PSBs, driven by 12.5% yoy NII growth, 17.2% PPOP growth, and an 8.7% decline in provisions. SBI, BOB, and INBK are likely to see higher other income, supported by gains from stake sales, while treasury gains should remain muted amid elevated yields. We view clarity on MD/CEO succession at HDFCB and KMB positively. We prefer KMB and HDFCB among large PVBs; KVB, RBL, and FB among SMID PVBs; UJJIVANS among SFBs; and SBI and INBK among PSBs.

Strong business growth, driven by FCNR(B) mobilization

Overall system credit growth remains strong, at 18.1% yoy as of 15-Sep-26, led by sustained retail momentum and healthy MSME and corporate growth, and aided by FCNR leverage, as reflected in 43% yoy growth in advances against FDs. Deposit growth also accelerated to 17.3% yoy from 12% in Jun-26, primarily driven by strong FCNR(B) deposit mobilization, resulting in a moderation in the LDR to ~81% from 83% earlier. A similar trend is visible across bank business updates, with PVBs/PSBs reporting healthy loan growth of >15% yoy; for deposits, growth for PVBs remains healthy at >15%, while for PSBs, it jumped to >10% yoy. We expect loan growth to remain strong, with PVBs likely to report 21% yoy/~8% qoq growth, PSBs ~19% yoy/~6% qoq, and SFBs ~30% yoy/~7% yoy, supported by FCNR leverage through overseas branches/GIFT City, while organic loan growth also remains healthy across banks. Deposit growth is also expected to remain healthy, with PVBs likely to report 20% yoy/~7.5% qoq growth and PSBs to clock 12.4% yoy/~5% qoq growth, supported by strong FCNR(B) mobilization. However, our discussions with banks suggest that these incremental FCNR(B) funds will be used to retire high-cost liabilities, partly deployed into investments and gradually deployed toward loans. Overall, banks are likely to take around two quarters to fully absorb the incremental liquidity.

Margins to compress on FCNR(B)-led liquidity inflow

With significant liquidity mobilized through FCNR(B) deposits and leverage against the same, bank NIMs are likely to witness compression in 2Q. However, we suggest focusing on NII growth for the quarter. Further, the recent 25bps rate hike should benefit banks with a higher proportion of floating-rate loans, largely PVBs, relative to fixed-rate lenders. We expect margins to gradually recover, supported by the retirement of high-cost liabilities and deployment of excess liquidity toward loans. We expect margins across our coverage universe to decline by 1–32bps qoq, with large PVBs seeing 7–32bps compression; IIB is likely to witness the sharpest decline of 32bps. For SMID PVBs, we expect margins to remain flat to decline by 31bps, with IDFCFB likely to see a 31bps compression, while RBL’s margin is expected to improve by 52bps, aided by the full-quarter impact of NBD Capital infusion. For PSBs, we expect margin compression in the range of 1–9bps qoq.

Asset quality remains benign, with decline in slippages, controlled credit costs

Fresh stress formation continues to ease across unsecured retail portfolios, including MFI, personal loans, and credit cards, while we expect slippages to decline qoq, supporting further improvement in asset quality. Management commentary suggests no material impact on MSME portfolios from external factors such as El Niño and geopolitical conflicts so far. However, we remain watchful of the broader macro environment, external events, and the evolving drought situation.

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