The brokerage house Motilal Oswal believes the next two years could look very different for financial stocks. According to the Motilal Oswal report, earnings growth across banks is expected to improve steadily as pressure on margins eases and credit growth remains stable.
The brokerage believes private banks may once again take the lead over public sector lenders. This is because competition for deposits increases and profit growth among state-run banks begins slowing down.
According to the brokerage report, “We expect banking sector earnings to rebound to ~15% CAGR over FY26-28E (consensus: 14%), led by ~15% NII CAGR.”
The brokerage further added, “Private banks with ~21% earnings CAGR are likely to outperform PSU banks with ~8% CAGR.”
Stocks in focus
Motilal Oswal’s preferred ideas in the banking and financial space include ICICI Bank, HDFC Bank, State Bank of India and AU Small Finance Bank.
According to the brokerage report, these lenders are better placed to benefit from stable loan growth, improving profitability and relatively stronger balance sheets compared to peers.
The brokerage also highlighted select mid-sized private banks where it remains more optimistic than the broader market consensus. These include RBL Bank, DCB Bank, Bandhan Bank and IndusInd Bank.
Why the banking sector may see a recovery
According to the brokerage report, banking sector earnings growth had remained relatively subdued in FY26, with overall profit growth of around 6.6% year-on-year.
However, Motilal Oswal now expects earnings momentum to improve gradually over FY26 to FY28. The brokerage believes stable loan growth, relatively steady Net Interest Margins and easing stress in unsecured lending portfolios could support profitability.
The report stated, “Sector earnings growth has gained momentum, with earnings expected to grow at a 15% CAGR over FY26-28E after a relatively subdued FY26.”
The brokerage also noted that asset quality concerns in unsecured loans have started easing compared to earlier expectations, reducing pressure on credit costs for several lenders.
Why private banks may outperform PSU banks
One of the key themes highlighted in the report is the expected divergence between private sector banks and public sector banks over the next few years.
According to Motilal Oswal, public sector banks had delivered strong earnings growth over the last few years because of better loan growth, comfortable liquidity and healthy margins.
But the environment is now changing.
The brokerage noted that rising competition for deposits is increasing the Cost of Funds for PSU banks. As a result, margins may remain under pressure going forward.
According to the brokerage report, “Consequently, we have reduced our NII estimates for PSU banks by ~3%, with the sharpest cuts for BoB, PNB, and Canara Bank vs. flat for private banks.”
The report also added, “From the NIM perspective, we expect private banks to witness relatively stable margins, with only a marginal downside risk despite a gradual rise in CoF.”
Mid-sized banks back in focus?
Motilal Oswal believes some mid-sized private banks could see a recovery after facing pressure over the past two years.
As per Motilal Oswal report, stress in unsecured retail and microfinance loan portfolios had earlier hurt earnings expectations for several mid-sized banks. But that trend may now be stabilising.
The brokerage said, “Bandhan Bank, IndusInd Bank, and AU Bank have seen earnings upgrades of ~3%, ~10-16%, and ~1%, respectively.”
At the same time, the report cautioned that not all mid-sized lenders are seeing improvement. Some banks, including RBL Bank and IDFC First Bank, have continued witnessing earnings downgrades.
What investors need to watch
While the brokerage remains constructive on select banking stocks, it also flagged a few risks investors should monitor carefully.
According to the report, rising geopolitical tension in West Asia, increasing competition for deposits and the transition towards the Expected Credit Loss framework could impact margins and profitability for some lenders.
The brokerage said, “We remain watchful of the evolving situation in West Asia, which could potentially lead to some stress build-up in the MSME and CV segments.”
Disclaimer: Investment in equity markets involves significant risks. The banking and financial sector projections, earnings estimates, and stock choices mentioned in this article are based on a research report by Motilal Oswal Financial Services and do not constitute direct buy, sell, or hold recommendations or investment advice from this publication. Financial performance projections like Compound Annual Growth Rate (CAGR) are estimates subject to regulatory changes, net interest margin fluctuations, and macroeconomic headwinds. Readers are strongly advised to consult a SEBI-registered investment advisor before making any personal financial decisions.
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