Foreign institutional investors (FIIs) significantly adjusted their banking-sector holdings during the June quarter, reducing their positions in large private banks while concurrently increasing stakes in several mid-sized and smaller private lenders. The June quarter, covering the first three months of fiscal year 2025, came amid a period in which India's banking sector remained the single largest component of benchmark equity indices by weight, meaning that FII positioning within this group carries implications beyond individual stocks.

The banks that appear to be attracting FII interest include Federal Bank, IndusInd Bank, IDFC First Bank, YES Bank, and RBL Bank. Among the smaller lenders referenced in connection with the rotation are Karnataka Bank, South Indian Bank, Equitas Small Finance Bank, DCB Bank, Tamilnad Mercantile Bank, Utkarsh Small Finance Bank, ESAF Small Finance Bank, and Suryoday Small Finance Bank.

Drivers Behind the Rotation

This shift reflects a preference among foreign investors for banks that present specific growth triggers and improved fundamentals. Mid-sized and smaller private lenders have, in several cases, undergone balance-sheet repair, improved asset quality, and pursued targeted lending strategies in high-growth segments such as retail, microfinance, and small and medium enterprise (SME) lending. India's overall credit growth has remained in double digits as reported by the Reserve Bank of India, and smaller lenders pursuing focused strategies in underserved segments have sought to capture a share of that expansion.

The large private banks that saw reduced FII exposure include HDFC Bank, ICICI Bank, Axis Bank, and Kotak Mahindra Bank. These institutions remain among the most prominent components of India's benchmark indices, the Sensex and the Nifty 50. HDFC Bank, following its July 2023 merger with parent HDFC Ltd, is India's largest private sector bank by assets, while ICICI Bank and Axis Bank rank among the top three.

Large Banks Still Offer Value

Despite the quarterly rotation, large private banks continue to offer strong franchises, established deposit bases, and reasonable valuations for investors. Their extensive branch networks, digital infrastructure, and diversified loan books remain competitive advantages in India's banking landscape, which is dominated by both large private sector banks and state-owned lenders such as the State Bank of India. India's banking sector is also governed by prudential norms set by the RBI, including capital adequacy requirements and asset quality reviews, which apply across lender categories.

Outlook Hinges on Earnings and Valuations

Whether large private banks can regain favour with FIIs will likely depend on the trajectory of future earnings and the evolution of valuations across the banking sector. As foreign investors continue to assess growth prospects, asset quality trends, and credit costs, the balance of allocation between large-cap and mid-sized lenders may continue to shift in subsequent quarters. Key markers to monitor include quarterly earnings results, net interest margin trends, deposit growth relative to credit growth, and gross and net non-performing asset ratios.

The broader context for this rotation includes FII activity across other sectors as well. Recent related coverage noted that FIIs had cut stakes in seven Nifty IT stocks before the index gained in July, and that foreign investors had doubled down on an AI-related stock that had risen approximately 200% year-to-date. Separately, reports indicated that FII inflows brightened the August outlook for Indian equities.

Source: Economic Times Markets