AU Small Finance Bank’s 31% deposit surge: Can strong CASA growth help offset shrinking margins?

AU Small Finance Bank Limited (NSE: AUBANK, BSE: 540611) delivered a robust 31% year-on-year growth in total deposits to ₹1,27,696 crore for Q1 FY26, marking one of its strongest quarterly deposit expansions in recent years. Current and savings account (CASA) deposits rose 16% YoY to ₹37,241 crore, pushing the CASA ratio to 29.2% and reinforcing its retail-heavy funding base. This strong liability performance comes at a time when the bank’s net interest margins (NIMs) shrank sequentially by 38 basis points to 5.4%, raising the key question of whether deposit-led momentum can help cushion profitability in a softening rate cycle.

The small finance bank’s stock closed at ₹790.30 on July 18, 2025, slightly below its 52-week high of ₹841. Institutional sentiment remains broadly constructive, but analysts have flagged the need for early evidence of margin stabilisation and secured lending growth before revising earnings forecasts for the rest of FY26.

Can AU Small Finance Bank’s aggressive deposit mobilisation and CASA expansion help stabilise its margins in a softening interest rate cycle?

The bank’s liability strategy is showing clear results. Stable deposits, including CASA, retail term deposits, and non-callable bulk deposits, now constitute 79% of its total base, which analysts view as a critical buffer against future funding cost volatility. Within CASA, current deposits surged 34% YoY to ₹6,348 crore, while savings deposits climbed 13% YoY to ₹30,983 crore, demonstrating strong traction among semi-urban and rural customers—segments where AU enjoys a competitive edge due to its deep branch network.

Management has actively recalibrated its deposit rates, cutting peak savings account rates by 50 basis points to 6.75% and term deposit rates by 90 basis points to 7.1% since March 2025. These moves align with the broader industry trend of passing on the Reserve Bank of India’s cumulative 100-basis-point rate cuts to customers. The strategy also reflects AU’s attempt to balance deposit mobilisation with cost discipline in a market where private banks are aggressively pricing retail deposits.

Institutional investors have interpreted these rate cuts as a positive step toward medium-term margin improvement, even though the full benefit of lower funding costs will take time to materialise. For now, the cost of funds declined only marginally by six basis points to 7.08%, while incremental CoF fell by 62 basis points compared to Q4 FY25.

Why do shrinking NIMs remain a concern despite record-high deposit growth?

The bank’s NIM decline underscores a structural challenge in balancing secured growth with profitability. Analysts noted that AU’s decision to prioritise risk-averse lending has reshaped its loan book composition. Secured retail and commercial lending grew 22% YoY, while unsecured segments, such as microfinance and credit cards, contracted 23% YoY due to cyclical headwinds and deliberate credit card book calibration.

This conservative shift protects asset quality, but it also compresses yields, especially when lending rates are adjusting downward faster than the cost of funds in a competitive market. Institutional investors remain watchful, citing that any prolonged NIM pressure could cap earnings upside despite strong deposit mobilisation.

However, the high proportion of retail CASA deposits provides a long-term advantage. CASA balances are inherently sticky, and analysts believe that AU’s deep presence in underbanked regions can help sustain deposit inflows at relatively lower pricing compared to private sector peers.

What could this mean for AU Small Finance Bank’s earnings trajectory in FY26?

The bank’s management has maintained a cautiously optimistic outlook, with Founder and CEO Sanjay Agarwal describing the policy backdrop as supportive. He cited easing inflation, surplus liquidity, and expected cash reserve ratio cuts as key tailwinds for credit growth. Agarwal, however, acknowledged that domestic demand recovery remains uneven, and global geo-political risks continue to weigh on trade flows and consumer sentiment.

Institutional sentiment suggests that AU Small Finance Bank’s ability to stabilise NIMs by the second half of FY26 will be a key earnings trigger. Analysts indirectly indicated that as the incremental cost of funds, currently at 7.08%, continues to decline, margin recovery could follow, particularly if credit demand in secured retail segments accelerates.

The bank’s strong capital buffers—20% capital adequacy and 18.2% Tier-I ratio—give it the flexibility to expand lending once economic activity picks up. If loan growth improves in tandem with its liability momentum, AU Small Finance Bank could maintain its double-digit earnings growth despite the current margin squeeze.