Whalesbook
The gap in loan growth between public sector banks (PSBs) and private banks widened notably in the December quarter of FY26. PSBs demonstrated strong lending increases, capturing a larger share of the market, while private banks navigated internal changes and faced profit pressures.
PSBs Drive Strong Growth
Public sector banks reported robust credit growth of 17-28% year-on-year for the December quarter of FY26. This significantly outpaced the 11-16% growth seen at private sector banks during the same period. Consequently, PSBs' overall loan market share rose to 54.4% by the end of December 2025, up from 53.11% a year earlier. Private banks' share slightly decreased to 40.6% from 41.07%.
Major state-run banks like State Bank of India, Canara Bank, Bank of Baroda, and Union Bank of India reported loan growth between 18-28%. This was much higher than that of leading private lenders such as HDFC Bank, ICICI Bank, and Axis Bank, which saw growth in the low-to-mid teens. PSBs gained about 50 basis points of loan market share, primarily from top private banks.
Reasons for PSB Momentum
Analysts point to several reasons for PSBs' strong performance. These include better asset quality, successful recovery of old bad loans (NPAs), and increased demand for corporate lending. The banking system's overall loan quality has improved, with gross bad loans (GNPAs) falling due to stronger credit assessment and recovery processes. PSBs also have more capacity on their balance sheets to support lending growth, as shown by their credit-to-deposit ratio of 81.7% as of December 2025, compared to higher ratios often seen at private banks.
Challenges for Private Banks
The slower growth at private banks is partly due to HDFC Bank's ongoing balance sheet adjustments following its merger with HDFC Ltd. The bank deliberately slowed lending to manage its credit-to-deposit ratio, which rose sharply post-merger. Although HDFC Bank returned to double-digit loan growth by Q3 FY26, its FY25 loan growth was only 5.4%. ICICI Bank's growth has also normalized, now tracking closer to the sector average.
Profitability Trends
Despite funding challenges, PSBs saw stronger profit growth, with a 17.5% year-on-year rise in net profit to ₹55,000 crore in the December quarter. In contrast, several mid-sized private banks faced profit challenges, and the private banking sector as a whole reported more modest net profit growth of 3.2% year-on-year. While profit margins across the sector faced pressure from intense competition for deposits and repricing, PSBs managed better growth in net interest income. Their higher loan-to-deposit ratios helped offset some margin pressures.
Valuations and Market View
PSBs generally trade at lower stock valuation multiples. As of March 2026, their price-to-earnings (P/E) ratios ranged from about 6.3x for Canara Bank to 12.4x for State Bank of India. Major private banks have higher P/E ratios: Axis Bank at around 14.9x, ICICI Bank at 17.5x, and HDFC Bank at 17.2x. Moody's projects a stable outlook for the Indian banking sector, expecting low bad loans and loan growth around 10-15% to match deposit growth. However, competition for customer deposits continues to squeeze profit margins.
Underlying Risks
While PSBs show strong loan growth and market share gains, potential weaknesses exist. Their improved profits and growth might hide deeper problems, especially concerning their funding sources and cost efficiency compared to private sector rivals. The high loan-to-deposit ratio means PSBs rely more on market borrowing, which can be more expensive. These significant market share gains by PSBs also stem partly from strategic slowdowns by private banks like HDFC Bank, which is still adjusting its balance sheet post-merger. Investors' views on PSBs' slower adoption of digital technology and operational efficiencies, areas where private banks are investing heavily, also contribute to their lower valuations. The risk of shrinking profit margins remains as deposit costs rise to meet loan rates, a trend that can affect banks with fewer funding options more.
Sector Outlook
India's banking sector is expected to remain stable, supported by strong economic growth that should drive loan expansion in the 10-15% range in FY27. Profit margins are anticipated to stabilize or slowly grow as deposit costs align with loan rates. Increased regulatory oversight and a focus on risk management should further strengthen the sector. However, external factors, such as geopolitical conflicts, could introduce uncertainty and affect the overall economy, potentially posing challenges to sustained growth and profitability for the banking sector.