Banks Brace For Margin Pressure In First Half Of FY26, Recovery Expected From Q3: Citi
Margins are expected to bottom out in the third quarter, with a gradual improvement from fourth quarter onwards as deposit costs catch up.
Kunal Shah, head of banks and financials director at Citi, outlined a two-phase outlook for Indian banks in fiscal 2026, highlighting margin pressures in the first half due to repo rate cuts and repricing of external benchmark linked rate loans.
Margins are expected to bottom out in the third quarter, with a gradual improvement from fourth quarter onwards as deposit costs catch up, potentially leading to a 25-30 basis points margin expansion by FY27.
Banks have already initiated deposit rate cuts, with private banks reducing savings deposit rates by 25 bps and term deposits by a cumulative 45 bps, Shah said.
This proactive adjustment is expected to ease funding costs over the next 18-20 months, supporting margin recovery, he said.
On asset quality, unsecured lending is stabilising among leading banks, though microfinance institutions may face elevated credit costs for a few more quarters. MSME and corporate segments remain resilient, with no significant spillover from stressed sectors. Credit costs and operational efficiencies are anticipated to underpin earnings growth despite some pressure on net interest income.
Top banking picks include HDFC Bank Ltd., ICICI Bank Ltd., and Kotak Mahindra Bank Ltd. They are expected to deliver steady earnings growth as margin pressures ease and credit costs remain manageable.
Shah recommends selective exposure to NBFCs, particularly those like Shriram Finance Ltd., with strong pricing power and funding cost benefits in used vehicles, business lending, and affordable housing segments.
This nuanced outlook aligns with broader industry trends where banks are balancing margin pressures with improving credit quality and operational efficiencies, setting the stage for a more stable financial sector in FY27.
