Whalesbook
The Unfolding Banking Sector Narrative
India's banking sector is at a crossroads, moving beyond the immediate impact of Reserve Bank of India's (RBI) liquidity management. While open market operations (OMOs) have injected substantial funds, foreign exchange sales have largely neutralized these efforts, leading to transient liquidity tightness and elevated funding costs. However, the more profound story lies in the fundamental reallocation of household wealth and the erosion of regulatory buffers, which collectively signal a more persistent headwind for deposit mobilization and credit expansion.
Structural Savings Diversion Erodes Deposit Base
The prevailing narrative of liquidity fluctuations may obscure a more critical, long-term trend: the significant migration of household savings away from traditional bank deposits. Between FY2012 and FY2023, the share of mutual funds in household gross financial savings surged from less than 1% to approximately 6%. By FY2025, the combined share of equities and mutual funds in annual household savings had climbed from around 2% in FY2012 to over 15.2%. This reorientation means a shrinking pool of stable, low-cost deposits available for banks, particularly impacting public sector banks (PSBs) that have historically relied heavily on such funding. The proportion of household deposits in total bank deposits fell from 64% in FY2020 to 60% by FY2025, while corporate deposits, often more volatile and interest-sensitive, increased their share.
Shrinking Buffers and Constrained Credit
Compounding the challenge is the steady decline in banks' excess Statutory Liquidity Ratio (SLR) buffer. The system's government securities to net demand and time liabilities ratio fell from 31% in September 2023 to 28% by December 2025. With combined SLR and Liquidity Coverage Ratio (LCR) requirements nearing 24% of NDTL, the headroom to support credit growth without straining liquidity management is diminishing. As SLR levels approach regulatory floors, deposit availability is poised to become a more critical constraint on incremental loan growth. Credit growth, while rebounding to 14.5% year-on-year by January 2026, faces a future where deposit accretion could lag significantly, leading to tighter loan-to-deposit ratios and potentially moderating credit expansion to 11-12% in the coming fiscal years.
Valuation Divergence and Peer Analysis
This evolving financial structure is beginning to manifest in market valuations. Public sector banks like Bank of Baroda (BoB) and Union Bank of India are trading at highly attractive P/E ratios, with BoB at approximately 8.09 and Union Bank around 7.84, signaling that much of their potential re-rating may have occurred. BoB's market capitalization stands at roughly ₹1.57 trillion, while Union Bank is valued at approximately ₹1.45 trillion. Both are considered value plays. In contrast, State Bank of India (SBI) is perceived as expensive, trading at a P/E of approximately 13.43, significantly higher than its PSB peers, with a P/BV ratio of 2.23 reinforcing its premium valuation. Its market cap is substantial, exceeding ₹1.12 trillion.
Private sector banks, ICICI Bank and Kotak Mahindra Bank, command higher multiples, reflecting their perceived resilience and stronger franchise value. ICICI Bank trades at a P/E of around 19.19 with a market cap of nearly ₹1.01 trillion, while Kotak Mahindra Bank's P/E is higher, around 22.17, with a market cap of roughly ₹414,321.5 Cr. This valuation gap underscores investor preference for the stronger deposit franchises and retail focus of private lenders.
The Bear Case for PSBs: Structural Hurdles
While PSBs have experienced significant re-ratings, the structural challenges identified pose a material risk to sustained outperformance. The decline in deposit share, coupled with shrinking SLR buffers, suggests that their ability to fund future loan growth without increasing reliance on more expensive wholesale funding or facing deposit rate pressures is diminishing. PL Capital's downgrade of Bank of Baroda and Union Bank to 'Accumulate' reflects this concern, noting limited scope for further re-rating. Valuations around 1.0x FY28 adjusted book value for some PSBs, paired with projected core ROA of 0.7-0.9%, suggest limited upside potential from current levels. Furthermore, the historical re-rating of 45-122% since FY23 highlights that much of the past growth narrative may be priced in. The shift in household savings away from deposits towards mutual funds is a secular trend that directly impacts the core funding model of these banks. Unlike private peers that have proactively diversified and strengthened their retail liabilities, PSBs may find it harder to adapt at the same pace due to legacy structures and market perception.
Outlook: Private Sector Banks Poised for Continued Momentum
The outlook favors private sector banks, which are better positioned to navigate the evolving deposit landscape. Their focus on retail liabilities, technological adoption, and a more agile approach to market dynamics provides a structural advantage. While PSBs are expected to grow robustly until H1FY27, private banks are anticipated to outpace them thereafter as the deposit accretion gap widens and loan growth dynamics recalibrate. The shift in household savings, a powerful structural force, is likely to be the primary determinant of sector performance in the medium to long term, creating a more challenging operating environment for banks heavily dependent on traditional deposit growth.