Q2 banking earnings preview: Net interest margins seen bottoming out, credit growth, lower costs to drive rebound in H2

Net interest margins (NIMs) for the banking sector are likely to approach their lowest level in the second quarter of the current financial year (Q2 FY26), while healthy credit growth along with lower costs of funds following rate cuts and an expected cut in the cash reserve ratio by the Reserve Bank of India will drive a rebound in the second half of the current fiscal year, according to analysts tracking the sector.

The banking sector, they note, is approaching an inflection point in the second quarter of the current financial year as NIMs approach their bottom following a cumulative 100 basis point (bps) repo rate cut in 2025.

While profitability is expected to remain under pressure in the September quarter, easing funding costs, policy support and early signs of credit growth revival are setting the stage for a gradual earnings recovery from the second half of the current financial year, analysts note.

Margins likely to bottom out

Interest margins are expected to hit their lowest point in Q2FY26 as the full impact of the repo rate cut flows through lending yields. Yields on fresh loans have already declined by 65 bps over the past six months, led by an 80 bps fall for private banks (PVBs) and a 62 bps decline for public sector banks (PSBs), analysts note.

On the liabilities side, the weighted average term deposit rate (WATDR) fell 5 bps month on month (MoM) in August to 6.99%, with a 20 bps decline over three months. While savings account rate cuts are largely behind, the full benefit of term deposit repricing is expected to kick in from the second half of the current financial year (H2FY26), aided by lower CRR requirements and the potential of further RBI easing.

Overall, margins are expected to dip sequentially by 5–15 bp in Q2FY26F. Large private banks could see a sharper decline, while mid-size and PSBs may see a more limited fall of 5–10 bps, cushioned by their MCLR-linked loan books and slower rate transmission. Net interest income (NII) growth is expected to remain flat.

Policy measures including a CRR cut, lower risk weights for MSME and home loans, higher loans against shares (LAS) limits, and lower NBFC infra risk weights are expected to accelerate credit growth.

Additional fiscal tailwinds like GST rate cuts and a possible 50 bps further repo rate reduction (December 2025 or February 2026) could push system credit growth to 11% in FY26, analysts added.

Asset quality to remain stable

Asset quality is expected to remain broadly stable. Large private and PSBs are likely to report comfortable asset quality trends, while unsecured retail segments (MFI, credit cards) continue to show some stress but with improving early collection trends. Mid-size banks may see higher credit costs, but visibility is improving in stressed segments.

Treasury gains for PSBs are likely to be lower in Q2FY26F—roughly half of Q1FY26 levels—due to a 20 bps rise in G-sec yields. Punjab National Bank is expected to fare better on treasury income, while Canara Bank could benefit from healthy other income from PSL certificate sales, analysts said.

Loan growth momentum will be a critical monitorable this quarter, especially heading into the festive season. Deposit growth has moderated to 9.5% YoY, with sequential contraction of 0.5%, pushing the loan-to-deposit ratio to 80.3%, analysts say.