As Indian banks prepare to report Q2 earnings starting next week, investors are bracing for a mix of strong profit growth alongside tighter profit margins. While annual earnings are expected to rise significantly, high funding costs from recent foreign currency deposits have put pressure on net interest margins.
The Indian banking sector enters the second-quarter earnings season for the 2026-27 financial year with a distinct two-sided outlook. As major private sector lenders like HDFC Bank, ICICI Bank, and Axis Bank begin reporting their performance starting the week of October 12, 2026, the market is balancing expectations of strong year-on-year profit growth against concerns regarding shrinking profit margins.
Profit Growth vs. Margin Squeeze
Analysts generally expect a healthy performance in bottom-line numbers, with projections for year-on-year net profit growth ranging between 19.6% and 25.4%. This optimism is supported by robust credit growth, which has remained strong at approximately 18% to 19% annually. However, the headline profit figures may mask a underlying challenge: a sequential decline in Net Interest Margins (NIMs). NIM is a key metric that measures the difference between the interest a bank earns on loans and the interest it pays on deposits.
Market data indicates that many banks may see a sequential contraction in their NIMs by 1 to 32 basis points. This pressure is primarily linked to the cost of managing liquidity from Foreign Currency Non-Resident, or FCNR(B), deposits. These foreign currency deposits had reached substantial volumes—totaling roughly $132.9 billion by late August 2026—providing banks with ample liquidity. However, the cost of mobilizing these funds was higher, creating a temporary drag on margins. The special swap window, which allowed banks to offer attractive interest rates on these foreign currency deposits, closed on August 31, 2026.
H2 Outlook and Recovery
While the immediate impact on margins is visible, many analysts view this as a temporary phase. The liquidity generated by these deposits is expected to be deployed into higher-yielding assets, such as corporate and retail loans, over the second half of the financial year. As banks successfully transition this surplus liquidity into active lending, the cost-to-income balance is projected to stabilize.
Beyond internal funding costs, investors will be monitoring the broader macroeconomic environment. While credit demand remains strong, potential risks include volatility in crude oil prices and inflationary pressures, with consumer price inflation projected at 5.2% for the financial year. Additionally, banks that have maintained a strong base of low-cost current and savings accounts (CASA) are likely to be better shielded from the higher interest costs that have impacted the broader sector.
What Investors Should Track
As the earnings season unfolds, the most critical data points for investors will be the management commentary on margin recovery and the growth of low-cost deposits. The ability of individual banks to deploy the surplus liquidity from the recent deposit influx into profitable loan segments will be a key differentiator. Furthermore, any guidance regarding the normalization of funding costs in the second half of the year will be essential for assessing whether the current margin compression is indeed a short-term hurdle.