India’s banking sector has entered a new phase of structural opportunity, driven by favorable macroeconomic conditions, regulatory support, and evolving market dynamics. One of the biggest catalysts has been the RBI’s final revision to Liquidity Coverage Ratio (LCR) norms. RBI has finalised new rules on how much extra “liquid buffer” banks must hold against deposits that customers can pull out instantly via internet/mobile banking (IMB). These buffers—called run-off factors—are being raised a little, but the overall package actually frees up a large amount of cash for banks to lend. The rules kick in from April 1, 2026. This has significantly reduced runoff rates for both digital and wholesale deposits which has created a supportive backdrop for the sector, enabling stronger credit growth and better margin management across banks.

• What is the LCR? It is a regulatory requirement to hold high-quality liquid assets to cover 30 days of outflows.

• What’s a “run-off factor”? Imagine a bank assumes that if things go wrong, some percentage of its deposits could be withdrawn very quickly (“run off”) in a panic. That assumed percentage is the run-off factor. Banks hold High-Quality Liquid Assets - cash, central-bank reserves, government bonds - to meet these sudden outflows. The more deposits assumed to run off, the more HQLA banks must keep idle.

Concurrently, the Q4FY25 earnings season has highlighted the resilience and divergence within the sector. ICICI and HDFC Bank stood out with robust profitability, strong asset quality, and cost efficiencies. These results indicate that fundamentally strong banks are better positioned to navigate the current rate environment, even as the repo rate heads into a softening cycle.

Importantly, this transformation is being reflected in the capital markets. The Bank Nifty index has rallied over 10% in the past 3 months, outperforming the broader Nifty50. This move has been fueled by a mix of regulatory optimism, bottoming out of credit costs, and renewed investor confidence in large private sector banks. However, this rally has also broadened to mid-tier banks that benefit from structural deposit franchise shifts and digital penetration.

Given this setup, stock picking within the banking sector now demands a more refined approach. Rather than buying the index passively, investors must distinguish between banks with superior risk-adjusted growth metrics, stable liability profiles, and capital discipline — the real drivers of sustainable alpha in this environment.

1. Start with Structural Tailwinds: Regulatory Relief & Liquidity Strength

The revised RBI guidelines on the LCR — a regulatory measure requiring banks to hold sufficient high-quality liquid assets to withstand a 30-day stress scenario — have emerged as a major inflection point for the sector. In April 2025, the RBI finalized more lenient norms compared to its July 2024 draft, reducing the additional run-off rate for digitally-enabled deposits from 5% to 2.5%, and for wholesale deposits (from legal entities like trusts and LLPs) from 100% to 40%.

This effectively means banks now need to maintain less liquid capital against such deposits, freeing up capital for lending and investment. According to Nuvama Research, if these norms had been applied to December 2024 data, sector-wide LCR would have improved by 6%, with all banks surpassing the 100% threshold. Leaders in this metric include SBI (136%), Kotak Mahindra Bank (132%), and ICICI Bank (125%).

This recalibration strengthens liquidity confidence in the system, particularly benefiting banks that rely more on digitally acquired retail deposits and structured wholesale funding. Kotak Mahindra, IndusInd Bank (IIB), and Federal Bank stand out in this regard, having already built high-yield, digitally scaled deposit franchises. These banks now enjoy a regulatory tailwind that effectively lowers their cost of holding liquidity, making their business models even more capital efficient.

2. Prioritize Asset Quality Over Aggressive Growth

The Non-Performing Asset (NPA) cycle in Indian banking appears to have stabilized and is now showing signs of meaningful improvement. ICICI Bank’s Gross NPA (GNPA) — which measures the total value of loans that are not generating income — declined to 1.7%, while its Net NPA (NNPA), which deducts provisions already made against bad loans, stood at 0.39%. Its Provision Coverage Ratio (PCR), a key indicator of how much risk the bank has covered through provisioning, improved to 76.2%, reflecting conservative and proactive risk management.

In contrast, HDFC Bank reported a GNPA of 1.33% but displayed an even higher PCR at 172%, indicating significant buffers despite a slightly higher net stress. This means the bank has nearly double the provisions relative to its bad loans, reinforcing investor confidence in its balance sheet strength.

A deeper look at stress assets — which include GNPAs, restructured assets, and high-risk loan categories (such as BB-rated exposures) — reveals that ICICI is particularly well cushioned. Its total provisions, which account for 3.07% of its gross loans, exceed its identified stress pool of 2.08%, resulting in a rare and highly favorable net negative stress profile. This indicates that even under adverse scenarios, ICICI is likely to avoid unexpected credit losses. While HDFC also has a healthy provision buffer, its incremental improvement in asset quality appears more gradual, giving ICICI a relative edge in terms of risk containment and provisioning discipline.

3. Look for Consistent Profitability with Margin Levers

Despite the ongoing repo rate cuts—which reduce the interest income banks can earn from their loan portfolios—both ICICI and HDFC have managed to protect their Net Interest Margins (NIMs). NIM is a critical profitability indicator that measures the difference between interest earned on loans and interest paid on deposits, expressed as a percentage of average interest-earning assets. A higher NIM reflects more profitable lending operations.

In Q4FY25, ICICI posted a strong consolidated NIM of 4.4%, with its domestic NIM even higher at 4.48%. HDFC Bank maintained a commendable NIM of 3.46%, even after adjusting for one-time CRR (Cash Reserve Ratio) benefit normalization, which otherwise distorts the true lending spread. These stable margins suggest that both banks have pricing power and have successfully repriced assets faster than liabilities, despite being in a rate-cut environment.

Operating leverage, which refers to the ability to grow profits faster than costs, is also coming through. ICICI has improved its cost-to-income ratio (a key efficiency metric) to 38%, while HDFC has maintained it at a steady 40%. This metric shows how much of the bank's income is consumed by operating expenses, and lower is better. The improvement in ICICI's case reflects better scalability and digital cost rationalization.

In addition, credit costs—defined as provisions made for expected loan losses as a percentage of total advances—have remained contained at 0.27% for ICICI and 0.48% for HDFC. This low level of provisioning indicates strong underwriting standards and suggests minimal stress in their loan books. Together, strong margins, controlled costs, and low credit impairments point to robust earnings resilience across interest rate cycles.

4. Growth vs. Risk: Assess Lending Mix and Loan-to-Deposit Ratios

Loan growth in the current environment remains steady, reflecting a cautious approach by top-tier banks in a cycle of softening interest rates and regulatory recalibration. ICICI Bank reported year-on-year (YoY) loan growth of 13.3% and quarter-on-quarter (QoQ) growth of 2.1%, while HDFC Bank posted 5.4% YoY and 4% QoQ growth, respectively. These figures suggest that while credit expansion continues, it is being pursued with discipline, particularly in light of evolving deposit dynamics and capital adequacy considerations.

One of the key indicators in evaluating balance sheet prudence is the Loan-to-Deposit Ratio (LDR), which measures how much of a bank’s deposits are used for lending. A lower LDR implies greater liquidity and lower funding stress. HDFC Bank has actively brought its LDR down to 96%, signaling a conscious effort to boost liquidity buffers and reduce dependence on volatile funding. In contrast, ICICI maintains a more conservative LDR of 82%, which is indicative of a more liquid and well-capitalized franchise.

Within the loan mix, ICICI’s business banking segment — typically comprising SME and MSME lending — grew a strong 34% YoY. This segment tends to offer higher yields compared to traditional corporate lending, although it also carries higher risk. The strong growth here underscores ICICI’s targeted approach toward high-margin verticals while managing portfolio risk through superior underwriting.

On the retail side, both banks continue to see stable growth in key loan categories such as home loans, personal loans, and auto loans. Importantly, this expansion is not accompanied by an uptick in delinquencies, suggesting that the banks are maintaining credit quality even as they scale retail operations. This stability across lending segments reflects a cautious yet opportunity-driven credit strategy aligned with current economic conditions and regulatory expectations.

5. Valuation vs. Earnings Quality: Be Willing to Pay Up

ICICI Bank trades at 2.9x its estimated Adjusted Book Value (ABV) for FY26 and 2.5x for FY27 — a valuation that reflects investor confidence in its core business strength and earnings visibility. ABV, or Adjusted Book Value, is a refined version of book value that adjusts for non-performing assets and provisioning, offering a clearer picture of true capital strength. HDFC Bank, while slightly cheaper, trades at 2.4x/2.1x its FY26/27E ABV, signaling similar high expectations from the market.

These valuation multiples are underpinned by strong profitability metrics. ICICI delivers a Return on Equity (RoE) of 17.9% and Return on Assets (RoA) of 2.1%, both of which reflect robust internal capital generation and balance sheet efficiency. HDFC’s profitability is also strong, albeit slightly lower.

What further sets ICICI apart is its improving asset quality. The bank's restructured loan book and BB-rated exposure — which are early warning indicators of stress — are both shrinking, suggesting enhanced credit underwriting and portfolio hygiene. Additionally, ICICI maintains ₹131 billion in contingent provisions, which are pre-emptive buffers held over and above regular provisioning, insulating it from future credit surprises.

Valuation support is further strengthened by a Sum-of-the-Parts (SOTP) analysis. This method aggregates the value of standalone banking operations with that of key subsidiaries. ICICI’s subsidiaries, including ICICI Prudential Life, ICICI Lombard General, and ICICI Securities, contribute an estimated ₹200 per share. Meanwhile, HDFC’s subsidiaries — HDFC Life, HDFC AMC, and HDB Financial — add roughly ₹228 per share. These non-bank verticals offer long-term growth levers and diversification, adding depth to the overall investment case.

Conclusion: A Selective Framework for Navigating 2025

With the regulatory backdrop turning favorable—marked by the RBI's supportive LCR norms and easing rate environment—Indian banks are entering a strategically rich environment for capital allocation. Net Interest Margins (NIMs) are proving resilient even as policy rates trend lower, indicating pricing power and operational efficiency among top banks. Simultaneously, asset quality is not only stable but improving across key metrics like GNPA, NNPA, and PCR, which together reflect a reduced likelihood of credit shocks.

This juncture, therefore, offers a unique entry point for investors looking to allocate capital into fundamentally strong banks. But this phase is not one where rising tides lift all boats. Instead of buying the banking sector passively via indices like Bank Nifty, investors must focus on banks demonstrating superior earnings consistency, disciplined risk management, and efficient capital deployment. It's a time to selectively back those banks that show not only profitability but also durability in the face of regulatory, economic, and competitive shifts.

In other words, this is not a theme-driven market rally. It's a stock-picking environment where differentiation in balance sheet strength, margin resilience, and provisioning strategy will drive long-term alpha. The challenge is no longer about being in banks — it is about choosing the right ones.

Investment Playbook:

• ICICI Bank: High-conviction compounder with best-in-class risk-adjusted returns, dominant provisioning, and growth levers in place.

• HDFC Bank: Steady long-term performer; accumulation candidate on dips with focus on margin normalization and PSL alignment.

• Federal, Kotak, IndusInd: Tactical bets for those tracking liquidity gains from revised LCR norms.

As the cycle turns, quality will outperform momentum. In banking, more than anywhere else, discipline is the alpha.

Glossary

• LCR (Liquidity Coverage Ratio): A regulatory requirement to hold high-quality liquid assets to cover 30 days of outflows.

• GNPA (Gross Non-Performing Assets): The total value of defaulted loans.

• NNPA (Net Non-Performing Assets): GNPAs minus provisions.

• PCR (Provision Coverage Ratio): Provisions made as a percentage of GNPAs.

• NIM (Net Interest Margin): The spread between lending and deposit rates.

• CASA (Current Account Savings Account ratio): The share of low-cost deposits in total deposits.

• LDR (Loan to Deposit Ratio): Measures liquidity risk based on how much of deposits are lent.

• SOTP (Sum-of-the-Parts Valuation): A method that adds up the values of different business units or subsidiaries.

• RoE (Return on Equity) and RoA (Return on Assets): Profitability metrics measuring returns generated on shareholder equity and total assets, respectively.