Iran war risk may cap bank loan growth at 12% in FY26

Why the Iran conflict matters for Indian banks

A prolonged Iran war could become a meaningful external shock for India’s banking sector through higher global uncertainty and supply-side disruptions. Ambit Capital has warned that these conditions can moderate credit demand, keep liquidity tight, and add pressure on banking margins over the medium term. The brokerage’s base view is that the sector remains structurally resilient, but near-to-medium term expectations may need tempering if the conflict persists. The key transmission channels flagged include slower loan growth, elevated funding costs amid tight liquidity, and potential second-order effects on asset quality.

Ambit’s bear-case: credit growth seen at 10-12%

Ambit Capital expects bank credit growth could slow to 10-12% in a bear-case scenario if the war drags on. The brokerage also cut its earnings compound annual growth rate (CAGR) estimate to 15.7% from 17.3%, citing the risk of a demand shock and near-term pressure on earnings due to macro uncertainty. The message from the report is that banks may still grow, but the pace could cool from recent highs if uncertainty affects investment and consumption. For investors, this matters because credit growth expectations are a key driver of earnings estimates and valuation narratives in the sector.

The “deposit paradox” and why liquidity is central

Ambit highlighted an additional structural risk alongside geopolitical uncertainty: the “deposit paradox”. According to the brokerage, household savings are increasingly shifting towards capital markets, tightening liquidity for banks and heightening rate sensitivity, particularly in urban-centric deposit pools. This trend can force banks to offer higher deposit rates to attract funds, raising funding costs. Elevated funding costs, in turn, can limit margin expansion even when loan yields are stable. The combination of structural deposit competition and a global risk-off backdrop is why Ambit expects liquidity conditions to remain an important swing factor.

Margin outlook: pressure now, gradual recovery from H1FY27

Ambit expects some recovery in net interest margins (NIMs), but warned the pace is likely to be gradual due to tight systemic liquidity. The brokerage said it anticipates granular NIM recovery from H1FY27. It also noted that while the tail-end of liability repricing may offer near-term stability through H1FY27, a more meaningful margin revival across FY27-FY28 hinges on the maturation of high-cost, long-term deposits. Ambit expects a stable repo policy rate in the near term, but added that a rate hike by the Reserve Bank of India (RBI) to manage inflation would likely be margin-accretive for private banks more than public sector banks because of faster yield transmission.

Asset quality remains stable, with system GNPA around 2.2%

Despite macro risks, Ambit said asset quality across the banking system remains stable, supported by strong balance sheets and provisioning buffers. It pointed out that gross NPAs have declined to around 2.2%, describing it as a secular improvement driven by recoveries and prudent underwriting. Ambit also said healthy reserve buffers and stable slippage ratios could help insulate the sector from macro shocks, implying deterioration may be contained even under stress. Separately, the broader industry narrative remains that bad loans have declined and capital buffers are above regulatory requirements, with provisions covering about three quarters of potential stress scenarios.

RBI’s ECL transition from April 1, 2027: what changes

India’s central bank announced credit reforms in October 2025 to enhance credit risk management practices and comparability across institutions. A key proposal is the phased implementation of an expected credit loss (ECL)-based framework starting April 1, 2027. The shift is expected to increase provisioning requirements, especially for stage 2 loans, where banks may need to provide for expected losses over the entire life of the loan. One example cited in the reporting is that a 60-day overdue account that earlier attracted a 0.25%-0.4% provision could require 5% under the new approach. While this can temporarily elevate provisioning and capital requirements, the stated intent is to make risk recognition more forward-looking.

Capital buffers and provisioning: private banks better placed

On capital, the aggregate capital adequacy ratio (CAR) of the four major private sector lenders stood at 18.26% as of September 2025, compared with 15.56% for state-owned banks, according to Market Intelligence data referenced in the material. Punjab National Bank’s CEO said a rough estimate of the ECL impact could be around 75-80 basis points on its CAR, spread over five years. Some lenders have already been building cushions through contingent and floating provisions, with Axis Bank, HDFC Bank and ICICI Bank cited as having sizable buffers. State-owned banks may face relatively greater pressure because they typically operate with thinner capital cushions and lower existing provisions, and some have been front-loading provisions ahead of the shift. Punjab National Bank estimated it may need an additional INR 90 billion to INR 100 billion in provisioning under ECL.

What RBI stress tests say about resilience under shocks

The RBI’s Financial Stability Report (FSR) said India’s financial system remains robust and resilient, supported by strong balance sheets and low market volatility, and that stress tests indicate banks can withstand shocks and keep capital ratios above regulatory requirements. Macro stress tests of 46 banks projected that the capital adequacy ratio may decline to 16.8% by March 2027 from 17.1% in September 2025 under a baseline scenario. Under adverse scenarios, the ratio may fall to 14.5% and 14.1%. The RBI said none of the banks may breach the 9% minimum requirement, but four could dip into their capital conservation buffer if no fresh capital is infused. Liquidity stress tests showed the aggregate liquidity coverage ratio (LCR) could fall from 131% to 116.8% under severe stress, with three banks failing to meet the 100% minimum requirement.

Key numbers at a glance

Stock preferences and what investors are tracking

Ambit said it prefers private bank stocks such as HDFC Bank and ICICI Bank. The rationale embedded in its note is that private banks can be better positioned in a tight-liquidity environment due to stronger franchises and faster transmission benefits if rates rise. In parallel, other brokerage commentary in the material points to an improving medium-term picture if margin pressure eases and credit costs moderate, though near-term loan growth is described as subdued at around 10-11% in FYTD26 in that view. Investors are also watching how banks manage the deposit competition, the pace of NIM recovery into FY27, and the operational readiness for ECL implementation from April 2027.

Conclusion

Ambit’s warning ties the Iran war risk to a clear set of banking variables: credit growth could slow to 10-12% in a prolonged-conflict scenario, margins may stay under pressure with recovery expected from H1FY27, and liquidity could remain tight amid the deposit paradox. At the same time, asset quality indicators remain supportive, with system gross NPAs cited around 2.2% and RBI stress tests suggesting banks stay above minimum capital requirements even in adverse scenarios. The next concrete milestones for the sector will be the evolving liquidity and rate backdrop, and banks’ preparations for the ECL framework scheduled to begin from April 1, 2027.