Banks at a crossroads: Rally or selloff on Budget Day?

Budget Day litmus test: Relief rally or reality check for banks?

• Banking stocks enter Budget Day after mixed performance in early 2026
• RBI likely to pause rates in Feb, with possible cuts later in 2026
• Budget's fiscal signals may drive relief rally or selloff in banking sector

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Banking stocks are entering Budget Day at a delicate juncture. After delivering steady gains through most of 2025 on the back of reasonable valuations, improving asset quality and stable earnings, the sector has lost momentum at the start of 2026. A mix of global trade tensions, tariff-related uncertainties and modest December-quarter results has triggered a bout of caution.

So far in 2026, performance across lenders has been mixed. Shares of HDFC Bank and Kotak Mahindra Bank were down around 7 percent each, while ICICI Bank has managed marginal gains. In contrast, SBI, Bank of Baroda and Axis Bank, along with Federal Bank posted gains of about 8 percent.

RBI policy action: Pause in Feb, easing later?

According to Moneycontrol’s poll, most economists and fund managers expect the RBI to maintain a status quo in its February policy meeting. However, a “neutral” stance could keep the door open for further rate cuts later in the year.

Vinod Nair, head of research at Geojit Financial Services, expects at least one rate cut in 2026, with the possibility of two to three cuts if global trade delays, particularly with the US, start weighing on growth prospects.

That said, the timing of any easing will depend heavily on the government’s borrowing programme and its capital expenditure roadmap outlined in Budget 2026.

For banking stocks, the Budget’s fiscal signals could determine whether the sector sees a relief rally or a post-Budget selloff. A credible fiscal deficit path, manageable borrowing numbers and sustained capex support would help keep bond yields in check, improve liquidity transmission and give the RBI greater comfort to ease policy without unsettling the rupee or debt markets.

A supportive fiscal backdrop would also help banks navigate the next phase of the rate cycle more smoothly, especially as margins begin to feel the cumulative impact of December rate cut.

Rate cuts positive for credit growth; margins the key variable

Rate cuts are generally supportive for credit growth and asset quality, but the core debate for banks is how effectively they can defend margins with profitability.

December-quarter results suggested that private lenders have so far managed to protect margins despite cumulative rate cuts of 125 basis points. In Q3, margins were supported by benefits from CRR cuts and ongoing deposit repricing, said Dnyanada Vaidya, BFSI analyst at Axis Securities.

She added that the full impact of the December rate cut will begin to reflect in the March quarter, weighing on asset yields. However, margins should still receive some support from continued repricing of term deposits, albeit at a slower pace.

Banks are increasingly tweaking their strategies to cushion the impact of falling rates. During the December quarter, lenders such as Federal Bank and HDFC Bank stepped up their focus on low-cost CASA mobilisation to offset declining asset yields. RBL Bank, meanwhile, leaned on a higher proportion of fixed-rate loans to lock in yields as the rate cycle turns softer.

HDFC Bank’s CFO, in the post-earnings concall, highlighted that easing cost of funds has supported margins—underscoring that banks are prioritising margin stability quarter by quarter rather than chasing aggressive loan growth.

What lies ahead?

With the full impact of the December rate cut expected to play out in the March quarter, any additional easing could keep pressure on net interest margins, cautioned Jignesh Shial, Director and Lead for BFSI at Ambit Capital.

“We remain cautious on a sharp acceleration in growth until the rate cycle stabilises. If the RBI continues to manage liquidity actively, growth is likely to remain orderly rather than aggressive,” Shial said. He added that most banks have already passed on rate cuts over the past month, with the full impact expected in Q4. With deposit repricing largely done, further rate cuts could lead to some margin compression.

However, Shial stressed that the sector’s fundamentals remain intact. “There are no earnings downgrades on the horizon. Credit growth is gradually improving, asset quality trends remain supportive, and over the next 12–24 months, as long as the RBI remains comfortable with system liquidity and loan-to-deposit ratios, the cycle continues to favour banks.”