Loan growth, profitability seen improving for public sector banks

The Indian banking sector could be due for a rise in profitability after several quarters of net interest margin (NIM) compression.

The Q2FY26 results suggest NIMs have bottomed out.

Credit costs could also fall given moderating stress in unsecured retail and microfinance institutions (MFIs).

System credit growth may lift to 13-14 per cent Y-o-Y (it was 11 per cent as of October 31) due to favourable fiscal policies (GST 2.0) and monetary policies such as cuts in cash reserve ratio and repo rate.

This could lead to mid-teens earnings growth over FY26-28 (7 per cent over FY24-26).

A broad-based pick-up in private-sector capex is not visible, but delinquency trends show improvement.

In Q2FY26, the adjusted net profit of public sector banks (PSBs) recorded Y-o-Y growth of 4.7 per cent, compared to a decline of 2.1 per cent Y-o-Y for private sector banks (PVBs).

The rise in PSB profits is attributed to fee income and treasury gains, alongside credit growth in retail and MSME segments, and lower opex.

The decrease in profits for PVBs is due to slower corporate demand, flat interest income, and continued stress in MFI and unsecured segments.

In H1FY26, large PSBs mobilised over Rs 45,000 crore via qualified institutional placement (QIPs) and Basel-III, while PVB raised over Rs 15,000 crore (mainly Tier-II bonds).

The impact of shifting to expected credit loss (ECL) models is estimated to be 60 to 70 bps of capital adequacy, which banks can absorb easily over four years.

The PSBs are also beneficiaries of the regulatory and governmental push for improved credit growth. PSBs have more exposure to corporate credit growth and to micro, small and medium enterprises (MSME) and to the infra sector, and hence, stand to benefit more from the policy thrust.

PSU banks (PSBs) could thus be the biggest beneficiaries due to improvement in credit costs, more money to lend, and better core profitability, especially for big banks like State Bank of India (SBI) and Bank of Baroda (BoB). Yields across banks have risen by 9 basis points for PSBs (as compared to a decline of 86 basis points for PSBs during Mar-Sep ’25). The weighted average term deposit rate declined by 4 basis points M-o-M in October ’25 to 6.87 per cent for PSBs.

On the macro side, GDP growth in Q2FY26 came in at 8.2 per cent, prompting upgrade in FY26 forecasts and raising expectations of modest policy rate cuts.

The earnings outlook for the overall banking sector is healthy, with net profit growth likely to hit 15 per cent in FY27 and 17 per cent in FY28.

Credit growth is up to around 11 per cent (October) from 9 per cent (May).

System loan growth has expanded by Rs 9.4 trillion in FY26 year-to-date vs Rs 7.8 trillion in the same period in FY25, implying robust growth.

A full 1 per cent cash reserve ratio reduction is now in effect, and will support credit.

Stress in unsecured segments has moderated according to management commentary and should translate into lower credit costs.

Scheduled commercial banks are adequately capitalised with median capital adequacy ratio (CAR) increasing around 60 basis points Y-o-Y to 17.1 per cent in Q2FY26.

The median CAR for PSBs rose by 54 basis points Y-o-Y to 17.2 per cent for Q2FY26, while for private banks, median CAR rose by 52 basis points Y-o-Y to 16.8 per cent.

The median common equity tier-1 (CET-1) for PSBs and private banks improved by 128 and 92 basis points Y-o-Y to 15.0 per cent and 15.3 per cent, respectively.

The RBI’s opening up acquisition financing to Indian banks with potential market size of $112 billion and removing disincentive for lending to corporates where overall banking system exposure is at Rs 10,000 crore are other positive steps.

PSU banks are guiding for an improvement in corporate loan growth from mid-single digits in H1FY216 to low double digits by the end of FY26.

MSME loan growth for PSBs has accelerated from 14.7 per cent (March 2025) to 16.7 per cent as of September 2025.

Among PSBs, SBI, Bank of Baroda and Canara Bank are trading near all-time highs.

The Nifty PSU Bank is the biggest gainer among NSE sector indices.

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