Margins pressure, credit costs may plague banks in Q1; asset quality seen largely stable

“Q1FY26 is expected to be a muted quarter with most banks juggling with many adversely moving aspects such as slowing advances growth, margin pressure from consecutive repo rate cuts, seasonally weak fee income, annual appraisal-related expenses in operating expenses, and sustained elevated credit costs for unsecured credit segments,” Systematix Research said in a pre-earnings note.

Provisional business updates by banks for Q1FY26 showed weak loan growth in Q1 even as deposits picked up pace, Mint reported on 4 July, 2025. Initial estimates showed sequential loan growth of 0.2-5% and deposit growth of 0.1-1.3%. This led to private banks’ credit-deposit ratio improving to 92% and for public sector banks remaining stable at 78%.

Loan growth for these banks was 5-32% year-on-year, barring IndusInd Bank, which saw a decline on a sequential and annual basis. Deposit growth, meanwhile, is estimated to be around 13% year-on-year.

As per RBI data, system loan growth has decelerated to 9.6% on-year in June 2025 from 11% in Q4 FY25, with advances slowing for most segments except MSME loans.

“This quarter has been characterized by subdued credit growth, with lending activity yet to gain meaningful traction,” brokerage firm Centrum said in a note, adding that the repo rate cuts have further intensified downward pressure on lending yields.

Net interest income–income from the core lending business–is seen rising 1-7% on year but falling 0.6-3.4% sequentially, as per estimates by four brokerage firms. 

Profitability

“Pre-provision profit (PPoP) should increase 5.2% on-year and register a growth of -1.5% on quarter,” according to Phillip Capital. Core operating profit (excluding treasury impact) is expected to fall 2.5% on year and 4.1% on quarter, it added.

Analysts said profitability is expected to be muted due to lower business and income growth, pressure on margins, and higher provisions. They peg profit after tax for the system at around 0-4.8% year-on-year and 0.8% quarter-on-quarter, with a decline of up to 12%. Within this, private banks are seen posting net profit of 1.4% on year, and public sector banks 7%.

Kotak Mahindra Bank, State Bank of India and ICICI Bank are analysts’ top picks among large banks, whereas IDFC First Bank and RBL Bank are the top choices among mid to small banks.

Bank of Maharashtra will kickstart the Q1 earnings season for banks on Tuesday. Among private banks, Axis Bank is set to be the first to declare its results on 17 July, followed by HDFC Bank and ICICI Bank on 19 July.

The Nifty Bank Index rose nearly 12.7% in the April-June quarter. In comparison, the benchmark Nifty 50 gained 9.3% during the period.

Margins

Margins of banks will be under pressure as they face the impact of the cumulative 100 basis point rate cut by the Reserve Bank of India between February and June 2025. While much of the impact of the lending side is expected to be borne in this quarter given that a significant portion of the loan book is linked to an external benchmark–usually the repo rate–the deposit side impact will be limited.

The share of external-benchmark linked loans is estimated to be around 46% for state-owned banks and at around 87% for their private sector peers.

Banks are expected to benefit from the first phase of savings and fixed deposit rate cuts (in April 2025) in this quarter, and then from the second phase (in June 2025) of rate cuts in the second quarter. The impact of cuts in savings account rates is typically faster than those on fixed deposits given the longer tenure of the latter.

Margins will also be under pressure due to adverse asset mix led by lower unsecured disbursements, weak liability mix due to slower CASA growth, and interest reversals on higher slippages in unsecured credit and agri credit.

Net interest margin for banks is seen falling 5-15 basis points on a sequential basis, as per estimates by several brokerage firms.

“We expect double-digit NIM decline for all banks under our coverage in Q1 FY26,” Motilal Oswal Securities said adding that margins should improve in the second half of the financial year led by a phased reduction in deposit rates and the 100 bps cut in banks’ cash reserve ratio which will come into effect from September 2025.

Other income

Despite frontline banks pulling back on employee and branch additions, opex should remain sticky due to tech expenses, annual increments and still elevated collections related costs, IIFL Capital said, adding that fee income growth is expected to decline 15% on quarter and 11% on year, following distribution led seasonally high base in Q4 FY25. However, with decline in government bond yields, trading gains should be high and aid overall non-interest income–which is seen growing 17% on year.

While some banks are expected to see gains in their treasury portfolios owing to the sharp rate cuts, overall outlook for fee and other income remains muted. As such, treasury gains too are seen limited due to change in accounting for AFS (available for sale) book, analysts said.

“The impact on P&L will be limited due to the implementation of the new investment guidelines (effective 1-April’24) wherein the MTM gains on the AFS portfolio will not be recognised in the P&L statement but will augment the AFS capital reserve,” brokerage firm Systematix said.

The yield on the benchmark 10-year government bond declined by 75 bps in Q1FY26 compared with 10 bps in the previous quarter.

Asset quality

While the system’s asset quality is largely stable, provisions and subsequently credit costs are elevated for banks, especially those with higher exposure to unsecured retail and microfinance loans, as they absorb the impact of small-ticket delinquencies.

According to analysts, credit cost for banks is likely to be 59 bps for Q1 FY26 compared with 64 bps in the previous quarter and 52 bps in the year ago period.

“Slippages have been moderately on the rise sequentially earlier for the system but Q1 FY26 may be flattish, adjusted for agri non-performing loans,” YES Securities said in a note. Typically, lenders tend to see higher agriculture slippages in the first and third quarter of a financial year owing to the cyclical nature of the business.

“Sequential evolution of provisions would be a function of not only slippages but also of recoveries and upgrades and pre-existing provision buffers,” the note said, adding that it expects a marginal rise in provisions for HDFC Bank, ICICI Bank, IndusInd Bank and Federal Bank.

Gross non-performing assets (NPA) ratio for the sector is pegged at 1.87% for the quarter, whereas net NPA ratio is seen at 0.49%.

“Peak MFI slippages are behind us with improving X-bucket collection efficiency and net forward flow rates, but they have not completely normalized yet. While personal loans and credit card NPAs may rise further, vintage analysis and early bucket delinquencies suggest that stress is peaking out,” IIFL Capital said. Stress in the ‘micro’ SME segment is also rising, which will impact PSU banks more.