The Government of India is considering raising the Foreign Direct Investment (FDI) limit in public sector banks (PSUs). This signals a major shift in the country’s banking system, allowing PSU banks to raise more funds from foreign investors. The proposed policy will not only strengthen banks’ capital position but also enhance their global competitiveness.
On September 24, PSU bank shares surged following the circulation of this news. Let us understand the potential changes and what it means for investors.
What’s Happening?
Currently, the cap on FDI in public sector banks in India is 20%, while voting rights are limited to a maximum of 10%, compared to 74% in private sector banks.
Policymakers believe that this change will boost PSU banks’ ability to raise capital and make them more competitive as financial institutions. This move is part of a broader reform package that the government is pushing forward to support the economy amid ongoing geopolitical concerns.
The government has clarified that even with increased foreign investment, its ownership will remain above 51%, ensuring that these banks retain their public sector status.
Remarkable Performance of PSU Banks
The proposal comes at a time when PSU banks have shown remarkable improvement in their financial position. There was a period when these banks struggled with high NPAs and weak profitability, but the situation has now changed completely. According to brokerage firm Motilal Oswal, these banks have achieved a ‘structural transformation’. In FY2025, the total profit of these banks reached a record Rs 1.5 lakh crore, accounting for nearly 48% of the overall banking sector’s profits.
Asset quality has also improved significantly. While the gross NPA ratio stood at 14.6% in FY18, it has now dropped to just 2.8% in FY25. The net NPA ratio is down to 0.5%, on par with private banks. The Provision Coverage Ratio (PCR) is also strong at around 79%, sufficient to handle potential risks. The Capital Adequacy Ratio (CAR) stands at a healthy 15–18%. This improved financial strength likely gives the government the confidence to take bold policy steps such as increasing foreign investment.
Potential Foreign Investment and Market Optimism
According to CNBC TV18, if the foreign investment limit is raised to 26%, about $1 billion of passive inflows could enter six major PSU banks through the MSCI Index.
If the FDI limit is raised to 26%, SBI could emerge as the biggest beneficiary with an inflow of $466 million.
According to Nuvama Alternative & Quantitative Research, other banks likely to benefit include Bank of Baroda, Punjab National Bank, Canara Bank, Union Bank of India, and Indian Bank, which could gain a spot in the MSCI index, attracting an investment of $177 million. This positive market reaction reflects investor optimism regarding the reform.
What’s in it for Investors?
Analysts at Motilal Oswal believe that PSU banks still have room for re-rating. Currently, most public sector banks are trading at 0.8–1x forward Price-to-Book (P/B) and 5–7x FY27E EPS, indicating potential upside in valuations.
Interestingly, in FY25, public sector banks recorded 12% loan growth, surpassing private banks’ 10% growth for the first time in 15 years, largely driven by strong demand in the retail and MSME segments.
Moreover, if the government raises the foreign investment limit above 20%, the impact could be even more positive. Additional foreign capital would strengthen bank balance sheets, improve their international profile, and accelerate the re-rating process. This would position PSU banks to compete more effectively with private banks, a trend likely to reflect in their stock prices.
What’s Next?
Motilal Oswal estimates that during FY26–28E, the covered PSU banks may witness around 14% CAGR growth in total income. However, the biggest challenge will remain the mounting pressure on Net Interest Margin (NIM). To address this, public sector banks are tweaking their strategies. They are focusing on high-yield segments such as Retail, Agriculture, and MSME (RAM), while also making efforts to increase fee income. These measures are expected to help maintain banks’ Return on Assets (RoA) at a stable 1–1.1% in the coming years.
Meanwhile, the government is moving forward with its disinvestment plans. Through Offer for Sale (OFS), it is reducing stakes in five banks: Bank of Maharashtra, Indian Overseas Bank, UCO Bank, Central Bank of India, and Punjab & Sindh Bank.
*The companies mentioned in the article are for information purposes only. This is not investment advice.
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