PSU banks have achieved a fundamental turnaround, with gross NPA ratio falling to 1.93% and net NPA ratio to 0.39% as of March 31, 2026, levels that now match or beat several private sector peers. According to The Economic Times, every single PSB maintained a provisioning coverage ratio above 90%, while fresh slippages continued to decline with the slippage ratio at 0.7% for FY26. Total recoveries, including from written-off accounts, reached ₹86,971 crore, marking a significant improvement from the sector's previous challenges. This transformation represents a historic achievement that once seemed impossible for the state-owned banking sector.
Despite PSU banks hitting record profit milestones and achieving historic low NPAs, market insiders are heavily shifting preference toward leading private sector banks. As reported by The Economic Times, Shrikant Chouhan, Head of Equity Research at Kotak Securities, states that while favorable operating momentum is likely to continue, they currently prefer leading private sector banks since they offer a more attractive risk-reward profile at current valuations. The shift is driven by superior earnings compounding potential and more attractive risk-reward dynamics at current valuations, with analysts explicitly tilting toward larger private sector banks. As the market transitions into a tougher macroeconomic environment marked by global uncertainty and intensifying deposit pressures, analysts caution that flocking to cheaper PSU stocks solely for their low valuations could backfire.
A key challenge facing the banking sector is the erosion of low-cost current and savings account deposits, as highlighted by Elara Securities' Prakhar Agarwal. According to The Economic Times, sustained pressure on low-cost deposits means incremental growth will be funded by retail term and wholesale deposits, creating pressure on spreads. Some banks have already raised deposit rates, and incremental spreads are narrowing, making FY27 a challenging period for deposit-dependent institutions. The combination of geopolitical uncertainty, margin compression, and tighter deposit competition is expected to prove particularly difficult for smaller, less differentiated lenders.
Among private banks, Motilal Oswal expects mid-sized players to outperform on earnings, supported by improving net interest margins, easing stress in unsecured portfolios, and relatively stable credit costs driven by better asset quality trends. As reported by The Economic Times, Agarwal argues that FY27 will favour banks with strong liability franchises and robust balance sheets, with large private banks best positioned to compound earnings even without a valuation re-rating. Large private banks with mid-teen returns on equity are particularly attractive, justifying a case for earnings compounding if not for valuation re-rating, while smaller, less differentiated lenders face more challenging conditions.
Despite the preference for private banks, some analysts maintain a cautious but optimistic stance on PSU banks. According to Axis Direct's Dnyanada Vaidya, most larger government-owned banks have maintained a 1% return on assets, a threshold that has historically supported strong stock performance. As reported by The Economic Times, she expects PSU banks to replicate the performance of larger private banks on credit growth, while maintaining stable loan-to-deposit ratios, though margin pressure is likely to persist near-term due to rising funding costs. Over the medium term, analysts expect PSU banks to maintain constructive asset quality outlook with no visible headwinds to credit costs, making them a viable alternative for investors seeking exposure to the banking sector.
