Equitas Small Finance Bank Q3 FY26: Asset Quality Shines as Provisions Normalise After Q2 Shock

The stock has responded positively to the recovery, trading at ₹69.67, up 0.13% on the day, and delivering impressive short-term returns of 13.56% over one month and 15.92% over three months, significantly outperforming the Sensex which declined 2.56% and 2.91% over the same periods respectively.

The quarter witnessed a dramatic normalisation of credit costs after Q2 FY26's exceptional provisioning exercise, which had resulted in the bank's first quarterly loss in recent years. Provisions and contingencies declined 66.19% quarter-on-quarter to ₹207.02 crores, enabling the bank to return to profitability despite a sequential decline in net interest income. The improvement in profitability marks a critical inflection point for the bank, which had faced significant investor concern following the Q2 results.

Financial Performance: Recovery Marred by Margin Compression

Equitas Small Finance Bank's Q3 FY26 financial performance presents a study in contrasts. Whilst the bank successfully returned to profitability with a net profit of ₹90.03 crores, the underlying operational metrics reveal persistent challenges. Interest earned in Q3 FY26 reached a record ₹1,691.68 crores, marking the highest quarterly interest income in the bank's history. However, interest expended also climbed significantly, resulting in net interest income of ₹851.63 crores. On a sequential basis, the Q2 FY26 comparison shows net interest income of ₹773.68 crores, representing a decline of 1.53% quarter-on-quarter.

The net interest margin compression remains a critical concern for investors. NIM declined 26 basis points sequentially to 6.29% in Q3 FY26 from 6.55% in Q2 FY26, continuing a worrying trend that has seen margins erode from 8.17% in March 2024 to current levels. This 188 basis point decline over six quarters reflects the twin pressures of rising cost of funds and competitive lending rates in the small finance bank sector. The CASA ratio improved marginally to 31.0% in Q3 FY26 from 29.0% in the previous quarter, providing some relief on the liability side, though it remains below the 32.0% achieved in March 2024.

Operating profit before provisions and contingencies stood at ₹240.56 crores in Q2 FY26, representing a decline from ₹314.77 crores in Q1 FY26. The normalisation of provisions to ₹207.02 crores in Q2 FY26 from the exceptional ₹612.25 crores in Q1 FY26 proved decisive in restoring profitability. This provision level aligns more closely with the bank's historical run rate, suggesting that the Q1 FY26 spike was indeed an aberration related to specific loan book clean-up initiatives rather than a structural deterioration in asset quality.

Asset Quality Excellence: A Rare Bright Spot

Amidst the margin pressures and profitability volatility, Equitas Small Finance Bank's asset quality metrics stand out as a significant strength. Gross NPA declined to 2.75% in Q3 FY26, marking the lowest level in recent quarters and demonstrating effective credit risk management. Net NPA remained remarkably low at 0.92%, unchanged from Q2 FY26 levels, indicating robust recovery mechanisms and adequate provisioning buffers. The provision coverage ratio stood at a healthy 66.93%, marginally lower than 67.03% in the previous quarter but well above the 56.06% recorded in March 2024.

The improvement in gross NPA from 2.92% in both Q1 and Q2 FY26 to 2.75% in Q3 FY26 suggests that the aggressive provisioning exercise undertaken in Q1 FY26 has successfully cleaned up the loan book. This 17 basis point improvement in gross NPA, whilst seemingly modest, is significant given the challenging operating environment for small finance banks. The bank's advances stood at ₹36,208.89 crores as of March 2025, representing a healthy advance-to-deposit ratio of 92.05%, indicating efficient deployment of deposits into lending activities.

The quality of the loan book is further evidenced by the consistent net NPA performance. Maintaining net NPA below 1% is a notable achievement for a small finance bank serving predominantly underbanked segments. The bank's focus on granular retail lending, combined with robust underwriting standards, has enabled it to navigate the credit cycle more effectively than several peers. However, investors should note that the provision coverage ratio of 66.93%, whilst adequate, leaves room for improvement compared to larger private sector banks that typically maintain coverage ratios above 70%.

Profitability Concerns: Return Ratios Under Pressure

The profitability metrics paint a concerning picture for Equitas Small Finance Bank. Return on equity (ROE) stood at a negative 1.56% for the latest period, reflecting the impact of the Q1 FY26 loss on trailing twelve-month profitability. Return on assets (ROA) similarly deteriorated to negative 0.16%, significantly below the bank's historical performance and peer group averages. These negative return ratios represent a stark departure from the bank's earlier performance when it consistently delivered ROE above 10%.

The cost-to-income ratio averaged 65.63% over recent periods, indicating that nearly two-thirds of the bank's income is consumed by operating expenses. Whilst this ratio is not unusual for small finance banks with extensive branch networks serving rural and semi-urban markets, it leaves limited room for margin compression. The operating profit to assets ratio averaged 10.42%, suggesting that the bank's core lending operations remain fundamentally sound despite the margin pressures.

Shareholding Pattern: Institutional Confidence Building

The shareholding pattern of Equitas Small Finance Bank reveals strong and growing institutional confidence. Mutual fund holdings surged to 45.20% in December 2025 from 43.27% in September 2025, representing a substantial increase of 193 basis points. This marks the continuation of a trend that began in March 2025 when mutual fund holdings stood at just 37.55%. The 760 basis point increase in mutual fund holdings over three quarters signals strong conviction from domestic institutional investors about the bank's recovery prospects.

Foreign institutional investor (FII) holdings declined marginally to 14.63% in December 2025 from 15.67% in September 2025, continuing a gradual reduction from the 16.47% held in March 2025. The 184 basis point decline in FII holdings over three quarters suggests some caution amongst foreign investors, possibly reflecting concerns about margin compression and profitability volatility. However, the total institutional holdings (FII + Mutual Funds + Insurance + Other DII) stood at a robust 64.58%, indicating strong overall institutional support.

The absence of promoter holding is noteworthy, as Equitas Small Finance Bank operates as a professionally managed institution without a controlling promoter group. This structure provides greater flexibility for institutional investors but also means the bank lacks a strategic anchor investor with long-term commitment. The 25 mutual funds holding stakes in the bank, along with 122 FIIs, suggest broad-based institutional participation rather than concentrated bets by a few large investors.

Peer Comparison: Valuation Discount Reflects Challenges

Equitas Small Finance Bank's valuation metrics reflect the market's concerns about its profitability trajectory. Trading at a price-to-book value of 1.35x, the bank commands a significant discount to peers such as AU Small Finance Bank (3.96x) and Ujjivan Small Finance Bank (1.96x). The P/E ratio remains not applicable due to the loss-making status on a trailing twelve-month basis, further highlighting the profitability challenges.

The comparison with peers reveals that Equitas Small Finance Bank's asset quality metrics are superior to most competitors, with gross NPA of 2.75% amongst the lowest in the peer group. However, the negative ROE of -1.56% significantly lags peers such as AU Small Finance Bank (12.75% ROE) and Jana Small Finance Bank (9.60% ROE). This disconnect between asset quality and profitability suggests that Equitas is facing margin and operational efficiency challenges that are not necessarily reflected in credit quality metrics.

The P/BV ratio of 1.35x appears reasonable given the negative ROE, as the market is essentially pricing in expectations of improved profitability ahead. Investors are paying a 35% premium to book value, betting that the bank can restore ROE to historical levels of 10-12% once margin pressures stabilise and provisions normalise. The third-largest market capitalisation of ₹7,949 crores amongst the peer group reflects the bank's established franchise and growth potential, despite current profitability challenges.

Valuation Analysis: Expensive Despite Recovery

At the current market price of ₹69.67, Equitas Small Finance Bank's valuation grade stands at "Very Expensive", reflecting the significant premium the stock commands relative to its current earnings power. The price-to-book value of 1.35x, whilst lower than high-performing peers, appears rich given the negative ROE and margin compression trends. The stock has appreciated 39.20% from its 52-week low of ₹50.05, driven by hopes of sustained recovery following the Q3 FY26 results.

The valuation grade changed to "Very Expensive" from "Fair" on October 27, 2025, as the stock rallied ahead of the Q3 results on expectations of provision normalisation. The market appears to be pricing in a rapid return to normalised profitability, with expectations that the bank can achieve ROE of 10-12% within the next 12-18 months. However, the persistent margin compression and elevated cost-to-income ratio suggest that achieving such profitability levels may take longer than the market anticipates.

The absence of dividend yield reflects the bank's need to conserve capital for growth and regulatory requirements. The latest dividend of ₹1 per share, with ex-dividend date of August 9, 2024, represented a token payment rather than a meaningful return to shareholders. Investors should not expect significant dividend income from Equitas Small Finance Bank in the near term, as the bank prioritises capital adequacy and growth over shareholder distributions.

Stock Performance: Short-Term Momentum Versus Long-Term Concerns

Equitas Small Finance Bank's stock performance presents a tale of two timeframes. Over the short term, the stock has delivered impressive returns, gaining 13.56% over one month and 15.92% over three months, significantly outperforming the Sensex which declined 2.56% and 2.91% over the same periods. This short-term outperformance reflects investor optimism about the provision normalisation and asset quality improvement visible in Q3 FY26 results.

However, the longer-term picture reveals significant underperformance. Over one year, the stock gained just 4.12% compared to the Sensex's 7.83% return, resulting in negative alpha of 3.71%. The two-year performance is particularly concerning, with the stock declining 33.93% whilst the Sensex gained 14.71%, representing a massive underperformance of 48.64 percentage points. This dramatic underperformance reflects the market's loss of confidence following the profitability challenges and margin compression witnessed over the past two years.

The stock's beta of 1.35 indicates high volatility relative to the broader market, with volatility of 33.41% significantly exceeding the Sensex's 11.23%. This high volatility makes Equitas Small Finance Bank suitable only for investors with high risk tolerance who can withstand sharp price swings. The risk-adjusted return of 0.12 over one year, whilst positive, is significantly lower than the Sensex's risk-adjusted return of 0.70, indicating that investors are not being adequately compensated for the additional risk they are taking.

Technical Analysis: Bullish Momentum Above Key Averages

The technical picture for Equitas Small Finance Bank has turned decisively bullish, with the stock changing trend to "Bullish" on January 13, 2026 at ₹67.14 from the previous "Mildly Bullish" stance. The stock trades above all key moving averages, with the current price of ₹69.67 positioned 0.09% above the 5-day MA, 3.85% above the 20-day MA, 8.99% above the 50-day MA, 15.25% above the 100-day MA, and 13.30% above the 200-day MA. This alignment of moving averages in ascending order provides strong technical support for the current uptrend.

The weekly technical indicators present a uniformly bullish picture, with MACD showing bullish signals, Bollinger Bands indicating mildly bullish momentum, moving averages confirming bullish trend, and KST oscillator also in bullish territory. However, the monthly indicators show some divergence, with MACD turning bearish and RSI showing no clear signal, suggesting that the longer-term technical picture remains uncertain despite the short-term bullish momentum.

Key technical levels to watch include immediate support at the 52-week low of ₹50.05, representing a 28.15% downside buffer from current levels. On the upside, the stock faces resistance at the 52-week high of ₹73.42, just 5.11% above current levels. A decisive break above this resistance level could open the path towards ₹80-85 levels, whilst a failure to sustain above the 20-day MA of ₹67.09 could trigger profit-booking towards the 50-day MA of ₹63.92.

Investment Thesis: Recovery Play with Execution Risks

The investment case for Equitas Small Finance Bank rests on three key pillars: superior asset quality metrics, strong institutional backing, and the potential for profitability normalisation following the Q1 FY26 provisioning shock. The bank's gross NPA of 2.75% and net NPA of 0.92% demonstrate credit underwriting capabilities that are amongst the best in the small finance bank sector. The 64.58% institutional holdings, with mutual funds increasing their stake to 45.20%, signal confidence from sophisticated investors who have conducted detailed due diligence.

However, significant execution risks temper this positive thesis. The 188 basis point NIM compression over six quarters from 8.17% to 6.29% represents a structural challenge that cannot be quickly reversed. Small finance banks operate in highly competitive markets where pricing power is limited, and the current interest rate environment provides little relief on the liability cost front. The negative ROE of -1.56% and ROA of -0.16% indicate that the bank is currently destroying shareholder value, and a return to acceptable profitability levels requires sustained execution over multiple quarters.

Key Strengths and Risk Factors

Outlook: What to Watch in Coming Quarters