We have upgraded our long-term recommendation on ICICI Bank Ltd. (IBN - Analyst Report) to Outperform from Underperform mainly on impressive fiscal third-quarter (ended December 2011) results. The company’s net earnings for the third quarter of fiscal 2012 improved significantly due to the improvement in the top line. However, a substantial rise in operating expenses was the downside.

We expect synergies from ICICI Bank’s dependence on domestic loans, stable funding base and leadership position in the insurance business. However at the same time, we are concerned about the company’s highly competitive operating environment and below-average credit quality.

With domestic loans representing a majority part of ICICI Bank’s loan portfolio, we anticipate that the company is less likely to be impacted by the sluggish international economic environment. The company has been marketing retail deposits on a large scale, thereby lowering the cost of funds and creating a stable funding base. All these will enable the company to efficiently deal with the challenging economic scenario.

Additionally, ICICI Bank has also been expanding overseas by offering technology-based banking services and opening additional offshore branches. The company has also been improving its services for offshore banking units by offering foreign currency deposits.

Furthermore, ICICI Bank is also making a concerted effort to shift its funding to low-cost deposits from wholesale term deposits. This should improve the company’s funding profile as well as lead to a growth in net interest margin.

On the flip side, ICICI Bank has been expanding its branch network for quite some time, which is resulting in higher operating costs. The growth in operating expenses will likely drag down bank’s financials over the near term.

Further, ICICI Bank operates in a highly competitive financial market, which includes many other Indian and international banks. Some of its heavyweight peers are UTI Bank, HDFC Bank Ltd. (HDB - Analyst Report), HSBC Holdings Plc (HBC - Analyst Report), IDBI Bank and IndusInd Bank.

Currently, ICICI Bank retains its Zacks #2 Rank, which translates into a short-term Buy rating.