Can PSU Bank Stocks Sustain Their Rally After a Stellar Six-Month Run?

Contents

Strong Earnings and Policy Buzz Drive the PSU Bank Rally Consolidation Buzz Could Spark the Next Leg of Growth FII Limit Hike Could Attract Billions in Passive Inflows Analysts Turn Cautious as Rally Enters Mature Phase PSU Banks Outperform, But Valuations No Longer Cheap The Road Ahead: Sustainable Growth or Cyclical Play?

Public sector bank (PSU) stocks have been on a remarkable run, with the Nifty PSU Bank index soaring 33% over the last six months — far outpacing the Nifty 50’s modest 4% gain. After years of underperformance, state-owned lenders are once again at the center of market optimism, fueled by robust earnings, policy hopes, and talk of sector consolidation.

However, as valuations climb and much of the good news gets priced in, analysts are beginning to wonder: Can the rally sustain, or is it time for caution?

Strong Earnings and Policy Buzz Drive the PSU Bank Rally

The recent surge in PSU bank shares has been driven by a potent mix of improving fundamentals and market speculation around government reforms. Over the last two quarters, state-owned lenders have consistently reported solid results, showcasing a recovery in asset quality, better provisioning, and robust credit growth.

Adding to the optimism are reports of potential PSU bank mergers and a possible increase in the foreign investment limit (FII cap). Together, these factors have pushed PSU bank stocks into the spotlight, making them among the best performers on Dalal Street in 2025.

Market veteran Ambareesh Baliga noted that while the sentiment remains positive, “investors should hold rather than chase prices higher,” as most of the news-driven triggers and quarterly results have already been factored into valuations.

Consolidation Buzz Could Spark the Next Leg of Growth

The market has been abuzz with talk of another round of consolidation among public sector banks, reminiscent of the earlier mergers that helped streamline India’s banking landscape.

According to reports, the government is considering merging smaller lenders such as Indian Overseas Bank, Central Bank of India, Bank of India, and Bank of Maharashtra with larger peers like Punjab National Bank (PNB), Bank of Baroda, and State Bank of India (SBI).

Baliga believes such consolidation could act as a fresh trigger for PSU bank valuations, particularly if merger synergies are well executed. “A government-led merger plan could drive a re-rating in the sector as investors anticipate stronger balance sheets and improved efficiency,” he added.

FII Limit Hike Could Attract Billions in Passive Inflows

Another potential catalyst for PSU banks is the anticipated increase in foreign institutional investment (FII) limits. Currently, FIIs can hold up to 20% in public sector banks, but analysts expect the government to consider raising it to 49%.

As per estimates from Nuvama Institutional Equities, such a move could trigger passive inflows of up to $4 billion, driven by MSCI-linked rebalancing. Major beneficiaries could include SBI, Indian Bank, PNB, Bank of Baroda, and Canara Bank, all of which stand to gain from increased global investor participation.

This expectation has added another layer of optimism to PSU bank valuations, even as analysts caution that the sector may be entering a mature phase of its rally.

Analysts Turn Cautious as Rally Enters Mature Phase

While liquidity-driven optimism and policy expectations have fueled PSU bank stocks, some analysts are now recommending a more measured approach.

InCred Equities, for instance, maintained a ‘Hold’ rating on SBI following its September quarter results, citing that “the scope for significant outperformance over private peers looks limited.” The brokerage flagged higher cost ratios and slower-than-expected growth as near-term risks.

During the September quarter (Q2 FY26), PSU banks collectively posted a 9% year-on-year rise in net profit to Rs 49,456 crore, with SBI contributing nearly 40% of the sector’s total profit. Indian Overseas Bank and Central Bank of India delivered the strongest profit growth, while Bank of Baroda and Union Bank reported a dip in profitability.

PSU Banks Outperform, But Valuations No Longer Cheap

In terms of stock performance, Indian Bank emerged as the top performer, rising 56% over six months. PNB and Bank of India gained around 23%, while SBI advanced 19%. Notably, all twelve PSU bank stocks delivered positive returns during this period — a rare feat in recent years.

However, as the rally matures, analysts warn that valuation comfort is fading. Treasury gains are expected to taper, while operating expenses could rise, especially with an upcoming industry-wide wage revision.

“Valuations are no longer cheap, though still below private peers,” said one Mumbai-based analyst. “For the rally to continue, we’ll need fresh catalysts — either in the form of regulatory reforms, credit growth surprises, or merger synergies.”

The Road Ahead: Sustainable Growth or Cyclical Play?

As the PSU banking space stands at a crossroads, the big question remains whether this rally can transform into a sustainable growth story or whether it remains a cyclical play driven by liquidity and policy optimism.

For now, analysts expect a more selective phase ahead, where only lenders with robust balance sheets, strong credit growth, and efficient management will continue to outperform.

Investors are advised to tread carefully, focusing on banks with consistent earnings visibility and lower dependence on one-off policy triggers.