### Sectoral Surge Reaches New Zenith
The Nifty PSU Bank index achieved an unprecedented high of 9,840.25 on February 23, 2026, marking a significant 2% intra-day gain and extending a potent rally that has seen the index climb 3.5% in just two trading days. This performance starkly outshines the benchmark Nifty 50, which posted a modest 1% rise over the same period [cite: Rewritten News]. Over the past month, PSU banks have demonstrated exceptional strength, soaring 12%, a stark contrast to the Nifty 50's 2.7% decline. State Bank of India (SBI) reached a new peak of ₹1,229.90, joined by Bank of Baroda (₹311.25) and Indian Bank (₹984) at their respective all-time highs [cite: Rewritten News]. This surge is underpinned by record Q3 FY26 profits and a significant improvement in asset quality across state-owned lenders.
### Valuation Dynamics and Analyst Divergence
Despite the impressive rally, the aggregate Price-to-Earnings (P/E) ratio for the Nifty PSU Bank index stands at approximately 9.59, with P/B ratios around 1.58. While these valuations are considered attractive compared to the Nifty 50's P/E of 22.4 and Nifty Bank's P/E of 16.47, analysts note that the rapid gains have compressed valuation gaps between PSU and private banks [cite: Rewritten News]. For instance, SBI's P/E ratio is around 13.85, Bank of Baroda's is 8.21, Indian Bank's is 10.61, and Union Bank's is 7.82. Analysts at Kotak Institutional Equities suggest that while PSU bank valuations have tightened, a significant re-rating in the broader banking sector would likely require greater confidence in private banks' growth and Net Interest Margin (NIM) outlook. Antique Stock Broking favors SBI for its strong franchise and Union Bank of India for its projected Return on Assets (RoA) of 1.15-1.25% by FY27 [cite: Rewritten News]. Axis Securities forecasts a 17% earnings CAGR for banks over FY26-28E, driven by declining credit costs and marginal NIM upticks [cite: Rewritten News].
### Regulatory Shadow Over Private Lenders
A significant counterpoint to the broader banking sector's positive narrative emerged with the Haryana state government's decision to de-empane panel IDFC First Bank and AU Small Finance Bank from conducting government business [cite: Rewritten News]. This action, effective February 22, 2026, follows IDFC First Bank's disclosure of a ₹590 crore fraud involving its employees and Haryana government accounts. The government also cited irregularities in deposit management, where banks allegedly retained funds in low-interest savings accounts instead of higher-yielding instruments, causing financial losses. This regulatory move, coupled with a potential review of AU Small Finance Bank's account handling, injects a note of caution for specific private sector entities, contrasting sharply with the bullish momentum in PSUs.
### Forward Outlook and Sectoral Resilience
The historical performance of the Nifty PSU Bank index reveals a substantial turnaround from past Non-Performing Asset (NPA) issues, showcasing robust fundamental strength with multi-year lows in Net NPAs and improved profitability metrics. The supportive economic environment, including government infrastructure spending and an anticipated GDP growth boost, is expected to fuel further credit expansion at state-owned banks. Analysts anticipate continued benign credit cost trajectories, supporting earnings growth. For SBI, analysts maintain a 'Buy' rating with a target price of ₹1,280 [cite: Rewritten News]. Bank of Baroda has an average 12-month price target of around ₹331.33 from multiple brokers. While the Nifty PSU Bank index is at a record high, sustained momentum above 9,700 could signal further upside for mid-tier constituents.
### Forensic Bear Case
The rapid ascent of PSU banks, while supported by improving fundamentals and a favorable macro-economic backdrop, carries inherent valuation risks. The compressed valuation gaps, particularly when compared to the broader market, suggest that much of the anticipated growth may already be priced in. The regulatory action against IDFC First Bank and AU Small Finance Bank, stemming from alleged fraud and mismanagement, serves as a potent reminder of operational and governance risks that can disproportionately impact specific institutions. Furthermore, the PSU banks' heavy reliance on government policy and the broader economic cycle makes them susceptible to shifts in fiscal priorities or unexpected economic downturns. While asset quality has improved, continued vigilance on credit growth sustainability and potential slippages, especially in unsecured loan segments or SME portfolios, remains critical.