Why PSU Banks Are Gaining Ground Over Private Banks in 2026

Mumbai: For years, private sector banks dominated India’s banking growth story. They expanded aggressively, improved profitability, and steadily gained market share from public sector banks (PSBs). However, in 2025–26, a noticeable shift is underway. PSU banks are showing relative strength, better margin stability, and greater lending flexibility compared to many private peers.

This change is not accidental. It is driven by balance sheet positioning, liquidity conditions, and the rising credit-to-deposit ratio across the banking system.

Below is a detailed analysis of what is happening and why PSU banks are currently better placed.

1. Credit Growth Is Outpacing Deposit Growth

Since FY22, India has witnessed strong credit growth supported by:

• Retail loan expansion

• Revival in corporate borrowing

• MSME financing

• Consumption-led demand

However, deposit growth has not kept pace with loan growth. As a result, the system-wide Credit-to-Deposit (CD) ratio has risen sharply — from around 72% in March 2022 to approximately 82% by early 2026.

A rising CD ratio means banks are lending a larger portion of their deposits. While this indicates strong economic activity, it also creates liquidity pressure.

When loan growth consistently exceeds deposit growth, banks face funding stress.

2. Private vs PSU Banks: A Significant Difference in CD Ratios

The divergence becomes clearer when comparing private and PSU banks.

By late 2025:

• Many large private banks were operating with CD ratios close to 90–92%.

• PSU banks were closer to 74–75%.

A CD ratio near 90% means the bank has already deployed most of its deposits into loans. This leaves very limited room to grow further unless fresh deposits are mobilised.

PSU banks, with CD ratios in the mid-70s, still have substantial lending headroom. They are not under immediate pressure to aggressively raise deposits or borrow from markets.

This difference in liquidity positioning is one of the biggest reasons behind the current outperformance of PSU banks.

3. Deposit Competition Is Intensifying

India is currently experiencing tight deposit conditions due to:

• Shift of household savings toward equities and mutual funds

• Higher consumption spending

• Slower growth in financial savings

Private banks, which expanded rapidly in retail credit, now need steady deposit inflows to sustain growth. To attract deposits, they are offering higher interest rates.

If deposits do not grow fast enough, banks borrow from wholesale markets. Market borrowing typically comes at higher and more volatile costs.

PSU banks, with extensive branch networks and a strong presence in rural and semi-urban areas, have relatively stable deposit bases. This reduces their dependence on high-cost borrowing.

4. Impact on Net Interest Margins

When deposit costs rise and lending rates cannot increase proportionately, margins shrink.

Private banks are experiencing sharper compression in lending-to-deposit spreads because:

• Their funding costs are rising

• Their CD ratios are high

• They have limited flexibility

PSU banks, with lower CD ratios, are less pressured to increase deposit rates aggressively. As a result, their margins have remained relatively stable.

Margin stability directly influences investor confidence, especially during liquidity-tight cycles.

5. RBI Rate Cuts and Weak Transmission

Since early 2025, the Reserve Bank of India has reduced policy rates significantly.

In theory, rate cuts should reduce borrowing costs for consumers and businesses. However, banks have passed on only part of the benefit.

The reason is simple: high CD ratios.

When banks are already stretched on liquidity, they cannot aggressively reduce lending rates. Doing so would further squeeze margins.

Private banks, being more fully deployed, are less able to pass on rate cuts. PSU banks, with greater liquidity buffers, are relatively more comfortable.

High CD ratios therefore weaken monetary policy transmission.

6. Market Share Stabilisation

For over a decade, PSU banks steadily lost market share to private banks. Their share of total credit fell significantly from the early 2010s to the mid-2020s.

Now, that decline appears to have stabilised.

Private banks are slowing credit growth due to funding constraints, while PSU banks have room to expand lending. As a result, PSU banks are beginning to stabilise — and in some segments slightly regain — market share.

This does not necessarily indicate a permanent structural reversal, but it does suggest a cyclical shift in advantage.

7. Asset Quality and Capital Position

Another factor supporting PSU banks is the improvement in asset quality over recent years.

• Gross NPAs have declined significantly

• Provision coverage ratios have improved

• Capital buffers are stronger

This means PSU banks are entering the current liquidity-tight phase with cleaner balance sheets than in the previous decade.

Private banks remain strong on asset quality, but funding stress is now emerging as the differentiating factor.

8. Why Liquidity Cycles Matter

Banking leadership often changes with cycles.

In the previous cycle:

• PSU banks struggled with high bad loans.

• Private banks had stronger balance sheets and capital.

In the current phase:

• Asset quality across the system has improved.

• Liquidity is becoming the key differentiator.

• PSU banks have lower CD ratios and stronger deposit cushions.

In liquidity-constrained environments, the bank with funding comfort typically performs better.

9. Risks to the PSU Outperformance Story

The current advantage for PSU banks depends on continued deposit tightness.

Key risks include:

• If deposit growth accelerates sharply, private banks regain flexibility.

• If credit growth slows materially, high CD ratios become less problematic.

• If economic conditions weaken and asset quality deteriorates, PSU banks may again face pressure.

Therefore, the present shift is cyclical rather than permanent.

Conclusion

PSU banks are outperforming not because private banks have weakened structurally, but because the liquidity cycle currently favours them.

The key drivers are:

• Credit growth exceeding deposit growth

• Private banks operating with high CD ratios

• PSU banks having significant lending headroom

• Deposit competition squeezing private bank margins

• High CD ratios limiting full RBI rate transmission

In banking, balance sheet flexibility often determines leadership. At this stage of the cycle, PSU banks are better positioned to navigate funding pressures and sustain growth.

If deposit conditions remain tight, the relative advantage for public sector banks may continue in the near term.