Bottoming Of Earnings Cuts Critical For Banking Sector To Do Well, Says Study

The Bank Nifty's returns were three percentage points lower than the NSE Nifty 50's in 2024, according to an analysis by IIFL Capital Services.

While the private banks' index witnessed a flat growth, the benchmark of the PSU banks was up by 14%. This, even as the PSU banks underperformed private banks in the second half.

"While valuations are inexpensive, we are still not constructive, given tepid earnings growth of 6% YoY in FY26E," it said, adding that it believes that "the bottoming of earnings cuts is critical for the sector to do well". And, it expects more earnings cuts.

PSU banks outperformed private banks by 120 percentage points over a three-year period, even as they underperformed by six percentage points in the second half of 2024.

Most PSU banks, excluding Bank of India, delivered good returns, while private banks Karur Vysya Bank Ltd., ICICI Bank Ltd. and City Union Bank Ltd. were among those that did well.

This underperformance aligns with earnings revisions. Private banks witnessed significant earnings per share cuts of 4–60%, while the PSU banks saw upgrades of 5–35%, according to the study.

In the near term, the study expects an upside for the PSU banks, especially State Bank of India and Bank of Baroda due to their correction of 27% from their peak, as well as due to their more stable earnings.

It has upgraded SBI to "buy" from the earlier suggestion of "add". However, among private banks, its preferred picks for the medium term were HDFC Bank, ICICI Bank, and Axis Bank. When it comes to loans, growth slowed down to 11% year-on-year compared to 16% in financial year 2023-24.

According to the IIFL study, banks' loan growth is expected to remain subdued at around 12% year-over-year in FY26 due to slowdowns in unsecured loans, vehicle loans and corporate lending.

While the gap between loan and deposit growth has narrowed, the research pointed out that the growth potential of some private banks was limited due to their loan-to-deposit ratios being high.

Deposit Share

Deposit-wise, the study expects private banks to maintain a lead over their public-sector counterparts in FY26. Growth for PSU banks has weakened to 9% YoY versus 16% for private banks. This, the study pointed out, was on account of private banks foraying into semi-urban and rural areas, as well as due to weakening government business. PSU banks have lost 15–70 bps of deposit market share.

Net Interest Margin

The report forecasted divergent outcomes for banks' net interest margins. Before the rate cuts, it expects the NIMs of some lenders like ICICI Bank, Kotak Mahindra Bank Ltd. and Axis Bank to witness a slight decline.

Post rate cuts, it expects most banks to witness the NIM declines. However, HDFC Bank Ltd. is expected to be less affected due to its interest rate swap book.

Unsecured Loans

The study expects credit costs to increase due to widespread stress in unsecured loans. It pointed to concerns also rising for microfinance institutions, vehicle financing, agriculture, and micro, small and medium enterprises loans.

While the MFI stress is yet to peak out, the asset quality of vehicle financiers is deteriorating, the report added. "We are monitoring Agri and MSME loans for potential risks."

Regulatory Tightening

There's a possibility of moderation in regulatory tightening, potentially including lower interest rates and delays or revisions to some draft regulations.

The study expects regulations to "potentially moderate and become more growth supportive, with lower rates (50 bps cut) and watered down, or a delay in various draft regulations" like liquidity coverage ratio, project finance, overlapping business, and expected credit loss.