Even as the government has no plans to raise foreign direct investment (FDI) limit in public sector banks (PSBs) from the current 20%, foreign portfolio investors (FPIs) have shown little appetite for the state-owned lenders despite a sharp improvement in financial performance over the past three years. Responding to a written question in the Rajya Sabha on Tuesday, Minister of State for Finance Pankaj Chaudhary said no proposal is under examination to enhance the ceiling to 49%.

Barring Canara Bank, where FPI stake hit an all-time high of 11.9% and the only bank with a double-digit stake, most PSBs are nowhere close to even the existing 20% limit. In fact, in four major banks, State Bank of India (SBI), Bank of Baroda (BoB), Bank of India, and Indian Bank, FPI stakes have fallen after hitting a high in FY24. In State Bank of India, foreign investor holding fell from 10.97% in FY24 to 9.49% in FY26. BoB saw a sharper correction, with foreign stakes dropping from 12.4% in FY24 to 8.71% in FY26. At Bank of India, the trend has been similar, with holdings slipping from 4.52% in FY24 to 4.24% in FY26, while Indian Bank saw a consistent decline from 5.29% in FY24 to 4.68% in FY26.

FPIs have broadly been on a selling spree in Indian equities, on the back of global risk-off sentiment, higher US bond yields, and geopolitical uncertainties, but the decline has been particularly notable in PSBs despite improving fundamentals.

Peak performance

Even without an increase in the FDI cap, foreign portfolio investors have considerable room to raise their exposure to state-run lenders. While FPI holdings had risen after the Covid period and touched a high in FY24, the latest holdings shows a retreat.

The lack of foreign interest contrasts sharply with the financial performance of the public sector banking system. The banking sector recorded a historic milestone in FY24, delivering cumulative net profit of more than Rs 3 lakh crore, supported by robust credit growth and improving asset quality. Public sector banks reported a 34% jump in net profit during the year, outpacing private banks which grew 25%. The trend continued into FY25 as PSBs’ profit after tax rose 26% year-on-year, maintaining a two-year compound annual growth rate of 30%, driven by declining provisioning costs, greater operating efficiency, and stronger non-interest income contributions.

The improvement in asset quality has been one of the most significant drivers of the PSB revival. Gross non-performing assets have fallen from 7.3% in FY22 to 2.6% in FY25. Public sector banks have also maintained healthy capital adequacy ratios under Basel III norms, with most large lenders consistently reporting CAR levels in the 16%–18% range.

Why investors are cold

While elevated US interest rates and risk-off sentiment have curbed foreign flows into emerging markets, investors appear cautious, specifically with regards to PSBs, on whether the recent profitability trend can be sustained as credit cycles mature and margins face pressure. Persistent valuation discounts for state-run banks also reflect the perception that government ownership constrains operational autonomy and long-term strategic decision-making. 

According to Nomura Financial Advisory and Securities, the entire banking sector's valuation at 2.1x one-year forward book value per share appears inexpensive, given the 8% discount to its 10-year average multiple. “With improving profitability, accelerating credit growth and a strong earnings growth outlook, the sector, in our view, is well-positioned for a meaningful re-rating,” mentions in the report, adding that among PSU banks, while the space offers value, the brokerage house favors SBI owing to its better core-profitability profile.