HDFC Bank, ICICI Bank, SBI,: Elara warns of complex NIMs challenges, which stocks to buy

Elara Capital has raised concerns regarding the widely held view that net interest margins (NIMs) for banks will improve in FY27. While consensus expects benefits from rate cut absorption in FY26 and liability repricing in FY27, Elara identifies several variables that may upend these assumptions. The brokerage highlights risks linked to deposit flows, competitive intensity, and reinvestment hurdles, all of which could complicate the NIM outlook for the upcoming financial year.

According to Elara Capital, “There are many moving variables and thus, NIM outcome may not follow a simplistic framework,” The firm expects continued pressure on deposits and anticipates possible NIM and net interest income (NII) revisions, as banks increasingly prioritise growth over margin. Elara asserts that FY27 may turn out to be a year where liabilities become valuable assets for banks, driving preference for institutions with robust liability franchises.

The brokerage notes a sustained pressure on yields, fuelled by heightened competition and increased efficiency among public sector banks. This intensified environment, combined with range-bound credit multipliers and a focus on growth over profitability, is expected to limit any manoeuvring room for banks on the yield side.

Elara Capital cautions that consensus assessments of funding cost benefits, especially those based on liability repricing in FY27, may face significant challenges. “System deposit growth has been lagging, and the system today is growing at much higher CD ratios, which would mean much higher deposit ask rate for FY27 – this would strain costs,” Elara explains. The report points to sticky or rising bulk deposit rates and ongoing retail deposit rate hikes as evidence of this challenging environment.

According to Elara, means that pricing will increasingly determine deposit accretion. The brokerage believes that consensus assumptions regarding funding cost relief could be overoptimistic, adding another layer of risk to the FY27 outlook for banks.

Investment income is also in the spotlight, with Elara citing rising reinvestment risks due to the widening gap between the repo rate and government securities. Interest income from investments historically accounts for around 15-20% of total interest income, so any challenges here could significantly impact sector NIMs.

Looking back over the past five years, Elara points out that upward interest rate cycles have helped banks achieve historically high NIMs. However, FY26 has already seen a decline, though funding cost benefits have provided a partial cushion. The brokerage questions whether non-bank financial companies (NBFCs), which are currently enjoying higher spreads than banks, can sustain this advantage.

In terms of sector positioning, Elara continues to favour larger private banks with strong liability franchises, noting that risk-reward appears sharply tilted towards these frontline institutions due to their earnings resilience and reasonable valuations. ICICI Bank and Kotak Mahindra Bank remain Elara’s top picks in the sector, reflecting a preference for scale and stability amid sectoral headwinds.

Mid-tier private banks, by contrast, appear less attractive to Elara, with valuations considered "rather full" and a slow path to further re-rating anticipated. For PSU banks, Elara expresses preference for State Bank of India (SBI), though it warns that a sustained re-rating in the public sector could take longer to materialise.

The outlook for the banking sector in FY27, according to Elara Capital, is shaped by a complex interplay of deposit dynamics, regulatory changes, yield pressures, and competitive threats. The brokerage maintains its stance that the most resilient performers will likely be those with established liability franchises and strong risk management, especially among larger private banks.

From the private banking space, Elara Capital has a 'buy' rating on ICICI Bank (Target price: Rs 1,707), IDFC First Bank (Target price: Rs 85), Federal Bank (Target price: Rs 250), DCB Bank (Target price: Rs 160) and City Union Bank (Target price: Rs 275). From PSU Banks, its has given a 'buy' tag to Bank of Baroda with a target price of Rs 290.

Elara has given an 'accumulate' rating on HDFC Bank (Target price: Rs 1,147), Kotak Mahindra Bank (Target price: Rs 2,481), Axis Bank (Target price: Rs 1,365), Karur Vysya Bank (Target price: Rs 265) and RBL Bank (Target price: Rs 315). From PSU Banking space it has same rating on State Bank of India (Target price: Rs 1,050) and Punjab National Bank (Target price: Rs 122).

It has a 'sell' rating on IndusInd Bank (Target price: Rs 720) and given Canara Bank (Target price: Rs 130) and Indian Bank (Target price: Rs 730) a 'reduce' rating. From the small finance bank (SFB) space, it has a 'buy 'rating on Ujjivan SFB (Target price: Rs 60) and Equitas SFB (Target price: Rs 70). AU Small Finance Bank has a 'reduce' rating with a target price of Rs 786.