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India’s banking industry is experiencing a revival in deposit inflows, but profitability metrics such as net interest margins (NIM) are projected to weaken in the first quarter of FY26, according to a report released by Phillip Capital.

The report observes that systemic deposit growth is accelerating, leading to a more balanced credit-to-deposit ratio. Business updates so far indicate credit expansion of just 0.4 per cent on a quarter-on-quarter (QoQ) basis. While deposit traction is a positive development, muted loan demand is weighing on interest income.

"Banking universe will see 1 per cent yoy (-1.5 per cent qoq) growth in NII. Sector NIM will decline 10bps qoq /30bps yoy as cost of funds remains stable," the report stated. The subdued performance is attributed to the lacklustre pace of credit disbursal and lower yields from repo-linked loans, despite funding costs holding steady.

Private Banks Outperform Public Sector Counterparts

Private banks are faring better than their public sector peers, with loans rising 0.5 per cent QoQ and deposits improving by 1.3 per cent QoQ. This led to a slight dip in their credit-to-deposit ratio, which now stands at 92 per cent, down 0.8 per cent sequentially. In contrast, public sector banks recorded marginal loan growth of 0.2 per cent QoQ, with no notable change in deposit levels. Their credit-to-deposit ratio remains unchanged at 78 per cent.

Despite stronger deposit growth, private banks are anticipated to post a 1.9 per cent YoY and 0.8 per cent QoQ drop in Net Interest Income. Public banks may also see a decline, with a smaller 0.3 per cent YoY fall but a steeper 2.4 per cent QoQ contraction.

Profitability Supported By Lower Credit Costs

On the earnings front, banks are expected to report marginal gains in profit after tax (PAT), underpinned by stabilizing credit costs. PAT across the sector is projected to rise 3.5 per cent YoY and 0.8 per cent QoQ.

Public sector banks may see a 7 per cent YoY increase in PAT, though they could face a 4.1 per cent QoQ dip. Private banks are likely to report a 1.4 per cent YoY and 4.2 per cent QoQ improvement in net profit.

Asset Quality And Credit Costs In Focus

The report highlighted signs of asset quality improvement, which is contributing to normalized credit costs. Credit cost for Q1FY26 is estimated at 59 basis points, a reduction from 64bps in Q4FY25 but slightly above the 52bps recorded in Q1FY25.

While deposit growth is strengthening, Phillip Capital stressed that banks will need to navigate narrowing margins and slower core earnings in the near term. These factors are expected to weigh on the sector’s performance as it enters the first quarter of the new financial year.