Can shares of PSU lenders keep their mojo after a stellar six-month rally?

PSU banks ride a six-month wave of optimism; analysts turn cautious

After being out of favour for years, shares of PSU lenders are finding their moment under the sun, with the Nifty PSU Bank index having soared 33 percent over the past six months, powered by a mix of tailwinds, far outpacing Nifty 50’s modest 4 percent rise.

The rally has been fuelled by a potent mix of improved fundamentals, talk of a hike in foreign investment limit and increasing buzz of another round of PSU bank consolidation. With much of the good news priced in, analysts believe the next leg of rally may be far more selective.

Market veteran Ambareesh Baliga said investors should “hold” rather than chase prices higher, given that “most news-driven triggers and quarterly results have already been baked into the valuations.”

PSB Consolidation Hopes

Baliga added that a potential government-led merger plan among state-owned banks could inject a fresh bout of excitement into the pack. “Reports of the government preparing plans to merge certain PSU lenders could be the trigger that the sector could see. Another round of consolidation among PSBs, with smaller banks being merged with larger ones, could drive a re-rating ahead,” he added.

Last month, Moneycontrol reported that the government is exploring another round of consolidation in the banking sector, with the proposal involving merging Indian Overseas Bank, Central Bank of India, Bank of India, and Bank of Maharashtra with larger lenders such as PNB, Bank of Baroda and SBI.

Hope of FII Limit Hike

Adding to the bullish sentiment, there has been a increasing hope around government’s potential move to raise the FII limit for public sector banks. According to estimates by Nuvama Institutional, if India raises the FII ceiling from 20 percent to 49 percent, PSU banks could attract up to $4 billion in passive inflows through MSCI-linked rebalancing, with SBI as the biggest potential beneficiary, followed by Indian Bank, BoB, PNB, and Canara Bank.

Time for Caution?

While liquidity-driven optimism has kept the momentum alive, analysts cautioned that the rally could be entering a mature phase. InCred Equities has maintained a ‘Hold’ on SBI after its September quarter results, stating that the scope for significant outperformance over large private peers looks limited. “Higher cost ratios coupled with weaker-than-expected growth could pose near-term risks for India’s largest lender,” the brokerage said.

During the September quarter (Q2FY26), state-owned lenders collectively posted a 9 percent on-year growth in net profit at Rs 49,456 crore, with SBI alone contributing 40 percent to the total earnings. Among peers, Indian Overseas Bank and Central Bank of India delivered the highest growth in quarterly profit, while Bank of Baroda and Union Bank were the only two lenders to report a decline in profitability.

Over the last six months, Indian Bank has led the PSU pack with an impressive 56 percent rise in share price, followed by PNB and Bank of India, both gaining around 23 percent, and SBI, which rose nearly 19 percent. Notably, all twelve PSU banking stocks have delivered positive returns during this period.

However, experts are now starting to warn that sustaining this pace will be difficult. Treasury gains are expected to taper off, and rising operating expenses - especially with the upcoming wage revision - could weigh on stock returns. Valuations, while still reasonable compared to private peers, no longer look cheap, said analysts. As investors start to look for the next cue, the sector stands at an inflection point. It remains to be seen if the space becomes a sustainable growth story, or stays as a cyclical play driven by liquidity and policy hopes.