Investors view these lenders as prime beneficiaries of the next credit upcycle, given their increased exposure to high-yielding retail and micro, small and medium enterprise (MSME) loans.
Credit to micro and small enterprises jumped 26% year-on-year in October, the strongest in two years, while medium enterprise lending climbed to a six-month high of 18% after a soft patch, Mint’s analysis of Centre for Monitoring Indian Economy’s (CMIE) latest data showed.
Retail credit growth also picked up to a 14-month high of 14% in October, though it remains below the 25%-plus surge last seen in July 2024. More importantly, these segments outpaced overall system credit growth of 12.5%, which itself hit a 13-month high during the same period, the analysis showed.
Tailwinds ahead
Trideep Bhattacharya, president and CIO of equities at Edelweiss Asset Management, sees a broad-based credit revival over the next six to twelve months, with easing microfinance stress further strengthening the case for mid-cap banks. “While credit growth could rebound across segments from a low base, MSME and retail are likely to grow faster,” he said.
This shift is crucial because mid-cap banks, with their strong regional footholds, are best placed to ride it, explains Ninad Jadhav, equity research analyst at LKP Securities.
Mid-cap banks gain from being close to the businesses they serve, allowing quicker assessments and faster loan approvals — vital for working-capital and small-business needs, Jadhav said. With new regulatory checks making large banks more selective and risk-averse, mid-caps now have more space to grow in the burgeoning MSME segment, he added.
With the rollout of expected credit loss-based provisioning, granular exposure norms and enhanced governance requirements, the Reserve Bank of India’s (RBI) latest regulatory requirements have made large banks more cautious and selective of MSME and retail credit in 2025.
Household budgets are also improving as inflation continues to ease in a low-interest-rate environment, noted Edelweiss Asset Management’s Bhattacharya. He added that the income-tax relief in Budget has helped households see a rise in disposable income, pare down debt, and set the stage for stronger retail credit growth next year.
Selective rally
Despite the Bankex delivering double the Sensex’s 5% return in the past year, experts still see a meaningful upside in mid-sized banks. However, even after their latest rally, many mid-cap banks still don’t attract much institutional interest because investors worry about their valuations, governance and deposit strength, said LKP Securities’ Jadhav. The jump in valuations looks hard to justify unless they can prove ROEs above 15% are sustainable, he added.
Markets still expect only the large private banks to hit the 15% mark in FY26, with ICICI Bank seen at around 16%, according to a BNP Paribas Exane report from November.
Mid-sized lenders lag well behind: AU Small Finance Bank is projected at about 13%, Federal Bank at 11% and IndusInd Bank at just 4%.
“Questions around disclosure practices, board quality and funding growth in a tighter deposit market also persist,” Jadhav said. “So major investors continue to treat mid-caps as secondary bets while relying on large private banks for core exposure.”
Raj Gaikar, research analyst at Samco Securities warned that only banks with clean balance sheets, steady funding and tight underwriting will further pull ahead, while MFI- and unsecured-heavy lenders facing higher credit costs and uneven collections will struggle to keep up. This divide is also evident in the latest earnings print, underscoring why a broad-based mid-cap rally remains unlikely for now.
Mid-sized banks such as Indian Overseas Bank, Bank of Maharashtra and IDFC First Bank posted a robust median profit growth of nearly 58% in Q2 FY26, while UCO Bank managed just 3% and AU Small Finance Bank saw a 2% decline, Mint’s review of September-quarter results showed. IndusInd Bank was the weakest, reporting a loss of about ₹445 crore.
Mint’s review of September-quarter results shows that an earnings turnaround for the broader mid-cap basket is still some distance away. Total income growth for both large- and mid-cap banks slowed to an eight-quarter low, with mid-caps rising 4% year-on-year while large banks grew 5%. Yet the profit gap was starker: large lenders posted a 6% increase in net profit, while mid-caps saw a 4% decline.
Lowering costs
Even so, analysts argue this low base sets the stage for a stronger earnings cycle ahead, with higher-yield segments firming up and funding costs easing.
Regional banks’ strong customer relationships and increased focus on deposit mobilization have made their low-cost current and savings account (CASA) deposit base more stable, said Harish Kapoor, vice president and research analyst of equities at Invesco Mutual Fund.
Mid-sized banks with better reach, customer engagement, digital capabilities, and brand trust are likely to benefit the most in the coming years, he added.
Gaikar of SAMCO Securities noted that falling funding costs in the low-interest-rate regime should further lift the profitability of mid-cap banks, given their larger exposure to high-yielding retail and SME loans.
“Credit costs are also moderating, particularly in microfinance and unsecured segments, as stress peaks and recoveries pick up, offering additional margin support,” he added.
Meanwhile, BNP Paribas Exane noted that funding costs could decline quickly in the months ahead as the gap between savings and term-deposit rates continues to narrow.
As the gap between savings and term-deposit rates narrows, customers are less likely to keep switching their money into fixed deposits. This helps mid-cap banks retain more low-cost savings deposits, lowering their overall cost of funds and reducing the need for costly bulk deposits, said Jadhav of LKP Securities.
While 2024 saw the credit-deposit ratio move to unsustainable levels, the pressure has eased to some extent, said Edelweiss Asset Management’s Bhattacharya. “The deposit crunch for banks appears to have peaked,” he added.
While 2024 saw credit-deposit ratio move to unsustainable levels, the pressure has eased to some extent,
However, even with funding costs easing and margins stabilizing, experts say it’s still too early to judge whether the recent improvement in low-cost deposits is truly structural.
“CASA gains still seem cyclical, supported by easier liquidity and lower fixed-deposit premiums,” said SAMCO Securities’ Gaikar. But structural improvements are starting to show in banks with stronger digital acquisition funnels and deeper customer stickiness in key regional markets, he added.
In the next 12-18 months, regional mid-caps, mid-tier PSUs and digitally efficient private banks are likely to gain the most as they turn daily customer activity into steadier low-cost deposits, said Gaikar.
