FDI Limit in PSU Banks: What the Proposed Increase Could Mean!

Introduction: Understanding FDI and the Current Cap

Foreign Direct Investment (FDI) represents capital inflows from overseas investors seeking long-term ownership and control in domestic companies. In India’s public sector Banks (PSBs), FDI is currently capped at 20 per cent, compared to 74 per cent in private sector banks. This restrictive limit has historically limited foreign participation and valuation growth in PSBs, despite their improving fundamentals.

Government’s Proposal: Aligning with Private Banks

The Indian government is reportedly considering increasing the FDI limit in PSBs to 49 per cent, aligning them more closely with private sector norms while ensuring that public ownership remains above 51 per cent. The Finance Ministry and RBI have been actively discussing this move, which could be finalized within a few quarters. This potential doubling of the FDI limit marks one of the most significant liberalization steps in India’s banking sector since privatization reforms began.

Impact: Higher Free Float and MSCI Weight Upside

Currently, foreign institutional investor (FII) holdings in PSBs range between 4.5 per cent and 12 per cent, leaving ample headroom under the 20 per cent cap. Raising this ceiling to 49 per cent could trigger USD 3.5–4 billion in passive MSCI inflows, as free-float market capitalization increases. State Bank of India alone could attract up to USD 2.2 billion, while other major PSBs such as Bank of Baroda, PNB, Canara Bank, Union Bank, and Indian Bank would also benefit.
MSCI indices are free-float weighted, meaning higher FII limits naturally expand index weights and attract passive global fund inflows, improving liquidity and valuations across the PSU banking space.

Sector Re-Rating: M&A Activity, Fundamentals, and Valuations

The timing of this proposed policy aligns with a resurgence in M&A deals within the financial sector—such as Emirates NBD’s USD 3 billion stake in RBL Bank and Blackstone’s USD 705 million investment in Federal Bank—signalling robust foreign confidence.
PSU banks have also demonstrated a structural turnaround, with Gross NPAs falling to 2.58 per cent (from 9.11 per cent in 2021) and RoA improving to 1.1 per cent in FY25. Record profits of Rs 1.78 lakh crore and strong recoveries underscore healthier balance sheets. Valuations remain compelling, with many PSBs trading at or below one time book value, attracting both domestic and foreign investors.

Market Performance and Outlook

The Nifty PSU Bank Index has surged nearly 27 per cent year-on-year, outperforming the broader market, with stocks like SBI, Indian Bank, and Bank of Baroda leading the rally. Analysts expect another 20–30 per cent upside as the FDI proposal progresses. The move could enhance governance standards, improve capital adequacy, and strengthen India’s banking competitiveness globally.

Conclusion

The proposed increase in FDI limits for PSU banks from 20 per cent to 49 per cent could be a transformational policy shift, unlocking billions in foreign inflows, improving liquidity, and raising global investor participation. Combined with better fundamentals, attractive valuations, and robust credit demand, this reform could drive a sustained re-rating of India’s public sector banking sector—making PSU banks the next big story in the Indian equity market.