New Delhi [India], October 19 (ANI): Indian banks could see lending growth strengthen and margins begin to recover over the coming quarters, even as competition for deposits and pressure on fee income remain key challenges, according to a report by IIFL Capital.

The report, which reviewed banks' July-September quarter results for FY27, said retail lending momentum was improving, while corporate credit demand remained healthy. It also highlighted improvements in asset quality across several lenders, providing support to the sector's earnings outlook.

"Retail disbursements continued to remain healthy. Retail growth is expected to improve as disbursements have picked up meaningfully," the report said.

However, the pace of recovery in net interest margins - the difference between what banks earn on loans and pay on deposits - is likely to vary across lenders, depending on their funding costs, loan mix and deployment of recently raised deposits.

HDFC Bank's management indicated that its margins had bottomed out in the September quarter and could improve gradually, supported by lower funding costs and the impact of recent rate increases. IIFL Capital also noted that the bank's retail loan growth had improved to 8 per cent year-on-year from 7 per cent in the previous quarter.

At ICICI Bank, management expects margins to decline further in the December quarter before beginning to improve from the March quarter. The report said the full impact of foreign currency non-resident (FCNR) deposits on margins would be visible in the coming quarters.

Loan growth remained strong across several lenders. HDFC Bank's advances rose 16 per cent year-on-year in the September quarter, while Axis Bank reported 23 per cent growth and ICICI Bank recorded 30 per cent growth. The report noted that corporate, small business and retail lending supported expansion across different banks.

Asset quality also showed signs of improvement. At Axis Bank, the credit cost declined by 20 basis points sequentially to 51 basis points, while gross and net slippage ratios improved by 30-35 basis points. IIFL Capital said the improvement in credit costs at some lenders was supported by lower fresh bad-loan formation rather than one-off recoveries.

Deposit mobilisation, however, remains an important concern. The report flagged increasing competition for deposits and a structural slowdown in current account and savings account deposit growth at some lenders, which could limit the pace of funding-cost improvement.

Banks' ability to sustain credit growth while improving margins will therefore depend on deposit mobilisation, the deployment of available liquidity and continued stability in asset quality over the coming quarters. (ANI)