Indian banks will get a lift from higher lending for the remainder of this year, though rising costs may drag on profits.

Most Indian banks reported better growth in lending and net interest income in the April-to-June quarter. Still, many missed earnings expectations on mark-to-market losses, or unrealized losses on investments, caused by market volatility. For the remainder of the fiscal year to March 31, 2023, rising interest rates will help banks' net interest margins.

"Outlook for the Indian banking sector for fiscal year 2023 remains positive, supported by the improved asset quality and increase in loan book," said Tusharika Aggarwal, research analyst at APAC Dividend Forecasting at S&P Global Market Intelligence.

Overall bank credit grew 14.3% year over year as of July 29 to 127.35 trillion rupees, according to Reserve Bank of India data released Aug. 10. Credit uptake has accelerated in recent months as the economy recovers from the COVID-19 pandemic. The International Monetary Fund expects India's gross domestic product to grow 7.4% in 2022, according to a July 26 press release. In contrast, the world economy may slow to 3.2% expansion this year, compared with 6.1% in 2021, dragged by downturns in Russia and China in the second quarter.

Most Indian banks "have raised their growth guidance for [fiscal 2023], factoring strong [first quarter] and improving growth impulses in retail, [small and medium-sized enterprises], and corporate portfolio," said Anand Dama, analyst at Emkay Global, in a note on Aug. 11. Overall nonperforming loan ratios are likely to decrease due to a better credit growth trajectory, and banks already have healthy provision buffers that should support their profitability.

However, operating costs have increased due to elevated business expenses, staff compensation, and investments in branches and technology. That "kept core profitability in check," Dama said, adding that banks will need to pass on the rate hikes and raise fees to protect their core profitability.

State Bank of India expects to continue its credit growth in the next few months. The nation's biggest lender by assets will be able to sustain its 14.93% growth in gross advances reported in the fiscal first quarter, as the bank has nearly 5 trillion rupees in term loans and underutilized working capital credit lines to its customers, Chairman Dinesh Khara said at a post-earnings conference call on Aug. 6.

Punjab National Bank CEO Atul Kumar Goel said during the company's July 29 earnings call that the lender is expecting 10% loan growth over last year, although that may be revised upward as "there is traction in the market."

Still, banks will be buffeted by market volatility. State Bank of India reported a 6.7% year-over-year decline in stand-alone net profit for the fiscal first quarter to 60.68 billion rupees, primarily due to mark-to-market losses on its investment book of 65.49 billion rupees. Similarly, Punjab National Bank posted 14.09 billion rupees in unrealized loss in the June quarter.

As of Aug. 22, US$1 was equivalent to 79.91 Indian rupees.