Banks' Q2 Earnings To Slow Amid Slower Loan Expansion, Rising Deposit Costs
Net interest margin (NIM) compression and weaker credit demand hit banking sector’s profitability in Q2FY25
The Indian banking sector is poised to report muted earnings growth for the second quarter of FY25, as a combination of slower loan growth, declining net interest margins (NIMs), and rising deposit costs weigh on profitability, according to Sharekhan's detailed Q2FY25 preview report.
The report anticipates a modest 10 per cent year-on-year growth in earnings across banks, largely driven by weaker net interest income (NII) and declining margins. Sharekhan’s insights for Q1FY25 highlighted early signs of this trend, where banks were already struggling with similar pressures, and the scenario is expected to extend into Q2FY25.
Loan And Deposit Growth
Loan growth slowed to around 14 per cent in Q2FY25, compared to robust growth in previous quarters. Deposit growth ranged between 11-13 per cent, indicating a narrower gap between credit expansion and deposit mobilisation. This dynamic has compelled banks to prioritise deposits to maintain liquidity ratios, which in turn has restricted loan disbursements. The trend of slower loan growth was first observed in Q1FY25, where system-wide growth dropped in the previous quarter.
Net Interest Margins (NIMs) Under Pressure
Both Q1FY25 and Q2FY25 witnessed NIM compression across the banking sector. Sharekhan's Q1FY25 report indicated a 3-5 basis point (bps) sequential decline in NIMs for private banks and a sharper 5-10 bps drop for public sector banks (PSBs). This trend is expected to continue into Q2FY25, with NIMs likely to drop further by 5-10 bps due to higher deposit costs and lower CASA ratios. PSBs, in particular, are more vulnerable to the rise in deposit costs as they have a larger reliance on fixed-term deposits.
Weaker NII Growth
For Q1FY25, Sharekhan reported that net interest income (NII) growth for most banks slowed to just 8 per cent year-on-year. This was mainly due to a higher cost of funds and the need to reprice deposits at higher rates. The Q2FY25 preview expects this trend to persist, with NII growth remaining subdued. Large banks, such as HDFC Bank and ICICI Bank, are likely to report flattish trends in NIMs, benefitting from a relatively stable funding structure. However, mid-tier banks like Axis Bank, IndusInd Bank, and Kotak Mahindra Bank will see more pronounced margin pressure due to a sharper increase in deposit costs.
Earnings Growth
While earnings for Q2FY25 are expected to show modest growth of around 10 per cent, this is significantly slower than previous quarters. In Q1FY25, the banking sector posted profit after tax (PAT) growth of 16 per cent, primarily driven by lower credit costs rather than strong core operational performance. Sharekhan's Q2FY25 report suggests that earnings in this quarter will be driven by stable asset quality and treasury gains rather than robust NII growth.
Deposit Repricing And CASA Decline
The report highlighted that banks are facing rising deposit costs due to repricing at higher rates, a factor that started to impact NIMs in Q1FY25 and is expected to intensify in Q2FY25. In addition, banks are seeing a reduction in their CASA (current account, savings account) ratios, which has put further pressure on margins. For instance, large banks like State Bank of India (SBI) and HDFC Bank saw their CASA ratios dip slightly in Q1, a trend that is expected to continue into Q2 as depositors seek higher yields in term deposits.
Talking about asset quality and credit costs, the report stated that both Q1FY25 and Q2FY25 have stable asset quality in the banking sector, with no major signs of stress in the corporate loan book. However, retail slippages—especially in unsecured loans, microfinance institutions (MFIs), and personal loans—remain areas of concern. It observed that slippages in the commercial vehicle, microfinance, and agriculture segments were higher in Q1FY25, and a similar trend is expected in Q2FY25. Despite this, overall credit costs remain well below long-term averages, supporting banks’ bottom lines.
It added that treasury performance has provided some respite for banks in Q1FY25, with declining bond yields improving profits from their investment portfolios. This trend is expected to carry forward into Q2FY25 as well. However, the overall growth in pre-provision operating profits (PPOP) is likely to remain muted due to weaker NII growth.
Outlook For Q2FY25
The banking sector continues to face challenges in the form of higher deposit costs, slower loan growth, and NIM compression. As a result, Sharekhan expects Q2FY25 to be another quarter of modest growth, with profitability supported by stable asset quality and treasury gains. Going forward, the focus will be on managing liquidity, boosting deposit growth, and navigating a challenging environment for NIMs. Large private banks such as HDFC Bank and ICICI Bank are better positioned to weather these pressures due to their strong capital buffers and diversified funding bases.
Public sector banks like SBI and Bank of Baroda, while facing more significant margin pressures, are expected to benefit from stable asset quality and treasury performance.
Q2FY25 is shaping up to be a challenging quarter for the banking sector, with slower credit demand and rising deposit costs putting pressure on NIMs. While earnings growth remains positive, it is muted compared to previous quarters, and banks will need to focus on managing costs and liquidity in the coming months. The sector's outlook will largely depend on how effectively banks can navigate these headwinds while maintaining asset quality and capital strength.
