Banks Q2 Preview: FCNR(B) Inflows Lift Growth But Squeeze Margins

Indian banks are expected to report healthy earnings growth in the September quarter, supported by strong loan growth and stable asset quality, but fresh FCNR(B) deposit inflows are likely to put pressure on reported net interest margins (NIMs). Analysts expect large private banks to lead core operating profit growth, while weaker treasury income could weigh on public sector lenders despite one-off gains from stake sales.

The key distinction for investors will be between reported growth and underlying operating performance. FCNR(B)-linked funding has boosted loan and deposit growth, but analysts say the resulting pressure on reported margins does not necessarily indicate a deterioration in core lending spreads.

The outlook for private lenders is stronger than that for public sector banks, although the margin impact is expected to vary with their exposure to FCNR(B)-linked funding. Nomura expects core PPOP growth at private banks to reach 18% year-on-year, compared with 16% for public sector banks. It also expects growth at the four largest private lenders to accelerate for a second consecutive quarter, led by ICICI Bank, Axis Bank and Kotak Mahindra Bank. For state-owned lenders, weaker treasury income is likely to weigh on operating performance, with one-off stake-sale gains expected to support reported profits at State Bank of India and Bank of Baroda.

The key earnings driver this quarter is how banks deploy the additional FCNR(B) liquidity and whether the resulting funding benefits offset the dilution in reported margins. Banks have used some of the inflows to reduce their reliance on expensive bulk deposits and certificates of deposit, which could lower funding costs in the second half of FY27. However, leveraged overseas lending, a higher share of lower-margin international assets and additional standard-asset provisioning complicate the reported numbers. The distinction matters because analysts expect underlying loan growth and core earnings to remain healthy even as headline margins decline.

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Here's what analysts expect from banks' Q2FY27 results:

Bank of America

• Large private banks: FCNR(B) inflows are expected to be healthy at HDFC Bank and Axis Bank, though below ICICI Bank. Normalised NIMs and the deployment of the funds will be key measures of underlying performance.
• Mid-sized banks: Core margins and loan growth will be important, alongside any early signs of weaker monsoon conditions affecting unsecured lending and microfinance portfolios. RBL Bank and IndusInd Bank are expected to report relatively better results in the segment.
• Public sector banks: Earnings are expected to remain steady, with less distortion from FCNR(B) flows. SBI, Punjab National Bank and Bank of Baroda are the brokerage's preferred names heading into results.
• Overall outlook: Underlying bank performance is expected to remain stable despite temporary distortions to several reported profit-and-loss items.

Nomura

• Core earnings: Banks under coverage are expected to report 17% year-on-year growth in core PPOP, supported by 12% growth in NII and contained operating costs.
• Private versus public sector banks: Private banks are expected to deliver 18% growth in core PPOP, compared with 16% for public sector banks. Among the four largest private lenders, ICICI Bank, Axis Bank and Kotak Mahindra Bank are expected to lead.
• Credit and deposits: FCNR(B)-linked funding lifts headline loan growth to 11-30% year-on-year and deposit growth to 9-29%. Underlying growth remains healthy even after excluding loans linked to the funding flows.
• Funding costs: Banks have used the additional liquidity to retire expensive bulk deposits and certificates of deposit. This could support funding costs in the second half of FY27.
• Margins: Large private banks are expected to report sequential NIM declines of 2-10 basis points, driven mainly by changes in funding and asset mix rather than weaker underlying earnings.
• Asset quality: Credit costs are expected to remain contained at 40-65 basis points for large private banks. A modest sequential decline in return on assets is expected at HDFC Bank, Axis Bank and Kotak Mahindra Bank as their balance sheets expand faster than profits.
• Preferred stocks: HDFC Bank, Kotak Mahindra Bank and ICICI Bank among large lenders, and IDFC First Bank and IndusInd Bank among mid-sized banks.

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Citi

• Margins: Reported NIMs are expected to fall by 5-15 basis points as FCNR(B)-linked deposits enlarge the balance sheet and overseas lending carries lower incremental margins. Citi expects the underlying margin trend to remain firm after adjusting for these distortions.
• Deposit growth: Sequential deposit growth is expected to be led by RBL Bank, at 26%, followed by Kotak Mahindra Bank and Yes Bank at about 11%. ICICI Bank and Axis Bank are projected to grow deposits by 8-9%.
• Credit growth: FCNR(B)-linked overseas lending is expected to inflate reported credit growth by 2-5% on average, with a larger impact at RBL Bank. Citi expects sequential credit growth of 5-10%, led by RBL Bank at about 14%.
• Credit costs: Standard provisioning on FCNR(B)-linked overseas exposures is expected to add 2-10 basis points to credit costs. Citi estimates credit costs of 2% at RBL Bank, 1.5% at IndusInd Bank and 1% at AU Small Finance Bank.
• Operating costs: Overseas borrowing expenses could weigh on operating costs, while fee income from leveraged loans and foreign exchange income may provide some offset.
• Treasury income: Hardening government bond yields are expected to keep treasury gains subdued.

Nuvama

• Business growth: Banks under coverage are expected to post 21% year-on-year credit growth and 16% deposit growth, supported by FCNR(B) flows and demand from corporates, NBFCs, MSMEs and select retail borrowers.
• Earnings: Private banks are expected to deliver 21% year-on-year earnings growth, compared with 14% for public sector banks. Lower credit costs and a favourable base are expected to support profitability, while weaker treasury performance could constrain public sector lenders.
• Margins: FCNR(B)-linked funding is expected to reduce private banks' reported NIMs by 5-20 basis points sequentially. Nuvama expects much of the impact to reverse over the following two to three quarters.
• Asset quality: Overall asset quality is expected to remain healthy, supporting lower credit costs. However, some public sector banks may build expected credit loss provisions, while private lenders could need additional standard-asset provisioning.
• Risks: Analysts flag potential stress in MSMEs, small business lending, commercial vehicles, construction equipment and gold loans. Rainfall deficits could also affect agricultural portfolios and rural-focused NBFCs.
• Preferred stocks: Kotak Mahindra Bank, ICICI Bank, RBL Bank, Karur Vysya Bank and Ujjivan Small Finance Bank.

JPMorgan

• Large private banks: NII growth is expected to accelerate to 11.8% year-on-year from 8.9% in Q1FY27, supported by loan growth. Reported NIMs are likely to moderate because of FCNR(B) inflows, although the brokerage views much of this as a mathematical effect rather than a broad deterioration in spreads.
• ICICI Bank: The brokerage prefers ICICI Bank among large private lenders, citing confidence in the stabilisation of underlying NIMs after excluding FCNR(B)-related effects.
• Kotak Mahindra Bank: Loan growth and the KMIL merger are expected to support NII, although the asset mix could weigh on reported margins.
• Public sector banks: Loan growth is expected to accelerate to 18.8% year-on-year. SBI is the preferred name, with NII growth estimated at 13% and its margin outlook remaining an important factor.
• Asset quality: Credit quality is expected to remain stable across lending segments, with no visible impact from disruptions linked to the Middle East conflict.
• Funding costs: Public sector banks are expected to face less pressure from FCNR(B) inflows than private banks. They are also prioritising profitability by reducing expensive wholesale deposits.
• Preferred stocks: ICICI Bank among large private banks and SBI among public sector lenders. JPMorgan also favours AU Small Finance Bank among mid-sized lenders.

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