Shrinking margins, lagging deposit growth, and sputtering demand for credit are likely to make the financial year ending March 2026 a tough one for India’s banks.While the Nifty Bank has outperformed Nifty50 (up 4.28%) this year so far, the forecast has only gotten dimmer for banking stocks, particularly after the recent growth warning from the country’s largest lender, State Bank of India. Chart as at 1:38 pm on May 29
The Reserve Bank of India has already cut interest rates by 50 basis points this year. Markets expect another 25-50 basis points rate cut in the coming months. This will squeeze lending rates lower and thereby, profit margin for banks because the cost of funds may take longer to fall. “Margins are likely to be under meaningful pressure,” said Rikin Shah of IIFL Capital, who expects them to fall by 20-25 basis points over the next three quarters. 100 basis points make a percentage point. A recovery may not happen until FY27, Shah added.One of the big reasons is that bond yields are falling fast. The 10-year government bond yield has dropped to 6.7%, a three-and-a-half-year low, partly due to the surplus liquidity resulting from the RBI’s record ₹2.7 lakh crore dividend to the government. While that’s good news for borrowing costs, it’s not so great for banks that make a spread based on the bond yields. If money market borrowings are significantly cheaper than bank rates, the borrower may naturally opt for the former.On the other hand, since early 2022, banks have seen credit grow faster than deposits, pushing the lenders to borrow via certificates of deposit (CDs)—short-term borrowing instruments that are costlier than regular deposits and more sensitive to shifts in liquidity.The pressure is already visible in the money market where average daily volumes rose 10% in FY25 to ₹5.5 lakh crore, reflecting banks’ growing reliance on short-term funding, according to the central bank’s latest annual report.While deposit costs may ease over time, the benefit won’t be immediate. Banks will likely continue to feel the pinch for a few more quarters.In the meantime, the demand for loans seems too sluggish for investors’ comfort. Annual non-food credit from scheduled commercial banks grew 12% at the end of March 2025 compared to 16.3% a year earlier. And, it isn’t improving in a hurry.UBS expects it to improve credit growth to hit 12% by the end of the current financial year, helped by government stimulus and easier liquidity, but that isn’t a lot. “Return on assets (RoA) in FY26 is likely to go down by 10 to 20 basis points,” Ashish Gupta, Chief Investment Officer at Axis AMC, said. RoA is a measure of profitability that shows how well a lender is using its assets to generate profit.Many large corporates are borrowing through bond markets or external commercial borrowings instead of going to banks. And while retail lending could see some support from falling rates, low-yield segments like home loans may not offer much help on the margin front.(Edited by : Sriram Iyer)First Published: May 29, 2025 1:52 PM IST
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