PSU bank index jumps 21% in 6 months; time to rethink investment strategy?

PSU banks rally 21% in 6 months, outpacing private lenders. Experts say strong earnings and credit growth fuelled the surge. Time to rebalance portfolio? Find out investment strategy in bank stocks

The past six months have handsomely rewarded investors who held bank stocks in their portfolios. The gains were even better – nearly double – for those whose investments were skewed towards public sector bank (PSB) index.

 

Ace Equity data shows that the Nifty PSU Bank index surged 20.6 per cent over the past six months (till September 10) as against a 9.8 per cent rise in the Nifty Private Bank index. By comparison, the Nifty Bank index was up 13.1 per cent and the Nifty50 11.19 per cent during the period.

 

While Indian Bank, Canara Bank, and Bank of India led the gainers pack among the PSBs, RBL Bank, IDFC First Bank, and YES Bank led from the front at the bourses in the private bank space during the above-mentioned period, data shows.

 

Analysts attribute the sharp rise in the Nifty PSU Bank index to sustained stellar earnings growth, and believe the upswing in the pack still has some momentum left.

 

"The outperformance of PSBs can be attributed to strong financial results, supported by expanding credit growth along with improving asset quality and rising treasury gains," said Anwin Aby George, equity research analyst tracking the sector at Geojit Investments.

 

He, however, added that the current metrics suggest PSBs’ outperformance may continue in the near term, with their growth rates likely aligning more closely with private banks over the long term.

 

Earnings growth: PSBs outsmart private peers

 

At an aggregate level, the net profit of state-owned banks surged 10.9 per cent year-on-year (Y-o-Y) to ₹0.47 trillion in the first quarter of 2025-26 (Q1FY26). This comes against a 3.9 per cent Y-o-Y decline in the net profit of private banks to ₹0.45 trillion during the same period, an analysis by CareEdge Ratings showed.

 

The credit growth of PSBs outpaced that of private sector banks – a trend seen for the last three quarters – on the back of a greater headroom for lending with stable credit-to-deposit (CD) ratios as compared to private peers. Additionally, PSBs have strengthened their position in the retail, agriculture, and MSME segments, enabling higher credit disbursal. MSME stands for micro, small, and medium enterprises. 

 

In fact, PSBs continued to capture higher market share in total credit, accounting for 53.8 per cent at the end of Q1FY26, as compared to 41.2 per cent share held by private banks.

 

On the deposits front, however, private banks achieved a growth of 12.1 per cent as of June 2025, outpacing PSBs' 9.8 per cent growth. That apart, while margin compression was witnessed across the sector in Q1FY26, operating performance was weaker for PSBs as compared to private banks.

 

Going forward, analysts at Antique Stock Broking expect FY26 systemic credit growth to be around 11 per cent, flattish Y-o-Y.

 

"Net interest margin (NIM) will decline in Q2FY26 due to the full-quarter impact of pass-through from the June 2025 policy rate cut. However, PSBs (excluding SBI) are likely to fare better as compared to private banks due to the benefit of savings account rate cuts taken by them in July," Antique said.

 

FY26 NIMs, it added, could compress by 20-25 basis points (bps) for private sector banks and PSBs alike. The brokerage has “Buy” ratings on HDFC Bank, Axis Bank, ICICI Bank, City Union Bank, Federal Bank, SBI, and Bank of Baroda. It has “Hold” on IndusInd Bank, and Punjab National Bank.

 

Valuation and investment ideas

 

With 1-year forward price-to-earnings (P/E) valuation metric in line with three-year average for both private and state-owned banks, analysts suggest investors should focus on mid- and small-tier banks available at attractive valuations.

 

"Although near-term challenges, in terms of NIM contraction, may persist for another quarter, it should not be a major concern. The focus should remain on the long-term growth prospects of these banks," said George of Geojit Investments.

 

Those at Emkay Global, too, cautioned that an uncertain macro environment amid the ongoing trade war and the rising asset-quality noise in unsecured business loans/SMEs (given the persisting stress in unsecured retail loans) could constrain growth in the near-to-medium term.

 

"Sharper rate cuts and slowdown in high-yielding SMEs, though partly offset by some acceleration in mortgages, could hurt margin and thus core profitability. Therefore, we prefer banks like ICICI Bank, HDFC Bank, SBI, Bank of Baroda, Federal Bank, and Indian Bank, which offer relative growth, margin, and asset-quality resilience," Emkay Global said.

 

Though Karur Vysya Bank and City Union Bank have limited exposure to US exporters, any sharper correction in these stocks should be bought into, given their otherwise strong fundamentals.