By the time it closed on August 31, banks had mobilized approximately USD 133 billion through this concessional facility. This wasn't just routine deposit growth—it was a structural shift in how banks fund their loan books.
The mechanics were straightforward. Banks accepted dollar deposits from NRIs for three to five years, then swapped the principal with the RBI at par, transferring currency risk to the central bank. This allowed banks to offer attractive rates—up to 7.1% on some tenors—while managing their foreign exchange exposure. The result? A massive liquidity infusion that reshaped Q2 FY27 results across the banking sector.
On the surface, the numbers look impressive. Yes Bank reported 23.8% year-on-year loan growth, Kotak Mahindra Bank delivered 24.7%, and HDFC Bank posted 16.3%. But scratch beneath the surface, and a different story emerges.
At Yes Bank, excluding foreign currency term loans extended against FCNR deposits, sequential growth drops to just 3.3%. FCNR-linked loans accounted for 62% of incremental advances. Bank of Baroda saw overseas advances rise 22% sequentially, representing 61% of incremental loans. Even HDFC Bank, with its stronger franchise, saw FCNR-linked loans account for 35% of quarterly loan accretion.
This divergence between headline and organic growth is most pronounced at mid-tier and regional banks.
This matters because it directly impacts earnings sustainability.
Kotak Institutional Equities estimates that large private banks face 10-15 basis points of quarterly NIM compression from FCNR deposits. Systematix expects a 7 basis points sequential NIM decline for the banking sector. The mechanics are clear.
First, undeployed funds earn lower returns. Banks mobilized USD 133 billion but a significant portion remains parked in SLR securities earning 6.0-6.5% rather than deployed in loans yielding 9.0-10.5%. Second, FCNR deposits cost 3.75-6.00%, compared to 2.0-3.5% for CASA deposits, creating a cost uplift of 200-250 basis points on substituted funds. Third, the liquidity surplus has created competitive pressure on loan yields, particularly in corporate segments.
The impact varies by bank. HDFC Bank, with its large balance sheet and moderate FCNR mobilization of USD 11.5 billion, faces 10-12 bps compression. Axis Bank, with USD 10.62 billion in FCNR deposits representing 7% of total deposits, faces 12-15 bps compression. Yes Bank, with very high FCNR concentration, faces 15-18 bps compression.
Despite margin pressure, large private banks are expected to deliver approximately 20% year-on-year earnings growth in Q2 FY27. How? Through multiple offsetting factors.
The primary driver is operating leverage from balance sheet expansion. HDFC Bank's average assets grew 16.8% year-on-year, ICICI Bank's loan portfolio grew 19.6%, and Kotak Bank's net advances rose 24.7%. Even with NIM compression, the volume effect drives strong net interest income growth.
But the real hero is credit cost reduction. HDFC Bank's credit costs improved by 20 basis points, ICICI Bank by 15 bps, and Kotak Bank by 15 bps. For HDFC Bank, this translates to approximately ₹640 crore quarterly profit before tax impact. Slippages have moderated across portfolios—retail slippages declined from 1.8% to 1.2% of advances, corporate slippages from 2.2% to 1.5%—while recoveries from written-off accounts have improved.
Fee income growth provides additional support. HDFC Bank's distribution fees grew 25%, ICICI Bank's digital payments income rose 30%, and Kotak Bank's wealth management fees increased 22%. Operating efficiency gains of 5% and tax rate optimization of 100-150 basis points contribute the final pieces of the puzzle.
Dolat Capital expects 19% year-on-year PAT growth for its coverage universe, but approximately 4-5 percentage points of this is optical rather than sustainable.
Axis Bank had an elevated credit-cost base in Q2 FY26 due to a one-time standard asset provision of ₹1,231 crore. In Q2 FY27, normalized credit costs of 45 bps compare favorably to 85 bps in the prior year, creating an optical benefit of approximately ₹870 crore. This is a one-time base effect that won't repeat.
RBL Bank received a capital infusion of ₹2,500 crore during the quarter, creating immediate interest income from deployment in government securities. For a bank with base PAT of ₹400 crore, this represents a 10% optical boost that will normalize as funds are deployed in higher-yielding loans.
Strip out these optical components, and genuine growth of 14-15% appears more sustainable. From Q3 FY27 onwards, growth is expected to moderate to 14-15% as these one-time factors fade.
Kotak Institutional Equities prefers frontline banks like HDFC Bank, ICICI Bank, and Kotak Mahindra Bank over mid-tier and regional banks for several reasons.
First, the divergence between headline and organic growth is much smaller. HDFC Bank's organic growth of 14.3% remains robust, compared to Yes Bank's 3.3% sequential organic growth. Second, large banks have stronger CASA franchises. HDFC Bank's CASA ratio declined 226 basis points to 31.6%, but this compares favorably to Yes Bank's 370 bps decline to 30.0%. Third, large banks have diversified funding sources and superior capital and liquidity positions.
Systematix's top picks—ICICI Bank, State Bank of India, and Kotak Mahindra Bank—possess specific competitive advantages in a margin-constrained environment. ICICI Bank has a strong digital franchise driving fee income growth. SBI has unmatched distribution and deposit mobilization capability. Kotak Bank has a conservative approach to FCNR deployment and strong risk management.
The good news is that the margin pressure is expected to be transitory. Kotak Institutional Equities notes that "the cost-of-funds benefit should build over 2HFY27 as maturing wholesale funding is not rolled over and the liquidity moves into loans".
The banking system's credit-deposit ratio has moderated to 80.8% as of September 15, down from its May 2026 peak of 82.7%. Banks have added to government securities, with the investment-deposit ratio rising to 26.5% from 26.1%, indicating they're parking surplus liquidity in SLR securities pending deployment.
By Q3 FY27, as excess funding is deployed or used to replace expensive liabilities, the full benefit of FCNR inflows should become visible. Analysts expect NIM recovery of 4-6 basis points sequentially in Q3, with further improvement in Q4.
For investors, the key is to look beyond headline growth numbers. Focus on organic growth metrics, CASA trends, and risk concentrations. Banks with strong organic franchises and conservative FCNR deployment strategies are likely to navigate this transition more effectively.
Monitor deployment ratios and timelines for NIM recovery signals. Track asset quality metrics for FCNR-linked loans compared to traditional portfolios. Watch for CASA rebuilding efforts as banks look to offset FCNR-related cost increases.
The FCNR(B) opportunity has provided short-term balance sheet support but created growth quality challenges that will take several quarters to resolve. Large private banks are positioned for sustainable growth of 16-18%, mid-tier banks at 10-14%, and regional banks at 8-12%. The divergence in growth sustainability is becoming increasingly clear as the one-time FCNR boost normalizes.
