Indian Banks Soar, But Foreign Investors Flee: What's Behind The Mystery?

Public sector banks (PSBs) in India are demonstrating remarkable financial resilience, yet foreign portfolio investors (FPIs) continue to exhibit a low appetite for these state-owned lenders. This stands in stark contrast to the impressive financial performance and asset quality improvements witnessed over the past three years.

The government has reiterated its stance, with Minister of State for Finance Pankaj Chaudhary stating in the Rajya Sabha that there are no plans to increase the foreign direct investment (FDI) limit in public sector banks from the current 20%, nor is a proposal to enhance it to 49% under examination.

Foreign Investor Stance

• Most public sector banks are far from reaching the existing 20% FPI limit. Canara Bank is an exception, with FPI stake hitting an all-time high of 11.9%.
• However, in four major banks—State Bank of India, Bank of Baroda, Bank of India, and Indian Bank—FPI stakes have seen a decline after peaking in FY24. For instance, State Bank of India saw its foreign investor holding fall from 10.97% in FY24 to 9.49% in FY25.
• Bank of Baroda experienced a sharper drop, with foreign stakes decreasing from 12.4% in FY24 to 8.71% in FY25. Similar declines were observed in Bank of India (4.52% to 4.24%) and Indian Bank (5.29% to 4.68%) over the same period.
• This retreat by FPIs occurs against a backdrop of global risk-off sentiment, higher US bond yields, and geopolitical uncertainties, which have generally curbed flows into emerging markets, including Indian equities.

Stellar Financial Performance

• The public sector banking system achieved a significant milestone in FY24, recording cumulative net profits exceeding ₹3 lakh crore, supported by robust credit growth and improved asset quality.
• PSBs reported a 34% jump in net profit during FY24, outperforming private banks, which grew by 25%.
• This positive trend continued into FY25, with PSBs' profit after tax rising by 26% year-on-year, maintaining a two-year compound annual growth rate of 30%.
• Key drivers for this revival include declining provisioning costs, enhanced operating efficiency, and stronger non-interest income contributions.

Asset Quality and Capital Strength

• A major contributor to the PSB turnaround is the significant improvement in asset quality. Gross non-performing assets (NPAs) have fallen from 7.3% in FY22 to 2.6% in FY25.
• Public sector banks have maintained healthy capital adequacy ratios (CAR) under Basel III norms, with most large lenders consistently reporting CAR levels in the 16%–18% range.

Reasons for Investor Caution

• Despite strong fundamentals, investors remain cautious about the sustainability of recent profitability trends, especially as credit cycles mature and margins face pressure.
• Persistent valuation discounts for state-run banks also reflect a perception that government ownership might constrain operational autonomy and long-term strategic decision-making.
• Nomura Financial Advisory and Securities noted that the banking sector's valuation at 2.1x one-year forward book value per share appears inexpensive. While the sector is well-positioned for a re-rating, the brokerage favors State Bank of India due to its superior core profitability.

Impact

• The continued lack of foreign investor interest, despite strong performance, could cap the potential valuation re-rating for public sector banks.
• It highlights potential structural concerns that foreign investors perceive, even with improved financial metrics.
• Impact Rating: 7/10

Difficult Terms Explained

• Public Sector Banks (PSBs): Banks where the majority stake is held by the government.
• FDI (Foreign Direct Investment): Investment made by a foreign entity in a domestic business, typically implying control.
• FPI (Foreign Portfolio Investor): An investor from another country who buys stocks, bonds, or other securities in a domestic market, usually without seeking control.
• NPA (Non-Performing Asset): A loan or advance for which the principal or interest payment remained overdue for a specified period (typically 90 days).
• CAR (Capital Adequacy Ratio): A measure of a bank's capital relative to its risk-weighted assets, indicating its ability to absorb losses.
• Valuation Discount: When a stock or sector trades at a lower price compared to its perceived intrinsic value or peers, often due to specific concerns.
• Operational Autonomy: The freedom of a company's management to make decisions and run the business independently.