The new proposal to increase the FDI limit for public sector banks may revolutionize the banking sector. PSBs will be connected to global capital & expertise, which can open doors for unprecedented growth and global partnerships.
With public sector banks contributing 55% of the total banking sector, doubling the FDI limit could reshape the future of banking in India. In recent news, the government is proposing to the RBI that the FDI limit for public sector banks be raised from 20% to 49%, which may tap into the potential growth for the PSB industry. However, the proposal is yet to be finalized and is under discussion between the Ministry of Finance and the RBI.
Turnaround Story of PSBs
PSU banks showed a remarkable turnaround in FY25. As in FY16, the banks incurred significant losses, and NPAs exceeded 6% of the advances. The IL&FS crisis in 2018 further fueled the fire, leading to an increase in provisions and losses being written off.
In 2018, PSU bank’s gross NPA rose to an alarming 14.6%. Various steps were taken by the RBI and the government, including IBC Resolution, improvement in governance, and digitalisation, which contributed to a successful turnaround for the PSU banking industry. In FY25, PSU Banks posted a record net profit of Rs 1.78 lakh crore, with NNPAs declining to a multi-year low of 0.52%.
Global capital for rural banking
India has 12 PSU banks, with combined assets of Rs 171 lakh crores as of March 2025, that account for 55% of the banking sector. PSU banks play a dominant role in extending loans and collecting deposits, particularly in rural areas. The decision to raise the FDI limit seeks to raise new capital infusion, strengthen the financial position of public sector banks, and align regulatory standards with those applied to private lenders. The PSU banking industry will be able to raise institutional capital and can access a global pool of investors.
Apart from the capital infusion, it can benefit from global innovative technology, stringent risk management, and corporate governance standards brought in by experienced international investors. Additionally, the majority of the stake of PSU banks remains with the government, which protects the voting rights and strategic control of the government.
Moreover, the PSU banking industry has been evolving very rapidly. In recent years, India has also focused on increasing its banking sector reach through various schemes like the Pradhan Mantri Jan Dhan Yojana and the Post Payment Banks. Schemes like these, coupled with major banking sector reforms like digital payments, neo-banking, the rise of Indian NBFCs, and fintech, have significantly enhanced India’s financial inclusion and helped fuel the credit cycle in the country.
Rising International Interest
In recent times, international interest has started to rise in the Indian banking industry, as Emirates NBD has announced that it will be investing around USD 3 billion in RBL Bank. Similarly, Japan’s bank Sumitomo Mitsui Banking Corporation had already bought more than 24% in Yes Bank. Federal Bank also raised around Rs 6,200 crore from Blackstone. These external capital infusions help Indian banks not just to raise capital efficiently but also allow them to follow global practices. Post-COVID, the PSU banks are performing well, but they still often trade at a discount compared to private banks due to historical issues with asset quality, perceived lower efficiency, and greater government control.
What’s for the Investors?
How should an investor take advantage of this recent development in public sector banking?
An investor should try to keep a close eye on the key performance indicators and avoid mediocre or suboptimal PSBs. Some important KPIs to look for in PSB:
- Loan book growth and composition: A cautious investor should keep a close watch on the YoY growth in the loan book of the public sector banks. The composition of loan books should also be carefully watched. PSBs mostly lend to MSMEs, the agricultural sector, retail lending, education, and housing. Indian Overseas Bank has grown its loan book at a higher rate compared to its peers at 20.78% YoY in Q2FY26. Bank of Maharashtra has also grown its gross advances by 16.83% YoY in Q2FY26, higher than the industry.
- Loan-to-Deposit ratio: It tells how efficiently the banks are using the deposits to generate income from lending. Most banks thrive between 80-90%, while lower than 70% is too conservative, and higher than 90% may lead to potential liquidity risks and regulatory concerns. Bank of Baroda and Bank of India are among the PSU banks with a higher domestic loan-to-deposit ratio at 82.32% in Q1FY26 and 81.82% in Q2FY26, respectively.
- Asset quality: It is one of the most important metrics, which is measured through NPA (Non-Performing Asset Ratio), indicating the proportion of bad loans and reflecting the bank’s effectiveness in credit risk management. In most international banking best practices, maintaining GNPA below 3% is considered ideal to ensure a bank’s stability and profitability. Indian Bank, Bank of Maharashtra, and Indian Overseas Bank have lower NPA ratios among the public banking industry. NPA for Indian Bank stood at 0.16% as of Q2FY26, whereas for Bank of Maharashtra, NPA stood at 0.18% as of Q2FY26.
- Deposit growth: It is important to track YoY growth of deposits as it provides a stable, low-cost source of funds to support lending and ensure liquidity. While private sector banks struggle to grow their deposit book, PSBs enjoy a large rural network, strong public trust, and stable retail deposits due to financial inclusion schemes. The Central Bank of India has grown its deposit book at a healthy rate of 13.40% YoY as of Q2FY26, whereas Bank of Maharashtra has also grown its deposit book at 12.13% YoY as of Q2FY26.
- Operational Efficiency: It reflects how well the bank manages its costs relative to its income. The cost-to-income ratio is one of the key metrics that indicates operational effectiveness. The lower the ratio, the better. Other ratios, such as business per employee, CASA ratio, profit per employee, and ROA, also need to be tracked. Bank of Maharashtra has a lower cost-to-income ratio of 37.10%, while Indian Overseas Bank also maintained its cost-to-income ratio at 45.76% as of Q1FY26. Bank of Maharashtra also maintained a higher CASA ratio of 50.35% compared to its peers as of Q2FY26.
- Net Interest Margin: It is one of the crucial metrics that an investor should look for. It measures the difference between interest income earned on loans and investments and the interest expense paid on deposits and borrowings, expressed as a percentage of the bank’s average interest-earning assets. The ideal NIM for the PSB is in the range of 2.5%-3%. It shows how well the bank manages its funding costs and loan pricing strategies. Bank of Maharashtra has been able to maintain a high NIM of 3.90%, along with Indian Overseas Bank, which also enjoys a high NIM of 3.35% as of Q2FY26.
Final words
Public sector banks play an important role in rural credit and financial inclusion. The proposed increase in the FDI limit aims to unlock significant growth for the PSU banking industry. It may attract global capital and expertise while preserving government control.
Growing international interest in the Indian banking industry will help bridge the gap between private sector banks and public sector banks through better access to capital and the adoption of global standards. Investors should focus on PSBs with consistent loan growth, healthy asset quality, and operationally efficient PSBs, which can leverage the global capital to tap the untapped potential.
Written by Ashish Sengupta
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