By Olivia Hart

Banks under Kotak Institutional Equities' coverage posted 20 per cent year-on-year earnings growth in Q2FY27, and the brokerage argues that frontline private lenders, State Bank of India and Bandhan Bank hold the strongest position as India's rate cycle turns upward.

The advantage, according to the analysis, rests on three pillars: a favourable loan mix, relatively well-placed liability franchises, and an ongoing shift toward lower-cost funding. Kotak continues to avoid regional banks, citing higher gold-loan exposure and relatively expensive valuations.

What did Q2FY27 actually deliver?

The quarter's headline numbers point to broad-based strength. Beyond the 20 per cent earnings growth, operating profit rose around 15 per cent, provisions fell 25 per cent, and net interest income climbed approximately 15 per cent.

The split between ownership categories tells a sharper story:

• Public sector banks delivered roughly 20 per cent earnings growth.
• Private banks posted about 25 per cent.
• Net interest margins stayed stable or improved at state-owned lenders, while most private banks reported a decline — partly attributed to the impact of FCNR deposits.

Loan growth remained strong across both categories. Treasury income contributions, by contrast, declined sequentially.

Why does the loan mix matter for margins?

Some recent demand for corporate credit reflects higher working-capital requirements rather than fresh expansion, as businesses confront elongated cash-conversion cycles and inflation. Kotak reads this as a signal: a gradual shift away from corporate lending could support net interest margins, even if headline loan growth moderates as a result.

For practitioners, the trade-off is straightforward. Banks that rotate portfolios away from corporate books may report slower loan growth, but they protect and potentially expand margins — the metric that drives earnings through a rising rate cycle.

How does funding cost fit into the picture?

Banks are replacing expensive wholesale borrowings with lower-cost term deposits, including through the FCNR route. The rate cycle itself could add a further tailwind to that shift.

Kotak cautions on one variable: the magnitude and sustainability of any margin expansion will depend on the duration and intensity of the rate cycle, together with the prevailing deposit and funding environment. Margin gains are conditional, not automatic.

What is the asset-quality outlook?

The brokerage expects the asset-quality cycle to remain favourable in the near term, supported by lower slippages and benign credit costs.

On gold loans specifically, Kotak sees limited near-term asset-quality risk, particularly at larger lenders whose customer mix skews toward larger-ticket borrowers with relatively lower risk profiles. That assessment cuts in favour of the big banks and against smaller, gold-heavy regional players — one reason the brokerage keeps them on its avoid list.

Among banks with higher microfinance institution exposure, Kotak favours Bandhan Bank.

Are the valuations still attractive after the rally?

Frontline private banks and SBI have rallied sharply over the past few weeks, which normally would argue against buying. Kotak's counterpoint: the re-rating followed a prior period of underperformance or absolute share-price declines, leaving valuations attractive despite the move.

Headwinds from fee income and operating expenses are expected to be significantly lower for frontline banks than for their peers — another structural edge the brokerage prices into its preference.

On mid-tier banks, Kotak remains watchful for opportunities but finds their prospective return profiles make it harder to turn constructive. The stance is a hierarchy, not a blanket call: frontline private lenders and SBI at the top, Bandhan among microfinance-exposed names, mid-tier banks on watch, regional banks avoided.

What changes for investors?

The analysis frames the rising rate cycle as a sorting mechanism across the sector. Banks with cheapening funding, favourable loan books and low fee-income pressure compound the benefit; those dependent on wholesale funding or weighted toward gold loans absorb more of the strain.

Net interest income, in Kotak's view, has room to grow from current levels even if loan growth moderates — the funding-cost shift does part of the work that volume growth would otherwise have to do alone.