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The Indian banking industry will reach an "inflection point" in the third quarter of the current financial year (Q3FY26), seeing a meaningful earnings recovery thereon, believes domestic brokerage Motilal Oswal.
This, the brokerage said, will be in the backdrop of easing deposit cost, improving liquidity, and stablising asset quality, supporting the banks' margins and profitability. This recovery is said to set the tone for FY27's double-digit earnings growth.
-Deposit cost repricing: As banks continue to reset term deposit (TD) rates and cut savings deposit rates, funding cost pressures are expected to ease. This is expected to provide some relief to NIMs from Q3FY26 onwards.
-CRR cut impact: The phased reduction in cash reserve ratio (CRR) by 100 bp, starting September 2025, will inject durable liquidity (estimated at ₹2.5 trillion), enhancing systemic liquidity and aiding margin stabilisation.
-Credit cost normalisation: Asset quality pressures, particularly in unsecured retail and Microfinance Institution (MFI) segments, are showing early signs of stabilisation. This should translate into lower credit costs for banks, particularly for mid-sized and MFI-heavy lenders.
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NIMs to remain under pressure in the near term
Despite the positive outlook, Motilal Oswal expects overall net interest margins (NIMs) of the banking industry to remain under pressure in the first two quarters of the current financial year. The continued transmission of a cumulative 100-basis point (bp) repo rate cut is expected to weigh on lending yields, with its full impact likely to play out during Q2 and Q3FY26.
Private banks hold better than PSBs
While the Weighted Average Lending Rate (WALR) on fresh loans surprisingly increased for private banks by 7 bps month-on-month (M-o-M) in May 2025, for public sector banks (PSBs), WALR decreased by 8 bps M-o-M. As a result, sectoral-level fresh rupee loan yield declined 6 bp M-o-M as against a decline of 5bp/9bp in Mar’25/Apr’25.
The WALR is the average interest rate a bank charges on its loans, considering the proportion of each loan in the bank's total lending portfolio
On outstanding loans, the WALR declined marginally by 1 bp M-o-M, as private banks’ WALR surprisingly increased 2 bps M-o-M, while PSBs’ WALR decreased 2 bps M-o-M.
Deposit costs easing
Motilal Oswal noted that the Weighted Average Term Deposit Rate (WATDR) declined marginally by 4 bps M-o-M to 7.07 per cent. During Feb-May 2025, the WATDR for PSBs declined 4 bps, while for private banks, it increased 4 bps. WATDR represents the average interest rate banks pay on term deposits.
Although the data does not directly reflect changes in savings account rates, most banks have implemented savings account rate cuts, with reductions ranging from 20 bps to as much as 100 bps in select buckets, the brokerage note said. These changes, along with savings account rate revisions, are expected to translate into easing funding costs from Q2FY26 onwards.
Investment strategy
Despite near-term headwinds, Motilal Oswal maintains a positive stance on select largecap banks. The brokerage’s top picks include ICICI Bank, HDFC Bank, and State Bank of India, citing their robust balance sheets, strong liability franchises, and healthy provision coverage ratios (PCRs).
These factors, the note said, should help these lenders navigate the current margin pressures better and benefit from a potential recovery in the second half of FY26.
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