Frontline private banks are well positioned to outperform as attractive valuations, resilient asset quality, improving funding dynamics, and the potential for earnings-led re-rating create a favourable investment case, according to Kotak Institutional Equities.
The brokerage has retained an overweight stance on leading private lenders, preferring HDFC Bank and ICICI Bank, while State Bank of India (SBI) remains its top pick among public sector banks. It believes the sector is entering a phase in which valuation re-rating will be supported by higher loan yields, lower funding costs, and steady earnings growth rather than rapid credit expansion.
Two key triggers could drive sector re-rating
Kotak said two developments could act as catalysts for banking stocks. The first is public sector banks’ efforts to improve loan yields, which could provide pricing support across the industry. The second is banks’ ability to raise low-cost foreign currency non-resident (FCNR) deposits and other overseas borrowings, helping ease pressure on funding costs.
The brokerage, however, remains cautious on the outlook for loan demand. It expects strong foreign capital inflows to reduce banks’ dependence on domestic deposits rather than trigger a meaningful acceleration in credit growth. Recent Reserve Bank of India data also suggests that credit growth has been supported more by substitution from bond markets than by a broad-based increase in borrowing demand.
Asset quality likely to remain resilient
Kotak expects asset quality to remain strong through FY27, with both private and public sector banks likely to report lower slippages. While lenders may increase provisions ahead of the transition to the Expected Credit Loss (ECL) framework, the brokerage does not expect this to materially weaken the sector.
Retail asset quality is entering this phase from a much stronger position than in FY23, supported by tighter underwriting standards since FY24 and the seasoning of weaker loan cohorts. Unsecured retail loans are expected to witness the sharpest improvement after the stress seen in recent quarters.
Although MSME portfolios could face some pressure if economic growth slows significantly, Kotak believes systemic risks remain limited. Government-backed guarantee schemes such as the Emergency Credit Line Guarantee Scheme (ECLGS) and the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) continue to provide meaningful support. Meanwhile, corporate balance sheets remain healthy, enabling banks to comfortably fund credit requirements despite sector-specific uncertainties.
Valuations still offer room for upside
Despite the banking sector’s recent outperformance, Kotak believes valuations remain attractive, with most frontline banks still trading below their estimated fair values. The brokerage sees scope for further multiple expansion alongside steady earnings compounding.
Within the private banking space, Kotak continues to favour HDFC Bank and ICICI Bank at current valuations. It believes Axis Bank will need to demonstrate stronger franchise performance before it can command a valuation premium over HDFC Bank.
Among public sector lenders, SBI remains Kotak’s preferred pick. While benign asset-quality trends and an improving funding environment could support greater risk-taking, the brokerage believes current valuations already capture much of the potential upside.
Disclaimer: This story is for educational purposes only. The views and recommendations above are those of individual analysts or broking companies, not Mint. We advise investors to check with certified experts before making any investment decisions.
