For India’s banks, the worst on margins may not be over yet

The hit, though expected, appears stickier than banks had guided. Many lenders had projected a recovery in the second half of the year, but second quarter post-result commentaries suggest the pressure could linger as deposits reprice slowly, credit growth picks up pace. and competition intensifies in low-yield segments such as housing.

The trend highlights the uneven impact of monetary easing—while borrowers benefit from cheaper credit, banks are struggling to keep pace as deposits reprice slowly. The trend underscores how rate cycles, funding costs, and credit growth are pulling profitability in opposite directions.

According to a 28 October report by CareEdge Ratings, banks’ average net interest margin (NIM) fell 21 basis points (bps) year-on-year in Q2FY26 (July-September). Private banks saw a 17 bps decline, while public sector banks’ margins contracted 27 bps.

Typically, private banks have a higher share of floating rate loans, meaning their loan repricing is steeper and faster compared with their PSU peers. As a result, private banks bore the bulk of the margin impact in Q4FY25 and Q1FY26, while PSU banks felt the effect in the first half of this financial year.

“This timing mismatch between loan yields and deposit costs continued to weigh on spreads. Competitive pressure in the home-loan segment has increased, especially as many PSU banks appear to have reduced rates (including via faster pass-through of EBLR-linked loans), which has placed additional strain on NIMs,” the report said.

A shift in lending mix towards low-yield yet stable segments such as housing and prime-client loans also contributed to the drag on margins.

Mixed guidance

Private sector lenders such as Axis Bank and HDFC Bank expect margins to bottom out in Q3 and improve in Q4 as deposit repricing kicks in and the cost of funds falls.

HDFC Bank’s chief financial officer Srinivasan Vaidyanathan said about 70% of the bank’s loans are floating rate, and lending rates have already fallen by 50 bps since December 2024, compared with a 30 bps fall in deposit costs.

“Slightly half or little more than half is what you are seeing flowing through in the cost of funds, which is where the savings deposit change has flown through, but the time deposit rate change, which is between a 70-80 bps or so change, that takes almost six quarters to flow in,” he said in the analyst call adding that it will take another 4-5 quarters for the entire impact to flow through assuming the repo rate remains the same.

ICICI Bank and Bank of Baroda, which have held margins steady, guided that NIMs will likely remain range-bound in Q3 despite deposit repricing and the 100-bps cash reserve ratio (CRR) cut announced in June.

“It will be a KCC quarter, as we call it. The level of non-accruals will also go up. And of course, there are continuing competitive dynamics in the market. So, all taken together, we see margins being range-bound,” ICICI Bank chief financial officer Anindya Banerjee said in the Q2 analyst call. KCC loans refer to Kisan Credit Cards, a category of agriculture loans for farmers which tend to see seasonally higher delinquencies in Q1 and Q3 of each year.

Bank of Baroda, while seeing a small sequential improvement in margins in Q2, said it’s adopting a more ‘wait and watch approach’ on margins. In the media call, chief executive officer Debadatta Chand said he expects margins to be range-bound in Q3–which is when the the bank will be able to take a call on how much more of a margin impact can be absorbed without compromising credit growth.

“That’s why we hold onto Q3 as a strategic quarter to decide whether we need to compromise on the margin or not,” he said. The bank maintained its credit growth guidance of 11-13% for FY26.

Limited room for relief

The mixed outlook stems from two factors—uncertainty over future rate cuts and a faster-than-expected pickup in credit growth that’s outpacing deposit mobilization.

If loan growth continues to outpace deposit growth, banks may have limited room to cut deposit rates further as they look to keep deposit rates attractive for customers. Combined with the hit from a lending shift towards lower-yielding secured loan segments such as housing, margins are likely to stabilize at the current levels

Punjab National Bank CEO Ashok Chandra said around 40-50% of deposits have been repriced, and while further benefits may emerge, it will be a “challenge” to pass on the entire 100 bps cut on the deposit side due to market competition.

“A slight decline in CASA ratios, and 12% growth in term deposits, contributed to funding-cost pressures. As repricing effects normalise, margins are expected to stabilize supported by significant equity infusion, extraordinary gains, improving liquidity conditions and easing funding costs,” CareEdge said in the note.

What’s next for rates

The RBI’s future course on interest rates adds another layer of uncertainty.

Highlighting “elevated uncertainty on the external front”, RBI Governor Sanjay Malhotra had in October said that even though there is policy space to further cut the policy rate, June was not an “opportune time” as it would not have had the desirable impact, as per the minutes of the June MPC meeting.

On 1 October, the MPC raised its growth forecast for FY26 to 6.8% from 6.5% earlier. It also cut its FY26 inflation forecast to 2.6% from 3.1%.

Any further rate cuts by the RBI in December 2025 could trigger a second round of loan repricing even as deposits continue to adjust with a lag, extending the transmission cycle and exerting fresh pressure on margins.

However, expectations of a December rate reduction have strengthened as inflation continues to cool. India’s September 2025 CPI inflation eased to an eight-year low of 1.54% from 2.07% in August, led by a sharp drop in food inflation, even as core inflation rose to 4.5%.