India banks face margin squeeze despite 18.8% credit growth

Deposit growth accelerated to about 17% as foreign-currency inflows boosted system liquidity.

Indian banking sector business growth remains strong entering the second quarter of financial year 2027, driven by sustained credit demand and an influx of Foreign Currency Non-Resident (Bank) deposits.

Systemic credit growth reached 18.8% year-on-year as of 15 September 2026, driven by retail demand, higher utilisation amongst micro, small, and medium-sized enterprises, and healthy corporate borrowing, according to a preview report by Motilal Oswal Financial Services. 

High FCNR(B) inflows of $133bn (£101bn) further supported lending capacity. Motilal Oswal expects overall credit growth for FY 2027 to settle at around 15.5%, led by mid-sized private lenders.

Deposit growth accelerated to approximately 17% year-on-year, up from 11% to 12% previously, with FCNR(B) inflows accounting for roughly 4.5% of total system deposits. 

The surge helped ease the sector's credit-to-deposit ratio to 80.8% from a peak of 83.4%. 

However, banks continue to struggle to secure low-cost deposits, and term deposit rates are expected to stay firm.

Private banks are forecast to lead second-quarter profit growth, with net profit estimated to rise 24% year-on-year and 1.7% quarter-on-quarter. 

Earnings across private banks are projected to compound at 20% annually between FY 2026 and FY 2028. 

Net interest income for private lenders is expected to grow 13% year-on-year, with ICICI Bank leading major private peers at 16.8% growth, followed by Kotak Mahindra Bank at 14%, HDFC Bank at 8.9%, and Axis Bank at 8.5%.

Despite profit growth, net interest margins for private banks are expected to shrink by 8 to 20 basis points during the quarter due to rapid expansion following FCNR(B) inflows and the leverage applied against those deposits. 

Margins are expected to recover gradually as banks lend out surplus liquidity and replace high-cost liabilities.

Public sector banks are also projected to deliver resilient second-quarter results, with net profit estimated to increase 27% year-on-year and 19% quarter-on-quarter. 

Stable net interest margins are expected to support a 10.8% year-on-year rise in net interest income, with earnings growing at an 11% annual compound rate through FY 2028.

Across Motilal Oswal's entire banking coverage, second-quarter net interest income is forecast to grow 11.9% year-on-year, with total net profit rising 25.4%. Overall sector earnings are expected to compound at 15% annually over the FY 2026 to 2028 period.

Asset quality across secured and unsecured portfolios remains stable, keeping new defaults and credit costs steady. 
However, the report notes potential risks from broader macroeconomic uncertainty and below-normal monsoon activity.