New Delhi [India], October 9 (ANI): Higher crude oil prices, an uneven monsoon and drought conditions in five states could pose risks to the asset quality outlook of Indian banks, even as credit costs remain benign, according to a report by 360 ONE Capital.

The report said asset quality and credit costs for both private sector banks (PVBs) and public sector banks (PSBs) continue to remain stable.

However, it highlighted the need to monitor management commentary on the potential impact of external pressures, particularly rising crude oil prices and weather-related challenges.

Higher crude oil prices could add pressure to the operating environment for businesses and households, while uneven monsoon conditions and drought in five states could create challenges for borrowers.

The report identified these developments as key factors that investors should watch while assessing the outlook for banks.

"We would watch out for the management commentary around any potential impact due to higher crude oil prices, uneven monsoon and drought situation in five states," the report said.

Despite these risks, the banking sector has seen an improvement in the balance between credit growth and deposit mobilisation.

According to the report, the gap between non-food credit growth and deposit growth narrowed to around 50 basis points in the second quarter of FY27, compared with around 500 basis points in the previous quarter. The improvement was supported by a pickup in deposit growth, backed by strong inflows under Foreign Currency Non-Resident Bank (FCNR(B)) deposits.

The report expects healthy FCNR(B) deposit mobilisation to ease pressure on domestic deposit growth and improve the liquidity coverage ratio (LCR) of banks.

However, the improvement in funding conditions may not fully protect banks from pressure on profitability.

While FCNR(B) inflows are expected to support growth in net interest income (NII), pre-provision operating profit (PPOP), profit after tax (PAT), earnings per share (EPS) and return on equity (RoE), the report expects net interest margins (NIMs) to compress in the second quarter of FY27.

For investors, the key issue will be whether banks can sustain earnings growth while managing margin pressure and potential risks to borrowers' repayment capacity.

Against the changing interest rate environment, the report said the risk-reward favours large private sector banks, citing their strong balance-sheet growth, operating profits, superior return ratios and attractive valuations.

The report's assessment suggests that while improving deposit mobilisation could support banks' funding position, investors should monitor crude oil prices, monsoon conditions and any signs of deterioration in asset quality in the coming quarters. (ANI)