Public-sector banks take returns lead; private banks hold valuation edge

Q2 results tilt towards state-owned banks, while FCNR(B) inflows cloud private lenders' margin outlook

On Monday, the Nifty fell 1.11 per cent, with private-sector banks (PVBs) leading the rout. State-owned lenders, in contrast, ended higher. This divergence is not limited to Monday’s session. Over the past year, the Nifty Private Bank index has fallen 4.36 per cent, while the Nifty PSU Bank index has risen 5.5 per cent.

 

The ongoing second-quarter (July-September/Q2) results season for 2026-27 has favoured public-sector banks (PSBs) over large private lenders so far, as heavy foreign currency non-resident (bank), or FCNR(B), inflows have weighed on margins at most PVBs. However, analysts do not expect the valuation gap between the two groups to narrow materially any time soon. Despite reporting higher returns on equity (RoE) than private banks, PSBs continue to trade at a discount, reflecting doubts about the sustainability of their returns, analysts said.

 

At Monday’s close, the Nifty PSU Bank index traded at a price-to-book (P/B) ratio of 1.15x, compared with 1.95x for the Nifty Private Bank index. A year ago, the respective ratios stood at 1.28x and 2.19x, according to National Stock Exchange data.

 

With at least 16 banks having announced their Q2 results so far, many over the previous weekend, bank stocks saw mixed reactions on Monday.

 

Axis Bank fell the most, down 4.2 per cent, followed by Yes Bank, HDFC Bank, and IDFC First Bank, which fell between 2.2 per cent and 3.5 per cent. ICICI Bank fell 1.15 per cent. In contrast, Union Bank, Punjab National Bank, Bank of Baroda (BoB),  and Canara Bank rose between 3.1 per cent and 5.3 per cent. 

 

 “Large PVBs saw margins impacted in Q2 by heavy FCNR(B) inflows, which, like term deposits, weighed on current account savings account ratios and raised the cost of funds. We expect HDFC Bank’s net interest margins (NIMs) to improve from the third quarter (October-December/Q3) onwards, while relief for ICICI Bank and Axis Bank is likely only from the fourth quarter (January-March/Q4),” said Ishank Gupta, equity research analyst for banking and financial services at Choice Institutional Equities.

 

The interest-rate outlook could also favour PVBs. Kotak Institutional Equities (KIE) expects a further 50-basis point increase in the repo rate, taking it to 6 per cent. Repo-linked loans account for 57 per cent of ICICI Bank’s loan book and 61 per cent of Axis Bank’s, compared with 31 per cent for State Bank of India and 35 per cent for BoB. This would leave PVBs better placed than PSBs to benefit from the expected rate hikes.

 

“While our estimates do not yet fully reflect the impact of FCNR deposit repricing, we see scope for positive earnings surprises as margin tailwinds play out. Coupled with resilient asset quality and still-healthy growth prospects, this reinforces our preference for frontline private banks as the best way to position for the next phase of the banking cycle,” the KIE report said.

 

 Gupta added that NIMs improved across PSBs, but profitability took a bigger hit from their greater exposure to investments amid rising government security yields.

 

Raj Gaikar, research analyst at Samco Securities, said PSBs have historically traded at a steep discount to their private-sector peers on a P/B basis. However, the gap has narrowed sharply in recent years following a strong rally in PSB stocks.

 

“PSBs operate with much higher balance-sheet leverage than large PVBs, which lifts RoE even when their return on assets is lower. PVBs earn more per rupee of assets, have stronger low-cost deposit bases, and have shown steadier earnings across cycles. The PSBs asset quality and capital have improved a lot,” he said, adding that the current valuation gap looks broadly fair rather than suggesting that either group is deeply undervalued.

 

Over the six months since around the start of the West Asian conflict, the Nifty Private Bank index has risen marginally by 0.7 per cent, while the Nifty PSU Bank index has fallen 7.2 per cent, pointing to a slower recovery for state-owned lenders. Gupta does not expect the valuation gap between PVBs and PSBs to close materially. “Strong performance could narrow the gap in the near term, but a valuation differential is likely to persist,” he said.

 

“PSBs have had a strong run, and much of the easy rerating is now behind us,” Gaikar said, adding that further gains must come from earnings growth rather than multiple expansion.

 

“PVBs will likely retain a premium because of their stronger deposit franchises, higher RoE, and steadier earnings. PSBs can sustain current valuations if execution continues, but a further sharp rerating looks unlikely. PVBs offer a better risk-reward profile from here,” Gaikar added.