After a strong year for PSU bank stocks, the focus is now shifting to sustainability as the Q4 earnings season approaches. While public sector lenders have delivered sharp gains backed by improving fundamentals, brokerages believe underlying trends in deposits, margins and earnings quality could drive a shift in investor preference.
Over the past 12 months, PSU banks have significantly outperformed, with the Nifty PSU Bank index rising 41%, compared to a 5% gain in the Nifty Private Bank index. This rally was supported by improving asset quality, profitability and growth momentum across PSU lenders.
According to a recent report by Axis Securities, sector-wide credit growth has picked up to around 15% year-on-year, led by PSU banks, small finance banks and mid-sized private lenders. However, the brokerage cautioned that deposit growth continues to lag, keeping funding costs elevated and competition for CASA intense.
“Deposit growth continues to lag, keeping funding costs elevated and competition for CASA intense. NIM trends are expected to remain divergent, with mid-sized banks and SFBs seeing NIM uptick, while large private banks and PSBs defend margins amid yield compression and sticky CoD,” Axis Securities said in the report.
Private Banks vs PSU Banks
Despite PSU banks’ strong rally, Nomura believes much of the re-rating is already priced in. PSU banks are trading at around 1.3 times one-year forward book value, about 27% above their 10-year average and near +1 standard deviation levels, limiting further upside from valuation expansion.
“PSU banks have re-rated on the back of real fundamental improvement — but the drivers are cyclical, and at +1SD (1.3x) of their long-term average; hence, further re-rating room is limited,” Nomura said.
In contrast, Nomura noted that private banks have de-rated to around 2 times one-year forward book value, well below their long-term average of 2.8 times. The brokerage believes this correction is overdone and that the risk-reward now favours private lenders.
Nomura also pointed to differences in earnings quality. PSU bank profitability has been supported by treasury gains and recoveries from written-off loans, while private banks derive a larger share of earnings from core lending and fee income. Over FY24 to 9MFY26, non-core income contributed 20–40% of PPOP for PSU banks, compared with 5–13% for large private banks.
“On a core-RoE basis, private banks lead clearly – headline RoE comparability with PSU banks is misleading,” Nomura added.
Nomura said PSU banks have grown loans faster than deposits since FY23, resulting in a steady loss of deposit market share. PSU deposit share declined from about 58.6% in March 2024 to 57.8% by December 2025, while private banks now account for around 36% of system deposits.
Nomura further noted that PSU banks have relied on drawing down statutory liquidity ratio (SLR) buffers to support loan growth, with SLR falling from around 25% in FY21–22 to about 20% in Q3FY26, approaching regulatory thresholds. This suggests limited room for further liquidity-supported expansion.
At the same time, Axis Securities pointed out that asset quality trends remain stable across the sector. The brokerage expects stress in unsecured portfolios to ease, with slippages likely to be sequentially lower in Q4, providing support to earnings visibility.
However, Nomura flagged higher leverage as a key risk for PSU banks. State-owned lenders operate with balance-sheet leverage of 12–17 times, compared to 6–9 times for private peers. According to the brokerage, this amplifies downside risk, as even a modest rise in credit costs can have a significantly larger impact on PSU bank profitability.
“This asymmetry in earnings risk is a structural, not cyclical, disadvantage for PSU banks — and it means headline ROE comparability in the current benign environment is misleading,” Nomura said.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.
