Banks are set to report strong Q1 FY27 treasury gains as bond yields slumped significantly during the quarter, helping recoup most of the mark-to-market losses incurred earlier. According to Business Standard, government bond yields declined by around 32 basis points during the quarter, while yields on the 15-year and 30-year government bonds fell by 50 basis points and 46 basis points, respectively. The fall in crude oil prices to pre-Iran-US war levels further aided sentiment in the domestic bond market, with the rupee appreciating 0.35 per cent against the US dollar in June, its strongest monthly gain since February. As reported by Business Standard, the bond rally during the quarter should translate into treasury gains for banks, with most lenders having marked losses on their investment books in the previous quarter. The rally in government securities is expected to generate treasury gains for banks, especially those with larger Available for Sale (AFS) and Fair Value Through Other Comprehensive Income (FVOCI) portfolios, with gains helping recover most of the treasury losses booked in previous quarters.
The Reserve Bank of India's latest foreign currency deposit scheme is emerging as a significant tailwind for banking stocks after they faced heavy foreign investor selling in May. According to Kotak Institutional Equities, the scheme creates an interesting juncture where re-rating is likely to be driven by yield discipline for public banks and improved access to lower-cost borrowings through FCNR deposits. As reported by Geojit Investments, RBI's FCNR(B) scheme has improved the outlook for banks by absorbing hedging costs (around 3.0-3.5%) on fresh 3-5-year deposits, enabling higher deposit rates and potentially mobilizing over $50 billion. The scheme allows banks to raise fresh or renew existing FCNR(B) deposits with maturities of three to five years and swap dollars with RBI at a concessional rate, with the central bank bearing the hedging cost to create a rare opportunity for overseas Indians to earn returns comparable to equities from fixed-income investments. Recent regulatory measures are expected to help India's banking sector navigate risks arising from the West Asia conflict and potential El Nino conditions, according to Nuvama, with FCNR(B) relaxations providing countercyclical support to growth, margins and asset quality.
Indian banks are positioned for improved interest margins in the July-September quarter as the RBI's liquidity-boosting measures take effect. According to reports from The Economic Times and The Hindu BusinessLine, these initiatives are driving down the cost of short-term funding, with certificate of deposit rates already seeing significant drops of up to 60 basis points over the past three weeks. The Financial Benchmarks India Ltd three-month CD reference rate fell to 6.65% last Friday from 7.25% on June 4, representing a substantial decline in funding costs. Four bankers confirm that some Indian banks could see stronger interest margins in the July-September quarter as the central bank's measures boost rupee liquidity and reduce the cost of borrowing for funds that mature within a year. As reported by YES Securities, banks' wholesale deposit costs have started easing since the RBI announcement, directly benefiting net interest margins. Any future interest rate upcycle could support margins for private banks because of their higher share of External Benchmark Lending Rate-linked loans, according to Nuvama, as these banks are better positioned to capitalise on regulatory tailwinds.
After being the most heavily sold sector by foreign investors in May with ₹23,141 crore outflows, banking stocks have found fresh momentum from the RBI's FCNR scheme and improved market conditions. According to Kotak Institutional Equities, two main things could trigger a valuation re-rating for the banking sector: public banks pushing their loan yields higher, which gives other players more room to price their loans comfortably, and banks successfully raising foreign currency borrowings to ease the pressure on their overall cost of funds. State-run Canara Bank, among the biggest issuers of CDs, expects the measures to help it refinance existing liabilities at much cheaper rates, according to MD & CEO Brajesh Kumar Singh. Indian Overseas Bank's MD & CEO Ajay Kumar Srivastava noted that the measures strengthen the ability to mobilise stable, longer-tenor deposits. The improved funding environment directly benefits bank profitability and allows for cheaper refinancing of existing debts. FCNR(B) relaxations could particularly benefit private sector banks that have been facing pressure on deposit mobilisation, as noted by Nuvama, with the measure expected to support funding availability and strengthen the liability franchise of banks.
According to SBI Securities, the banking sector is riding multiple tailwinds, including credit growth staying robust in the 14-16% range and recent moderation in crude oil prices after easing tensions in the US-Iran war. The pressure on banks' net interest margins is also expected to reduce this fiscal year as older deposits get renewed at lower interest rates. As reported by Bloomberg data, most lenders that are part of the Nifty Bank index are trading above their five-year average price-to-earnings multiples. For instance, State Bank of India is at 11.5 times as against its long-term average of 9.86 times, Kotak Mahindra Bank is at 22.83 times against 21.66 times, while Axis Bank is at 16.2 times compared with 13.5 times. According to Geojit Investments, valuations remain attractive, offering a stock-specific accumulation opportunity, with large private and major public sector banks benefiting the most, though challenges from high deposit demand and limited supply remain. Nuvama prefers banks over non-banking financial companies (NBFCs), and within banks, favours private sector banks over public sector lenders, expecting large private sector banks to deliver above-system credit growth and maintain healthy return on assets in the range of 1.8 per cent to 2.1 per cent during FY27-FY29.
