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MOFSL BFSI picks 3.0: Earnings rebound and reasonable valuations to drive sector performance

Remain constructive on the sector; stance tilting in favor of banks amid better earnings outlook

* Over the past 12 months, the Nifty Financials and Nifty Bank Index have outperformed the Nifty 50 by 11% and 7%, respectively. However, banking stocks continue to show divergence, with both Private and PSU banking segments delivering mixed returns.

* While our bias was tilted towards NBFCs and non-lending financials in earlier editions, we are now incrementally adopting a more balanced view, as we expect the performance of banking stocks to improve with an impending recovery in earnings.

* Additionally, management commentary is turning constructive. This, coupled with a demand uptick led by the GST rate cut and potential resolution on tariffs (as negotiations have resumed), is expected to boost investor sentiment.

* Even as the macro-environment continues to evolve at an unprecedented pace, the biggest challenge we face is event risk. This has adversely impacted the performance of some of our BFSI picks. However, we take comfort in the fact that despite these external events impacting prices, the aggregate performance of our model portfolio remains strong. This resilience, supported by multiple winners, has resulted in the portfolio’s outperformance against both Nifty and Bank Nifty.

* In this note, we present an updated view along with a refreshed list of our top 16 BFSI stocks, selected from our overall BFSI coverage of ~70 stocks. Please refer to Exhibit 1 for details on the MOFSL BFSI picks 3.0. Below, we summarize our insights on various BFSI segments and highlight our preferred ideas:.

Banks: Headwinds continue; earnings growth on the cusp of turnaround

* The banking system has witnessed a deceleration in credit growth to ~10% YoY, led by moderation in key retail and corporate segments. The reduction in GST rates, coupled with lagged benefits from income tax cuts, is expected to drive demand and support loan recovery over 2HFY26. We project credit growth of 11% for FY26, with further acceleration to ~13% in FY27E.

* Sector earnings growth has turned negative due to margin pressure from elevated funding costs and yield compression arising from the transmission of repo rate cuts. Additionally, asset quality stress in unsecured loans and sectors like MSME and CV continues to weigh on near-term profitability.

* Despite these headwinds, signs of stabilization are emerging. Deposit repricing is underway, and the phased CRR cuts are expected to ease liquidity constraints, thereby supporting margin recovery. Additionally, improvements in unsecured retail stress (MFI) and a moderation in credit costs over 2H will support medium-term earnings. We estimate FY27 earnings growth to recover to ~18.4% (~3% YoY growth in FY26).

Nifty Financials and Bank Nifty indices outperform Nifty 50 index

* Over the past 12 months, the Nifty Financials and Bank Nifty indices have outperformed the Nifty 50 by 11% and 7%, respectively. However, banking stocks continue to show divergence, with both Private and PSU banking segments delivering mixed returns. Notably, the market-cap weighted return of our model portfolio (~12%) exceeds indices’ returns, with Nifty 50, Nifty Bank, Nifty Financials, and BSE-200 all reporting 9-11% returns.

* The Nifty Private Bank Index delivered a modest 3% return over the past 12 months, even as large-cap banks such as HDFCB, ICICIBC, and Kotak Bank delivered healthy returns of 16%, 12%, and 9%, respectively. Mid-sized PVBs, including RBL Bank, CUB, and KVB, led the pack with returns of 27%, 22%, and 14%, respectively. On the other hand, IIB was the biggest underperformer due to reported accounting discrepancies. We upgraded RBL Bank in Apr’25 after a gap of nearly two years, and the stock has since delivered ~45% returns following the upgrade.

* The NBFC sector has recently shown subdued performance in asset quality and loan growth. Stress is evident in CV, micro-LAP, and small-ticket unsecured MSME loans, as asset quality challenges have spilled from unsecured (MFI) to small-ticket secured segments. While rate cuts are expected to support margins (in select products) and boost demand, lenders are prioritizing high-quality lending with tighter underwriting standards. Recent GST rate cuts could stimulate consumption, potentially improving demand and auto volumes. AB Capital, LTFH, BAF, Muthoot, and MGFL have all delivered returns ranging from 30% to 50% over the past 12 months.

* The non-lending financial sector witnessed mixed performance, with a sequential recovery in capital market players, subdued performance for general insurers, and steady performance by life insurers. The AMC space continued its healthy momentum, led by strong SIP inflows and robust fund performance among listed players. However, exchanges and brokers witnessed muted stock performance in the recent past, led by expectations of further regulatory clampdown on F&O volumes. BSE, HDFC AMC, and Anand Rathi delivered sixmonth returns of 69%, 49%, 58%, respectively, in six months. Life insurance companies reported a healthy 1Q performance, led by a product mix shift towards non-par policies, which boosted VNB margins. The reduction in GST rates may further improve the IRR on non-par products, enhancing the business mix. Max Life, HDFC Life, and SBI Life posted steady six-month returns of 53%, 21%, and 26%, respectively, over the past six months. The general insurance segment continued to underperform due to changes in accounting (1/n regulations), muted auto sales growth, and weak economic activity impacting sales of commercial lines products..

Private Banks: Performance remains divergent amid sector challenges

* Business momentum has been modest, with NIMs declining sharply due to the transmission of repo rate cuts and elevated stress in unsecured lending segments. CASA mix also moderated following the seasonal CA flows in 4Q. Growth in corporate was sluggish, and unsecured loan growth has weakened amid stress in MFI, PL, and CC. Meanwhile, MSME and vehicle finance portfolios also showed signs of moderation, further pressuring portfolio growth and overall lending yields.

* Margins are expected to contract further in 2QFY26. However, most banks have already implemented SA and TD rate cuts, and the phased reduction in CRR effective Sep’25 should help recoup margins in 2H. 

* Unsecured retail stress shows early signs of easing, but challenges persist in cyclical sectors like CV loans and MSMEs, with credit costs expected to normalize in 2HFY26. Large private banks with more diversified and secured portfolios continue to fare better.

* We expect PVBs to report an earnings CAGR of ~20% over FY26-28, with growth bottoming out at ~5% in FY26. Preferred Buys: ICICI, HDFCB, and Federal Bank.

PSU Banks: Modest earnings growth amid margin pressure

* Margins for PSBs contracted due to their quicker loan repricing cycle; however, robust treasury gains helped limit any material dent to earnings.

* Slippages remained well-contained for most PSBs, supported by minimal exposure to unsecured lending. The GNPA ratio was stable or lower across the board, with PCR levels healthy at ~75-90%. The normalization of credit costs over the coming years, along with the transition to ECL, will be closely monitored.

* RoA for PSBs has largely matured, and we expect earnings growth to remain modest. We estimate PSB earnings growth to sustain at a 14% CAGR over FY26- 28 vs 38% CAGR over FY22-25. Preferred Buys: SBI, CBK, and INBK.

SFBs: Operating performance to improve led by AQ recovery.

* Small Finance Banks (SFBs) faced significant challenges, mainly due to elevated stress in MFI and unsecured loans. However, collection efficiencies are seeing some improvement. The new MFIN guardrails implemented in FY26 are expected to keep growth measured while aiding gradual improvement in asset quality. However, some lenders anticipate that elevated stress in the MFI segment could persist until 3Q, keeping credit cost risks tilted upward. We expect credit costs to stay high through 1HFY26, before moderating in 2H.

* Margins have witnessed moderation due to repo rate cut, elevated funding costs, and the declining mix of high-yielding MFI segment. We estimate nearterm NIMs to remain under pressure. However, recent SA and TD rate cuts, along with the phased benefit from the CRR reduction, are expected to keep funding costs lower and enable a gradual margin recovery. Preferred Buy: AUBANK.

Payments and Cards: Reiterate Neutral on SBICARD and PAYTM

* SBICARD: SBICARD’s provisioning remains elevated, reflecting persistent AQ concerns. Receivables are expected to grow 10-12% YoY, and we anticipate an improvement in card sourcing and volumes over the medium term. NIMs are likely to expand at a calibrated pace, aiding gradual RoA recovery. Reiterate Neutral.

* PAYTM: The company reported its maiden operational profit in 1QFY25, led by disciplined cost control. Disbursement growth remains healthy, supported by strong traction in the merchant business. We estimate significant earnings expansion over FY26-28 but reiterate a Neutral rating.

NBFCs: Growth trends divergent; earnings outlook to improve in 2H

* NBFCs have posted a subdued performance amid a challenging macroenvironment, with mixed growth and AQ trend across different segments. Vehicle financiers clocked 18% YoY growth, large HFCs grew at a modest 9% YoY, while affordable and small-ticket HFCs saw a 13% YoY increase. Gold lenders reported a solid AUM growth of 22-40% YoY, while MFI players continued to exhibit moderation, with loan book declining between 1% and 58% YoY as of Jun’25.

* For VFs, AQ deterioration was driven by seasonality and lower vehicle utilization caused by the early onset of monsoons, which pressured borrowers’ cash flows. However, trends are likely to improve in 2HFY26. VFs also noted that the broader macro weakness (partly due to muted capex activity) has necessitated higher collection efforts.

* NIM trends differed across HFCs, with large players like LICHF seeing margin contraction, while affordable HFCs benefited from lower funding costs and stable yields. We estimate sector NIMs to improve in 2HFY26 as the benefits of lower borrowing costs from rate cuts gradually flow through.

* NBFC-MFIs showed improvement in PAR levels across geographies, including Karnataka. Sequentially lower credit costs were supported by steady collection efforts and reduced PAR accretion. MFIs (except Spandana) reported better collection efficiency, with expectations of continued progress in the coming quarters, enabling faster normalization in credit costs.

* We continue to remain optimistic about a recovery in the NBFC sector in 2HFY26, supported by lower borrowing costs providing NIM tailwinds and GST rate reduction boosting consumption and loan volumes. Preferred Buy: SHFL, LTFH, ABCL, and HomeFirst

Capital market: Structural story intact; regulatory actions a key monitorable

* The capital market witnessed a healthy recovery in 1QFY26, led by steady growth in cash volumes and strong traction in commodities, though F&O activity softened due to regulatory changes. BSE benefited from higher premium turnover and improved non-expiry day trading, while MCX saw robust gains from surging bullion and energy contracts.

* Among brokers, ANGELONE reported sequential revenue growth, aided by MTF activity, though profitability was impacted by IPL spends and new business investments. Certain regulatory actions, such as the Jane Street ban (which impacted Nuvama’s volumes) and SEBI’s potential move to increase the tenure of expiry contracts, have also adversely impacted sector performance.

* The AMC industry, however, delivered strong performance, with QAAUM rising to INR72.1t, driven by record SIP inflows and sustained equity participation. SIP inflows reached an all-time high at INR273b in Jun’25, underscoring resilient retail participation.

* Wealth managers remain optimistic about sustaining flow momentum, with yields expected to remain broadly stable in the near term. We continue to closely monitor the impact of recent regulatory changes, as they have influenced stock price movements and financial performance. Preferred Buys: Nuvama, HDFC AMC, and ABSL AMC.

Insurance: Life insurance poised for stronger growth in 2HFY26

* The life insurance industry witnessed muted growth in 1QFY26, with ULIP momentum slowing on a high base. Private players drove ~10% YoY APE growth, compared to muted ~2% for LIC. A favorable shift in the product mix towards traditional products boosted VNB margins across players, supported by higher ticket-size products, better persistency, and improved rider attachment.

* HDFCLIFE, SBILIFE, and MAXLIFE reported strong APE growth with margin expansion, while IPRU saw a decline in APE despite margin gains. Surrender charges implemented from Oct’24 impacted 2HFY25 growth. However, with GST benefits and a favorable base, 2HFY26 is expected to see strong growth for life insurance.

* General insurers reported subdued growth, with a soft recovery in the motor segment and the health segment impacted by accounting changes (1/n regulations). Pricing actions emerged as a key lever to protect margins, with STARHEAL and NIVABUPA implementing price hikes to counter medical inflation. ICICIGI gained market share in retail health while maintaining discipline in motor, although health claims ratios remained elevated.

* NEP growth was healthy for ICICIGI/STARHEAL/NIVABUPA at 14%/12%/20%. However, sustained margin expansion will hinge on continued pricing adjustments and better claims experience. The abolition of GST on insurance products, in the absence of input tax credit, may adversely impact sector profitability. Additionally, while GST rate cuts may boost vehicle sales, the reduction in vehicle prices could adversely impact motor premium growth.

MOFSL BFSI picks 3.0: Remain constructive on the sector; earnings turnaround and reasonable valuations to drive performance

* From our bias being tilted toward NBFCs and non-lending financials in the earlier editions of this note, we are incrementally taking a more balanced view as we expect sector performance to improve with an impending recovery in earnings. Additionally, management commentary is turning constructive, which, coupled with a demand pickup driven by the GST rate cut and potential tariff resolutions following resumed negotiations, is likely to support investor sentiment.

* Banks: We continue to prefer large cap banks as their valuations appear reasonable given the earnings outlook. These banks stand out due to their strong balance sheets, healthy PCR, and relatively better growth prospects, which are expected to enable a steady earnings trajectory. We estimate private banks’ earnings to post ~20% CAGR over FY26-28, while PSBs are expected to post a 14% CAGR over the same period. ICICIBC, HDFCB, and SBIN are our top large cap picks. In mid-size banks, we prefer AUBANK.

* NBFCs: Vehicle financiers are expected to benefit from GST cuts, although asset quality will remain under close watch in the near term. SHFL remains our preferred pick in this segment. Large HFC: We maintain our preference for PNBHF as we continue to like the franchise and believe that the stock has corrected significantly post the sudden CEO resignation. We expect the company to deliver steady growth and margins, led by a change in the product mix. We also like Aavas Financiers as with the new Promoter CVC Capital Partners in the driver’s seat, it is working closely with the senior management of Aavas to front-end the branch expansions and expand in newer Southern States in India (where affordable housing business has traditionally been strong). With the digital transformation now complete, we expect Aavas to now embark on a stronger AUM growth trajectory. NIM will improve during the course of FY26 because of the decline in its CoB. At current valuations of 2.3x FY27E P/BV, we believe that there is very little downside risk in Aavas. Diversified: We continue to prefer AB Capital (due to its steady execution across all its businesses) and LTFH, as receding sectoral pain in MFIs is expected to drive improved growth and profitability.

* Life & General Insurance: We like Max Financials given its (1) above-industry growth trajectory, (2) robust agency channel, at a time when the broader industry is pivoting towards agency-led distribution and (3) higher share of nonpar products, which should prove favorable in a declining interest rate environment. Additionally, a favorable outcome on the proposed reverse merger could serve as a further tailwind for the stock. Among general insurers, we prefer Niva Bupa for its diversified distribution network and strong management team.

* Capital Markets: We prefer Aditya Birla AMC for its strong fund performance and reasonable valuations. We also continue to like HDFC AMC as we maintain our structurally positive view on the AMC space. NUVAMA remains our preferred pick in the wealth management space, given our expectation of improved profitability in medium term though Jane street ban could impact near term volumes. CAMS remains our preferred pick amongst the intermediaries and we have added this to our MOSL BFSI picks.

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