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PSU banks delivered 27.6% returns in 2025. The framework called the move early. Now the question is whether the easy gains are behind us, or whether the run continues.
Why PSU banks ran in 2025
Three reasons converged.
Asset quality genuinely improved. NPAs that had haunted PSU banks for a decade got cleaned up. Provisions reduced, profitability normalized.
Credit growth picked up. Government infrastructure push, capex cycle restart, retail credit demand. PSU banks are leveraged to broad credit growth more than private banks because their footprint covers tier 2 and 3 cities.
Valuations were absurdly cheap. SBI was trading at 0.7 times book value. State Bank of India, the largest bank in India, was priced like a struggling regional. Mean reversion had to happen, and it did.
What’s still working in the thesis
Credit growth remains supportive. The government capex push is a multi-year tailwind, and PSU banks fund a chunk of it.
Asset quality is now better than it has been in 15 years. Gross NPAs are below 5% across most large PSU banks, down from above 10% in earlier cycles.
Profitability, while improved, is still below private bank standards. There’s room for further margin expansion as operational efficiency improves.
The valuation reality check
The cheap-to-fair-value re-rating has largely happened. SBI now trades around 1.3 to 1.4 times book. That’s not expensive, but it’s not the gift it was at 0.7.
The next leg of returns has to come from earnings growth, not multiple expansion. That’s a different dynamic. Multiple expansion was easy money. Earnings-driven returns require execution.
Earnings growth at 12 to 15% annually, holding multiples constant, gives 12 to 15% returns. Reasonable but not spectacular. The 27% returns of 2025 are unlikely to repeat.
The merger uncertainty problem
Government noises about further PSU bank consolidation have been ongoing. A merger announcement creates short-term volatility. Mergers in PSU banks tend to be operationally complex and dilute near-term performance.
The market has been pricing this uncertainty for years. If a merger happens, expect volatility. If it doesn’t, the overhang lifts.
Position sizing from here
Three scenarios for PSU banks over the next 12 to 18 months.
Base case. 12 to 15% returns from earnings growth. PSU banks deliver in line with the broader market or modestly better.
Bull case. Credit growth accelerates further, asset quality continues to improve, multiples expand modestly. 18 to 22% returns possible.
Bear case. A growth slowdown, or a credit cycle issue, or a merger that gets execution wrong. 5 to 10% returns or even mild correction.
For investors who already hold PSU banks at meaningful sizes, this isn’t the time to add aggressively. Take profits if the position has grown beyond 8 to 10% of portfolio. Maintain core exposure at lower allocation.
For investors who are underweight or absent, the entry today is at fair value, not cheap. Smaller position sizes (3 to 5%) make sense. Don’t chase the prior performance.
The PSU bank story isn’t over. It’s just no longer the no-brainer it was. The next leg requires more selectivity. SBI, Bank of Baroda, Canara, and PNB all behave somewhat differently. Which specific name you hold matters more now than it did when the entire space was being re-rated together.
Easy money in this trade was 2024 and 2025. From here, it’s a more normal investment with a still-positive but less spectacular outlook.
