Banking Sector Rebound: How India's Lenders Are Hitting an Inflection Point

The report highlights that following "flattish" earnings in FY26, banks, particularly in the private sector, are expected to see a significant revival backed by improving loan growth dynamics, a cyclical recovery in net interest margins (NIMs), and easing stress in unsecured retail portfolios.

"We believe banks' earnings are at an inflection point - following flattish growth in FY26, we expect a strong rebound to 21%/14%/18% cagr for Pvt/PSU/ overall banks over FY27-28E," noted the report.

According to the brokerage, private banks' earnings are projected to grow at a robust 21 per cent CAGR over FY27-28, while public-sector banks (PSBs) are seen delivering 14 per cent CAGR. At the aggregate level, the sector is likely to record an 18 per cent CAGR, marking a strong turnaround from the muted profitability visible in FY26.

A key driver of this uptrend is the bottoming out of loan growth. The report notes that while credit expansion has shown early signs of stabilisation, the recovery will likely be modest rather than aggressive. Much of this improvement is expected to come from a revival in consumption demand, supported by recent fiscal and monetary easing.

However, structural factors, such as bond-market disintermediation and sensitivity of home-loan demand to lower interest rates, will keep overall credit growth in check.

The second pillar of the anticipated earnings revival is a cyclical improvement in NIMs. With the Reserve Bank of India having already infused durable liquidity and initiated a CRR cut, banks are expected to experience a 7-9 bps expansion in NIMs. This, along with the repricing of term deposits, should offset the impact of another likely 25-bps policy rate cut. However, the report stresses that NIM recovery will be slower for state-run banks compared to their private counterparts, given the lag in MCLR-linked lending rate adjustments.

The third factor contributing to improved profitability is the expected easing of asset-quality pressures in unsecured retail products. Bureau data indicate cooling stress levels in personal loans and credit cards, while corporate asset quality remains benign.

Large private banks, in particular, face minimal MSME-related risks, helping keep credit costs contained. Even though provisioning may rise marginally in FY26 due to ageing-related requirements, credit costs are forecast to improve by 8 bps in FY27 as slippages recede.

Overall, IIFL believes the risk-reward for India's banking sector remains favourable. With earnings momentum accelerating and valuations still inexpensive relative to the broader market, the brokerage expects the sector to see re-rating tailwinds.

- ANI