State-owned lenders are delivering stronger returns and attracting fresh investor interest, but analysts say doubts over the durability of profits continue to keep them cheaper than private-sector rivals.
Public-sector banks have taken the lead in India’s second-quarter earnings season, but analysts say the market is still not ready to award them the same valuation as large private lenders. Stronger returns on equity at state-owned banks have not been enough to close the discount, with investors still questioning whether the improvement can last through a full cycle.
That gap was visible in Monday’s market levels. The Nifty PSU Bank index traded at a price-to-book ratio of 1.15 times, while the Nifty Private Bank index stood at 1.95 times, according to National Stock Exchange data. A year earlier, the comparable multiples were 1.28 times and 2.19 times, suggesting that some of the rerating in state-run banks has already happened even if the wider divide remains intact.
The latest results have also produced a mixed reaction in share prices. Axis Bank led declines among major lenders, while HDFC Bank, Yes Bank, ICICI Bank and IDFC First Bank also fell. By contrast, Union Bank of India, Punjab National Bank, Bank of Baroda and Canara Bank rose, reflecting investor enthusiasm for state-owned banks that have shown stronger earnings momentum in the current quarter.
The pressure on private banks has come largely from heavy foreign currency non-resident bank deposits, or FCNR(B) inflows, which have acted like term deposits and pushed up funding costs. Choice Institutional Equities said that this has weighed on net interest margins at large private lenders, though it expects HDFC Bank’s margins to improve from the December quarter and sees relief for ICICI Bank and Axis Bank only later. Kotak Institutional Equities said its preference remains with frontline private banks, arguing that margin tailwinds, resilient asset quality and steadier growth could still drive earnings upside.
The policy backdrop may also tilt in favour of private banks if interest rates rise further. Kotak expects another 50 basis points of repo-rate increases, which would favour banks with more repo-linked lending on their books. ICICI Bank and Axis Bank are more exposed to such loans than State Bank of India and Bank of Baroda, giving private lenders greater leverage to benefit from a tighter rate environment.
Even so, analysts do not expect the valuation gap to disappear quickly. Raj Gaikar of Samco Securities said public-sector banks still trade at a discount because investors remain uncertain about the durability of their returns, even after a sharp improvement in asset quality and capital strength. He added that state-run lenders have already enjoyed a substantial rerating, so further gains would need to come from earnings growth rather than a larger jump in valuation multiples.
Over a longer recent stretch, the difference in performance has also been clear. Since the beginning of the West Asian conflict, the Nifty Private Bank index has risen only modestly, while the Nifty PSU Bank index has declined, pointing to a slower recovery in state-owned names. Gupta said the rerating potential for public-sector banks may not be exhausted, but the market is likely to keep assigning them a lower multiple than private peers until they prove that stronger profitability can persist across different parts of the lending cycle.
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