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Indian banks are expected to see further improvement in interest income growth as a rising rate cycle and a shift towards a more favorable loan mix support earnings, according to a report by Kotak Institutional Equities, which expects asset quality to remain stable and credit costs to stay low in the near term.
The report said banks under its coverage recorded a 20 per cent year-on-year increase in earnings in the second quarter of FY27, supported by healthy growth in operating profit and a decline in provisions. Net interest income (NII), the difference between interest earned on loans and interest paid on deposits, grew around 15 per cent year-on-year during the quarter. Operating profit rose around 15 per cent, while provisions declined 25 per cent year-on-year, helping improve overall profitability. Private banks reported earnings growth of around 25 per cent, compared with nearly 20 per cent for public sector banks. Kotak said the banking sector was positioned to benefit from the changing interest rate environment, although the extent of improvement would depend on funding costs and the duration of the rate cycle. "We expect NIMs to improve, supported by a more favorable loan mix, even if this entails some moderation in headline loan growth," the report said. Net interest margin (NIM) measures the difference between the interest banks earn on loans and the interest they pay on deposits, relative to their interest-earning assets. The report noted that banks were replacing higher-cost wholesale borrowings with lower-cost term deposits, including through foreign currency non-resident (FCNR) deposits. It also expects lending to gradually shift away from corporate loans, where some recent demand appears to be linked to higher working-capital requirements. However, Kotak cautioned that the scale and sustainability of margin improvement would depend on the intensity and duration of the rate cycle, as well as the deposit and funding environment. Asset quality remained firm during the quarter, with lower fresh additions to bad loans supporting the trend. Kotak said it saw limited near-term asset-quality risks in banks' gold-loan portfolios, given their customer mix, which is tilted towards larger borrowers with relatively lower risk profiles. The report also noted that interest income growth was healthy, while non-interest income remained relatively subdued, increasing by just 2 per cent year-on-year. Kotak expects the combination of a better loan mix, changing funding costs and a favorable asset-quality trend to support banks' earnings, while the pace of margin improvement will remain dependent on interest rate and deposit conditions. (ANI)
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