India’s banking sector is expected to see improved profitability over the next few years as lending yields strengthen and funding costs gradually decline. Large lenders such as ICICI Bank, HDFC Bank and State Bank of India are likely to lead margin recovery, supported by favourable lending conditions and steady credit demand. A report by Motilal Oswal Financial Services indicates that rising fresh loan yields and easing deposit costs could help banks maintain stable and improving net interest margins in FY27.
Fresh loan yields increased significantly in January 2026, indicating a supportive pricing environment for banks heading into the final quarter of the financial year. The report noted that yields on new loans rose by 44 basis points month-on-month for public sector banks, 18 basis points for private banks and 39 basis points across the overall banking system. At the same time, the weighted average lending rate on outstanding loans declined slightly by 2 basis points to 9.04%, suggesting that most repo-linked repricing adjustments have already taken place following the December 2025 rate cut. With policy rates stabilising, any further compression in yields is expected to be gradual.
Deposit costs are also beginning to ease, which may further support banking sector margins. The weighted average term deposit rate for the banking system declined by 4 basis points month-on-month in January to 6.74%, continuing the gradual decline observed in December. The spread between term deposit rates and the repo rate remains close to a 4-year high of around 1.5% for both public and private banks. This indicates there is still room for further moderation in funding costs during the first half of FY27.
Credit growth across the banking system has also shown steady improvement. Systemic credit growth recovered to 13.7% year-on-year and has remained above 13% in recent fortnights. The report expects loan growth to sustain at about 14% CAGR between FY26 and FY28, driven by steady retail demand, revival in unsecured lending, improving SME and corporate credit uptake and stronger consumption trends. Profit growth is projected to outpace loan growth, with profit after tax expected to increase by 15.1% in FY27 and 17.8% in FY28. Within the sector, the brokerage highlighted AU Small Finance Bank along with ICICI Bank, HDFC Bank and State Bank of India as well-positioned to benefit from stable margins, consistent growth and operating leverage.
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