Struggling Performances in Q1 for Banks: Profit Margins Contract, Loan Expansion Decelerates, Credit Worthiness Under Scrutiny
The Q1 earnings season for the Indian banking sector is shaping up to be a challenging one, with analysts predicting a period of weak performance primarily due to slowing loan growth, margin pressures, and concerns on credit quality.
Key contributing factors include weak loan growth, margin pressure, and asset quality concerns. The credit growth as of mid-June stood at 9.6%, with industrial credit growth at just 4.8% year-over-year (YoY) in May, significantly lower compared to 8.9% YoY last year. This slowdown is attributed to private sector banks prioritizing margin protection over credit growth, leading their loan books to be driven more by retail and SME segments. Overall loan book growth for Q1FY26 is expected to be around 10.8% YoY, down from 12.6% in the previous quarter.
The Reserve Bank of India's interest rate cuts in April and June are anticipated to reduce banks' net interest margins. Net Interest Income (NII), which is the difference between interest earned on loans and interest paid on deposits, is projected to grow only about 2% YoY. For example, Axis Bank’s NII is expected to increase modestly by around 2.8% YoY but with margin contraction due to lower returns on advances not being fully offset by lower cost of deposits.
Elevated provisions and higher slippages are likely to weigh on profits. For example, Axis Bank is expected to see a 51% sequential rise in provisions due to write-backs in the previous quarter becoming non-recurring and seasonally higher agricultural loan slippages.
In summary, the combination of slower credit growth, compression of interest margins following RBI rate cuts, and cautious provisioning due to asset quality risks are driving expectations for a weak earnings season for Indian banks in Q1 FY26. Despite some YoY profit growth for large private banks like Axis Bank, the overall sector is facing headwinds from these key factors.
Sources: [1] JM Financial Report [2] InCred Equities Report [3] Business Standard, June 2023
- The slowing loan growth, margin pressures, and credit quality concerns in the banking sector indicate a challenging quarter for the economy.
- The banking sector's focus on margin protection over credit growth could lead to a shift in loan books towards retail and SME segments.
- The Reserve Bank of India's interest rate cuts are expected to impact the financial sector, reducing banks' net interest margins and growth in Net Interest Income.
- Elevated provisions and higher slippages are expected to impact the profitability of banks, with Axis Bank predicted to see a significant increase in provisions.
- Weak loan growth, shrinking interest margins, and cautious provisioning are all contributing to a predicted weak performance for the Indian banking sector in Q1 FY26, impacting the broader economy.
- Investors and wealth management businesses must exercise caution when considering the finance sector, given the current market headwinds, and may want to explore alternative avenues such as DeFi, in light of these circumstances in personal-finance and business setting.
