In its latest banking sector report, InCred Equities said it expects profitability for public sector banks (PSBs) to moderate in the upcoming rate cut cycle, as margin pressure intensifies and non-core income fades. 

Despite this, the brokerage expressed preference for PSBs like Punjab National Bank (PNB) and Canara Bank (CBK), citing their relative liquidity strength and valuation comfort. Within its broader coverage, InCred stated it prefers large private sector banks over PSBs due to stronger fundamentals and greater growth visibility.

Private sector vs public sector banks: Who is better placed?

InCred highlighted that margins for PSBs are structurally lower by 5–10 basis points, even by Q4FY27, assuming a 50 basis point cut in the repo rate. The firm has built in margin compression of 15–20 basis points for FY26. According to InCred, savings account deposits, which form around 30 percent of average interest-earning assets for PSBs, offer limited downward repricing scope. Additionally, benefits from MCLR cuts are expected to be constrained due to heightened pricing competition in the system.

The brokerage noted that banks capable of preserving their margins by improving loan-to-deposit ratios, increasing the share of higher-yielding assets, and enhancing low-cost deposit mobilization will be better positioned in this environment. InCred added that profitability is also likely to be weighed down by lower non-core income—particularly from treasury gains and recovery from written-off accounts—as well as normalized credit costs.

PNB and Canara Bank Favoured Among PSBs

Among the state-run banks under its coverage, InCred said it prefers PNB and Canara Bank. The firm assigned an ‘ADD’ rating to both, citing strong balance sheet liquidity, lower credit cost expectations, and valuation comfort. For PNB specifically, InCred pointed out potential upsides from the recovery of written-off accounts and optionality from tax rate reductions. In the case of Canara Bank, the brokerage highlighted moderating credit costs and favourable valuation metrics.

Meanwhile, InCred maintained a ‘HOLD’ rating on State Bank of India (SBI), Bank of Baroda (BoB), and Bank of India (BoI). It noted that while SBI and BoB remain strong franchises, current valuations limit the upside. As for BoI, InCred flagged low balance sheet liquidity and weak profitability as key reasons for its conservative stance.

PSB Rally May Not Recur as Rerating Potential Fades

Looking back at the PSB stock rally between March 2021 and July 2024, InCred attributed the outperformance to improving stressed loan coverage, low credit costs, and deployment of surplus liquidity. This period also saw strong non-core income supporting profitability. Valuations for PSBs had rerated significantly—from 0.6x forward P/BV in March 2021 to 1.3x by July 2024.

However, the brokerage cautioned that this structural momentum may not repeat. Over the last six months, PSB stocks under its coverage have corrected by nearly 15 percent. InCred said that any future rerating will be contingent on the pace of volume growth and the trajectory of margins. As of Q3FY25, PSBs posted healthy 14 percent year-on-year credit growth, but InCred warned that this growth would increasingly depend on their ability to mobilize deposits and maintain liquidity.

In conclusion, InCred said it prefers private sector banks for their superior liability franchise, better growth dynamics, and valuation support. While PNB and Canara Bank stand out as tactical bets within the PSB segment, the broader state-owned banking space may face structural challenges in preserving profitability amid a rate cut cycle. With this view, InCred also initiated formal coverage on BoB, BoI, CBK, and PNB in its report.

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.