Will the Reserve Bank of India's move to attract foreign currency deposits from non-resident Indians be the catalyst that banking stocks have been waiting for? Brokerages say banks' lower funding costs could strengthen the prospects of higher valuations, as they look to recover after foreign portfolio investors pulled out ₹23,141 crore from banking and financial stocks in May, making it their most heavily sold sector.
RBI's move this month to boost foreign currency non-resident (bank), or FCNR (B), deposits is positive for banks as it helps them raise foreign currency deposits at a lower cost, with the central bank bearing the hedging expense. This would improve liquidity, strengthen balance sheets and support lending, especially for banks with a strong non-resident Indian (NRI) customer base, market participants said.
“We are in an interesting juncture in the cycle, where re‑rating is likely to be driven by yield discipline (public banks) and improved access to lower-cost of borrowings (FNCR deposits),” according to a 25 June report by Kotak Institutional Equities.
According to the brokerage, two main things could trigger a valuation re-rating for the banking sector: public banks pushing their loan yields higher, which gives other players more room to price their loans comfortably, and banks successfully raising foreign currency borrowings to ease the pressure on their overall cost of funds.
On 5 June, RBI had announced it will absorb the foreign exchange hedging cost on fresh FCNR (B) deposits. This creates a rare opportunity for overseas Indians to earn returns that may be comparable to equities from what is essentially a fixed-income investment.
In a broader plan to draw in dollars and support the rupee, under the scheme, banks can raise fresh or renew existing FCNR(B) deposits with maturities of three to five years and swap the dollars with RBI at a concessional rate. Since the RBI is taking care of the hedging cost, banks effectively face zero hedging expense, which had earlier limited their ability to offer attractive interest rates on dollar deposits.
According to Vinod Nair, head of research at Geojit Investments, RBI’s FCNR(B) scheme has improved the outlook for banks by absorbing hedging costs (around 3.0-3.5%) on fresh 3–5-year deposits, enabling higher deposit rates and potentially mobilizing over $50 billion. This is expected to ease funding pressures, support credit growth, improve liquidity, and moderate the elevated credit-to-deposit (CD) ratios, he said.
The regulator's move simultaneously addresses pieces of the macro jigsaw such as balance of payments, currency and liquidity. Since the announcement, banks' wholesale deposit costs have started easing, said a YES Securities report on 25 June.
RBI's recent measures allowing banks to collect FCNR deposits without interest rate caps, leverage limits, or cash reserve requirements will make it much easier to bring in new deposits and boost net interest margin of lenders, said Sunny Agrawal, head of fundamental research at SBI Securities.
A bull-run in sight?
Beyond this regulatory boost, the banking sector is riding multiple tailwinds, including credit growth staying robust in the 14-16% range. Moreover, the recent moderation in crude oil prices after easing tensions in the US-Iran war has also eased inflation anxieties and cooled expectations of further interest rate hikes.
The pressure on banks' net interest margins is also expected to reduce this fiscal year as older deposits get renewed at lower interest rates. Supported by exceptional asset quality and strong corporate and personal balance sheets, the sector offers comfortable valuations alongside an expected mid-teen earnings growth rate through FY26-FY28, Agrawal of SBI Securities added.
The Nifty Bank index was down 2.5% in FY26, marking its weakest showing since the 37% crash in FY20. But fortunes had then changed rapidly: the index rallied nearly 74% in FY21 during the post-covid recovery period. Whether FY27 will see a repeat of that stellar run remains to be seen, but banking stocks have already returned 16% so far this fiscal year.
Geojit's Nair said valuations remain attractive, offering a stock-specific accumulation opportunity, with large private and major public sector banks benefiting the most.
Having said that, Nair also highlighted that “high deposit demand, limited supply, and a risk premium that does not fully reflect the underlying risks pose challenges that could ultimately offset the expected mobilization”.
According to Bloomberg data, most lenders that are a part of the Nifty Bank index are trading above their five-year average price-to-earnings (P/E) multiples. For instance, State Bank of India is at 11.5 times as against its long-term average of 9.86 times, Kotak Mahindra Bank is at 22.83 times against 21.66 times, while Axis Bank is at 16.2 times compared with 13.5 times.