India's banking sector witnessed a sharp acceleration in credit growth, surging by 17.7% year-on-year as of June 15, according to a report by financial services firm Motilal Oswal Financial Services (MOFSL). The brokerage believes the performance of mid-sized private banks is set to exceed the larger banks in the first quarter of FY27, owing to strong loan growth, asset quality and healthier earnings.

Key Highlights

• India's bank credit growth reached 17.7%, with mid-sized private lenders expected to outperform in Q1 FY27.
• Motilal Oswal forecasts stable asset quality, healthy earnings growth and moderating credit expansion during FY27. 

The report said the surge in lending was supported by higher demand for working capital loans amid rising input costs, a regulatory shift from the Loan-to-Deposit Ratio (LDR) to the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) framework, and stronger corporate borrowing as bond yields increased during the first quarter. However, MOFSL expects overall credit growth to moderate to around 14% in FY27 as the current momentum gradually normalises.

The report attributed the lending surge to increased working capital loan demand driven by rising input costs, policy change from the Loan-to-Deposit Ratio (LDR) to the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR), and strong corporate borrowing in the wake of rising bond yields during the quarter. But the overall credit growth is expected to ease to around 14% during FY27 as the momentum is coming to a normal level.

Mid-Sized Private Banks Expected to Lead Loan Growth

Across its banking coverage universe, the brokerage forecasts quarter-on-quarter loan growth of 1.2% to 5.4% in Q1 FY27.

Among private lenders, AU Small Finance Bank, RBL Bank, DCB Bank and IDFC FIRST Bank are projected to deliver the strongest sequential loan growth of 3.9% to 5.4%. Among large private banks, ICICI Bank is expected to lead with approximately 4% sequential loan growth, outperforming other major lenders. Public sector banks (PSBs), on the other hand, are expected to report comparatively modest loan growth of less than 3% sequentially.

Deposit Growth Continues to Lag Lending

The report noted that system-wide deposit growth stood at 12% year-on-year, trailing credit expansion despite improving money multiplier trends. As a result, the credit-deposit (CD) ratio has increased to 83.4%, forcing banks to rely more heavily on wholesale deposits.

Competition for deposits remains intense, making it difficult for banks to mobilise low-cost Current Account Savings Account (CASA) deposits. Consequently, term deposit rates are expected to remain largely sticky. MOFSL also believes the government's Foreign Currency Non-Resident (FCNR) deposit window could provide temporary support for deposit mobilisation through September 2026.

Also Read: RBI's M&A Funding Reforms to Hit Private Credit Returns: Moody's

Mixed Outlook for Net Interest Margins

The brokerage expects a mixed trend in Net Interest Margins (NIMs) during Q1 FY27.

Among mid-sized lenders, IndusInd Bank, Federal Bank and DCB Bank are expected to report margin expansion. In contrast, Axis Bank,Kotak Mahindra Bank, HDFC Bank and ICICI Bank, could witness marginal pressure on margins.

Other lenders, including AU Small Finance Bank, Bandhan Bank and Equitas Small Finance Bank, are also likely to report moderate NIM contraction, while PSU banks are expected to maintain relatively stable margins.

Asset Quality Remains Healthy

MOFSL said asset quality across the banking sector continues to improve, with stress in unsecured retail lending, including personal loans and credit cards, gradually easing. Conditions in the microfinance segment are also returning to normal.

Although the ongoing geopolitical tensions in West Asia have not yet impacted banks materially, the brokerage warned that sustained increases in input costs and pressure on corporate profitability could affect borrower repayment capacity over time. Credit costs, however, are expected to remain stable for large private banks and benign for PSU lenders.

Earnings Outlook Remains Positive

Motilal Oswal projects a healthy earnings trajectory for the banking sector during Q1 FY27:

• Net Interest Income (NII) is expected to grow 10.9% year-on-year and 3.5% quarter-on-quarter.
• Profit After Tax (PAT) is projected to rise 9.6% year-on-year, although it may decline 4% sequentially due to seasonal factors.
• Banks under MOFSL's coverage are expected to deliver an earnings CAGR of around 15% between FY26 and FY28.

Private banks are forecast to post 10.1% annual profit growth, while PSU banks are expected to deliver around 9% year-on-year earnings growth, supported by stable margins and treasury gains as bond yields soften. Among financial services companies, SBI Cards is expected to report 18.8% profit growth, while Paytm could register 26% revenue growth, driven by higher gross merchandise value (GMV) and healthy contribution margins.

The report attributed the lending surge to increased working capital loan demand driven by an increase in input costs, policy change from the Loan-to-Deposit Ratio (LDR) to the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) regime in the first quarter, and increased corporate borrowing in the wake of rising bond yields during the quarter. But the overall credit growth is expected to ease to around 14% during FY27 as the momentum is coming to a normal level.