FPIs pulled out a massive $2,882 million from banking and financial stocks in January—the biggest outflow for the sector since they withdrew $3,109 million in October, showed data from National Securities Depository Ltd.
In comparison, FPIs offloaded consumer durables stocks worth $1,403 million and software and services stocks worth $747 million.
In January, when Donald Trump took oath as US President, FPIs offloaded $9,052 million in equity investments compared to their net buying of $1,825 million in December 2024.
FPIs are moving capital from emerging markets in response to changing US policy, the threat of a trade war, and the resulting upside risk to inflation. To be sure, the financial sector always sees a high rotation of money as banks hold significant weight in major Nifty indices.
However, the sector is grappling with a range of issues, including high funding costs, asset quality concerns, and rising credit costs, all while loan growth remains sluggish. On top of it, tight liquidity driven by weak deposit growth, forex operations and emerging stress in unsecured lending has made investors more cautious about the sector.
Over the past six months, the Nifty Financial Services has inched up just 3%, while the Nifty Bank has barely moved, giving investors flat returns. The Nifty Private Bank has dipped 0.3%, and the Nifty PSU Bank has tumbled 10%, all against a 3% decline in the Nifty 50 over the same period, according to data from markets data provider Capital Market.
The Nifty IT, with 10% gains over the past six months, led the pack among all sectoral indices on the National Stock Exchange.
Banks have seen lower growth in high-margin products like unsecured and credit card loans as compared to lower-margin segments like housing loans, which may put pressure on their financial performance, said Alok Agarwal, head of quant and fund manager at Alchemy Capital Management.
Moreover, he added, a falling interest rate environment could further squeeze lenders’ margins. “There has been a widespread positive consensus regarding the Nifty Private Bank, but it is not outperforming. In fact, the ratio of the Nifty Private Bank to the Nifty 500 is close to an 11-year low,” he said, citing data from Bloomberg.
He believes the sector has a disproportionately high weight in the indices and is quite over-owned.
Not all is bad
That said, Agarwal thinks the risk-reward for banks is fairly balanced. “However, in a lower rate scenario, banks’ net interest margins (NIMs) are likely to fall, while non-banks could see their margins expand, making them a more appealing option.”
He also sees potential in capital markets with structurally rising financialization of savings and no balance sheet risk. “The recent changes to personal income tax slab rules can potentially widen the tax net, with more money available for savings through capital markets. On the other hand, insurance looks a bit overvalued,” he added.
The Union Budget 2025-26 revised tax slabs and raised the exemption limit to ₹12 lakh under the new regime, which is a big relief to India’s middle class.
“Asset quality-wise, most segments are showing stable trends except unsecured lending,” said Amey Sathe, fund manager, Tata Asset Management.
He said early signs of credit card stress are stabilizing, with further improvement anticipated in the coming quarters. “On microfinance institutions, stress continues and will persist for another two to three quarters. However, lenders are provisioning aggressively. This means credit cost burden is likely to fall in the second half of FY26.”
Also, Budget 2025’s proposal to double the credit guarantee cover for micro, small and medium enterprises (MSMEs) from ₹5 crore to ₹10 crore will enhance lending opportunities for banks and non-banking financial companies (NBFCs), according to foreign wealth manager Julius Baer India.
Furthermore, a lower fiscal deficit is expected to ease yields, creating a favourable environment for lenders. This development bodes particularly well for corporate-focused and state-run banks, as it positions them to accelerate new lending initiatives, said the foreign brokerage.
A gradual recovery in sight
Nitin Aggarwal, head of BFSI, institutional equities at Motilal Oswal Financial Services, expects earnings erosion to reach its lowest point by 2025-26, paving the way for a revival in earnings growth from 2026-27 onwards.
Dhaval Gada, fund manager at DSP Mutual Fund, expects foreign investors to return once the relative opportunity, especially in the US, is less attractive. He explained that foreign investors are moving capital back to the US amid concerns over the economic slowdown, valuations, and currency depreciation.
However, while valuations appear stretched at present, selective opportunities still exist, offering potential returns in specific banking stocks, he clarified, adding that 2025 may not be a blockbuster year due to moderating earnings growth led by rate cycle and asset quality normalization, along with regulatory changes impacting performance in the life insurance sector.
That said, he believes the alpha generation will come from picking the right companies, likely in the NBFC space.
Even Kaitav Shah, lead BFSI analyst at Anand Rathi Institutional Equities, is optimistic about the sector, believing that a strong pipeline of capital expenditure will drive credit growth for lenders.
Ultimately, easing liquidity conditions and higher disposable income should bolster deposit growth, which, in turn, will improve loan growth. “While a rate cut cycle would put some pressure on margins and credit costs may inch up in the medium term, the strong asset quality of top banks suggests that credit cost normalization may take longer, which is a positive sign,” said Shrikant Chouhan, head equity research, Kotak Securities Ltd.
