India’s banking and financial services (BFSI) sector could be in the midst of a more robust growth phase, as Motilal Oswal Financial Services Ltd (MOFSL) is turning more optimistic on banking stocks, especially for the large private lenders, and with the banks in general.
In its latest BFSI Picks 4.0 report, the brokerage said healthy credit demand, easing pressure on net interest margins (NIMs), improving asset quality and stronger earnings visibility are expected to support the sector over the next few years.
Credit Growth Remains Robust
According to the report, in India's banking system healthy loan demand in various segments remains.
Banking system credit grew 17.6%, supported by:
- Corporate lending
- Retail loans
- MSME financing
- Higher demand for working capital loans.
These increases in bond yields have caused many corporates to turn to bank borrowings instead of the debt market, he said.
MOFSL expects banking system credit to grow at a 14% CAGR between FY26 and FY28.
Private Banks Expected to Lead Earnings Recovery
We see that sector profitability will be significantly improved in the next three years, the report says.
Banks under MOFSL's coverage are expected to make 15% earnings CAGR in FY26-FY28 after earnings growth in FY26 of 6.6% expected growth in FY26.
As a result, private sector banks will perform better than public sector banks.
Private banks: ~21% earnings CAGR (FY26–FY28). Public sector banks: ~8% earnings CAGR
The brokerage believes that sustainable loan growth will be a key driver of the recovery with a reduction in NIM pressure and less stress in unsecured retail lending.
Margins and Asset Quality Improvement.
In spite of this, banks’ net interest margins were still under pressure as lending rates were pushed down to lower levels, but a drop in funding costs has helped to soften part of the impact.
MOFSL also expects improving asset quality, particularly in unsecured retail loans, to reduce credit costs for several mid-sized lenders and to sustain business profitability in the future.
Big Private Banks Are The Preferred Bet
Despite the mixed stock performance of the last year, the brokerage still favors large private sector banks, saying:
- Attractive valuations
- Strong balance sheets
- Better long-term growth prospects
- Improving management commentary
The Nifty Private Bank Index remained largely flat in the past year as major banks like HDFC Bank, ICICI Bank and Kotak Mahindra Bank have performed poorly due to FII selling, macroeconomic uncertainty and margin issues.
Mid-Sized Banks Outperformed
With a few mid-sized private lenders leading the pack, while large banks were lagging, some mid-sized private lenders made good returns.
Among the top performers were:
- RBL Bank
- South Indian Bank
- Federal Bank
- City Union Bank
- Karur Vysya Bank
These banks in particular significantly outperformed many of their larger peers in the period.
Model Portfolio Beats Benchmark Indices
MOFSL also highlighted the performance of its BFSI model portfolio.
According to the brokerage:
BFSI Model Portfolio: ~25% return since inception. Nifty Financial Services Index: ~10%. Nifty 50: ~5%
The portfolio was robust in the face of geopolitical tensions, tariff uncertainty, crude oil volatility and currency fluctuations, the report indicated.
Outlook
Motilal Oswal has a positive medium-term outlook for the BFSI sector and thinks healthy loan growth, stable margins and asset quality could result in a more favourable environment for banking stocks after a subdued period.
But investors should be aware that brokerage reports are based on research opinion and are not the best predictors of future performance. Investments should be made based on the individual aspirations for financial goals, risk tolerance and independent research or advice from an experienced financial adviser.
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