Rs 6 lakh crore in 6 months! PSU banks are eating private lenders' lunch and the rally isn't over yet

Led by a confluence of superior credit growth, multi-decadal low bad loans, and record profitability, PSU bank stocks are now Dalal Street’s one of the most compelling stories. The combined market capitalisation of India's 12 PSU banks has swelled by Rs 5.75 lakh crore to Rs 21.35 lakh crore in the last 6 months amid a valuation re-rating that private sector lenders have been unable to match.

The Nifty PSU Bank index is up roughly 34% over this period while the Nifty Private Bank index has managed just 7% return. Public sector lender Bank of India leads with a 50% gain. SBI, the country's largest lender, is up 47%. Union Bank has added 42%. Canara Bank, Indian Bank, Bank of Maharashtra, Bank of Baroda, and PNB have each rallied between 20% and 39%.

The question investors are now asking is not why this happened, but whether it can last. To answer that, you have to start with the credit growth story because that is where PSU banks have decisively pulled ahead.

In Q3, public sector banks sustained loan growth of over 14.5% year-on-year, led by SME and retail lending and supported by wholesale. Private banks clocked under 12%. On a sequential basis, PSU banks grew approximately 5.5% quarter-on-quarter versus 3.5% for private peers. SBI revised its credit growth guidance upward to 13-15%. Bank of Maharashtra came in at 20%, UCO Bank at 16.74%, and Indian Overseas Bank led the entire sector at 24.13%.

"PSU banks have consistently outperformed their private-sector peers in credit growth over the last two quarters," Vinod Nair, Head of Research at Geojit Investments, told ET Markets. "Driven by this momentum, most PSU banks have raised their credit-growth guidance for FY26 and FY27. This expansion is supported by adequate capital buffers and healthier credit-to-deposit ratios."

Behind the loan growth numbers lies a deliberate strategic pivot that analysts say has fundamentally changed the quality of PSU bank earnings. State-owned lenders have aggressively churned their portfolios away from low-yielding corporate loans toward high-yielding RAM segments like retail, agriculture, and MSME which now constitute the majority of portfolios for many banks.

"The public sector banking industry is currently in a 'Goldilocks phase,' characterised by high credit growth, multi-decade low NPA levels, and record-breaking profitability," said Ninad Jadhav, Equity Research Analyst at LKP Securities. "They are successfully defending margins by churning portfolios away from low-yielding corporate loans toward high-yielding RAM segments." GNPA and NNPA ratios, he notes, are at historic lows, "supported by robust recovery mechanisms and disciplined underwriting."

Sunny Agrawal of SBI Securities echoes the constructive view. "Asset quality continues to remain robust with healthy provisions, supported by minimal unsecured credit exposure. NIMs are likely to stabilise during the next two quarters as incremental deposits are coming at a lower rate. As bond yields cool off, treasury gains will also be an earnings kicker," he said.

The asset quality improvement is not merely cyclical but the engine of a structural re-rating. Nair at Geojit puts it plainly: "A significant strengthening in asset quality with NPAs at multi-decadal lows has reduced provisioning requirements and directly boosted overall profitability. These strong fundamentals have triggered a valuation rerating and created a positive market bias toward the sector, which should sustain momentum in the short to medium-term."

That re-rating is still not complete, which is precisely why the bull case remains intact on valuations. "Most PSU banks are trading at a 1-year forward P/BV multiple of 1.0-1.5x versus private peers which are enjoying higher multiples of 2.0-2.5x," said Agrawal. "PSU banks offer a favourable risk-reward proposition for long-term investors."

Jadhav says sustaining a return on assets above 1% at scale is narrowing the historical valuation gap with private peers. “PSU banks are now known for their pristine asset quality and capital self-reliance, supported by increasing dividends and minimal need for equity dilution." In other words, these are no longer turnaround stories but compounding businesses.

There is, however, a structural headwind that no analyst is dismissing. A major theme reshaping the liability side of banking is the financialisation of household savings. Depositors increasingly moving funds away from low-cost CASA accounts toward mutual funds, equity markets, and real estate. This tightens the deposit base industry-wide and keeps funding cost pressure alive, complicating the NIM outlook even as loan books grow.

Jadhav flags that "credit growth is consistently outperforming deposit growth, leading to a tightening of the Credit-Deposit ratio across the industry" — a dynamic that bears watching as it could eventually constrain the pace of lending if deposit mobilisation does not keep up.

Nair is measured in his longer-term assessment. "While PSU banks are currently trading at elevated valuations, some cautiousness is advised on a long-term basis. PSU banks will have the pressure to sustain the gap-up improvement in key drivers such as NIMs, credit-to-deposit ratio, and asset quality compared to quality private peers," he said.

But for now, investors are seeing ‘sarkari’ banks as serious, self-sustaining growth businesses.

(Data: Ritesh Presswala)