Indian banks are expected to report a 25.4% year-on-year rise in net profit for the second quarter, supported by strong credit growth. However, banks face temporary pressure on profit margins due to large inflows from foreign currency deposits that are yet to be fully invested as loans.
The Indian banking sector is heading into the second quarter of the 2027 fiscal year with expectations of a strong 25.4% year-on-year rise in net profit. This growth is primarily fueled by resilient business activity, with system-wide credit expansion maintaining a steady pace of approximately 18%.
While the overall earnings picture looks positive, banks are currently navigating a unique situation regarding their profit margins, often referred to as Net Interest Margins. These margins represent the difference between the interest a bank earns on loans and the interest it pays on deposits. Recently, banks received a massive inflow of approximately $127 billion through Foreign Currency Non-Resident (FCNR-B) deposits. While this provides banks with significant liquidity, it has created a short-term challenge.
Because these funds arrived in bulk, banks are still in the process of transitioning this liquidity into productive assets like loans. Until this money is fully deployed, it acts as a cost on the balance sheet, temporarily pushing down profit margins. Data suggests that private sector banks are feeling this impact more acutely, with expected margin compression of 7 to 32 basis points. In contrast, public sector banks appear to be more shielded, with projected margin declines ranging from 1 to 9 basis points.
On the operational side, banks are using these foreign currency inflows to pay off more expensive, high-cost wholesale debts. Analysts expect this strategy to take about two quarters to stabilize. As banks finish this transition, margins are expected to begin recovering in the second half of the year.
Asset quality, a critical monitorable for investors, remains stable. The stress in unsecured retail portfolios, such as credit cards and personal loans, has shown signs of easing compared to previous periods. However, the outlook is not without risks. External factors, particularly the performance of the monsoon, remain important. Below-normal rainfall could impact rural credit cycles, potentially affecting the repayment capacity of borrowers in agricultural sectors.
Looking ahead, the market will focus on how effectively individual banks convert these excess deposits into profitable loans. The next few months will be crucial for observing whether banks can maintain their loan growth pace while normalizing their margins. Investors will be keeping a close watch on management commentary during the upcoming earnings calls to understand the timeline for full fund deployment and margin recovery.