Banking stocks have been on the rise in the past one month with those of public sector banks gaining the most. Indeed, in some cases, investors have been more gung-ho about a recovery in banks than the bank managements. Look at the above chart of banking indices. The Bank Nifty has risen 4.5% since July, while the public sector banking index has gained 14%. This despite 22 out of 36 listed banks posting losses for the March quarter.

The reason is that investors believe the worst is over for banks. Considering the mountain of provisioning lenders have done over the last three years, investors believe banks have enough insurance against toxic assets and from here on earnings can only improve.

Hence the large losses in the March quarter were seen as the final sweep towards a clean balance sheet.

Will the new found bullishness of investors, such as Morgan Stanley, on Indian banks withstand the test of time?

Well, the Q1 results of banks show that this optimism is misplaced.

Public sector banks reported cumulative losses of 11,867 crore. Net profit of private lenders plunged on an aggregate level. ICICI Bank Ltd reported a historic loss, Axis Bank’s performance left much to be desired and the country’s largest lender State Bank of India (SBI) reported a quarterly loss of 4,876 crore. Slippages have slowed, but most of the recoveries have been tied to just two bad assets successfully resolved under the insolvency and bankruptcy code.

That brings us to the progress of the insolvency cases. One needs to only look at the provisions banks have made against the top 40 accounts referred under the IBC. Provisioning ranges from 65% to 80%, which means bankers are expecting huge haircuts. Lenders made 65% more provisions in the June quarter compared with a year ago.

Finally, recoveries are not substantially higher than the historic trend for banks. Write-offs are also not substantially lower. Even at the core business level, banks have shown weak performance. The pre-provisioning operating profit of most corporate lenders has hardly grown and, in many cases, has fallen.

That said, some lenders will show a marked improvement compared with others. Given that corporate balance sheets are improving with leverage coming down, future asset quality is likely to be better. Revival in credit growth, too, will make bad loan ratios look less ugly. As recoveries through insolvency proceedings trickle in, interest income and margins are likely to show expansion.

The question is, when will the improvement in performance come through? Some analysts, such as Gautam Chhugani of Bernstein, see a more normalized earnings year only in FY20.

Even so, lenders under prompt corrective action will continue to suffer as their main source of income—lending—is severely restricted.

In short, Indian banks should brace for another year of tepid performance and their stocks should start reflecting the restraint that these banks’ managements have shown in their outlooks.