Mutual funds cut stakes in private banks for second month, managers call it a “tactical shift”

After touching a 20-month high in April, private banks’ allocation in domestic mutual fund portfolios has declined for the second straight month. In June, weightage dropped to 17.9 percent, down 50 basis points (bps) from May, according to the latest Motilal Oswal Financial Services (MOFSL) Fund Folio report. Despite the fall, allocations remain 70 bps higher year-on-year. Fund managers attribute the dip to tactical, short-term reallocations rather than any fundamental shift in view. They continue to back the long-term story, citing stable asset quality, improved liquidity, and reasonable valuations.

Not a Structural Shift
Elara Securities’ domestic liquidity tracker indicates several large AMCs reduced their exposure to private banks in June. HDFC AMC was 8.4 percent overweight the sector, while Quant was underweight by 7.7 percent. Other fund houses including ICICI Prudential, Kotak, Axis, and Nippon were also underweight, while Franklin Templeton and Mirae marginally raised allocations. PSU bank weightages remained stable or declined across most AMCs.

“Over the last 12–15 months, private banks dealt with liquidity constraints. They operate with high credit-deposit ratios, and deposit growth wasn’t keeping up. Now that liquidity has improved post-rate cuts, pressure on deposits is easing, but credit growth has moderated to around 10 percent system-wide,” said Harshvardhan Agrawal, Vice President – Equity at Bandhan AMC. The fund house has mostly maintained its private bank holdings.

While banks are beginning to benefit from improved liquidity and a normalization in credit-deposit ratios, Agrawal said some short-term capital may have moved to sectors with near-term tailwinds. “We’re looking at just two months of data. These could be tactical moves. Before this, private banks had relatively high weightage,” he said.

Margin Compression Near-Term
Fund managers widely expect net interest margins (NIMs) to remain under pressure in the short term, mainly due to the 100 bps rate cut cycle. Lending rates, particularly those linked to external benchmarks such as the repo rate, tend to reset faster than deposit rates, creating temporary margin compression.

“Margins may come under pressure this quarter and possibly into the next. But eventually, the benefits of lower cost of funds will kick in,” said Shibani Sircar Kurian, Senior EVP, Senior Fund Manager & Head – Equity Research at Kotak Mahindra AMC. “Private banks continue to gain market share in both loans and deposits. FY27 should be a strong year for banks, as they benefit from lower rates and improving credit growth. Asset quality has also remained largely stable, which should help keep credit costs under control.”

Christy Mathai, fund manager at Quantum Mutual Fund, echoed the sentiment: “Floating rates will come down, impacting margins over the next two to three quarters. But this is temporary and should be factored into the numbers. Margin recovery can follow. We have a long-term view of typically two to three years or more and remain positive on the sector.”

Banks Hold Steady in June
Despite the dip in fund allocations, bank stocks held firm in June. The Nifty Bank index ended the month marginally higher, supported by treasury gains in PSU banks and stable operating performance.

As previously reported by Moneycontrol, early Q1 FY26 earnings for banks have been a mixed bag. Net interest income (NII) rose just 4.3% year-on-year—its slowest pace in several quarters—and declined 1.3% sequentially. However, operating profit increased 24% year-on-year and 13% sequentially, the strongest growth in seven quarters, aided by improved cost control and leverage.

Valuations Still Attractive
Despite moderation in profitability, fund managers remain constructive on the structural story and see current valuations as supportive.

“We have been positive on private sector banks and the view remains,” said Kurian. “There is adequate liquidity, and over time, that should support gradual improvement in credit growth. Given their return on equity (ROE) profile, current valuations remain attractive when compared to long-term averages.”

Mathai added, “We remain constructive on private banks from a medium-term perspective. Even though NIMs have come off and profitability has moderated, we believe most of this is priced in. Valuations are attractive with private sector banks trading at about 1.5x to 2.2x FY26 book value, which is below or at their long-term averages. Asset quality is stable, capital buffers are strong, and provisioning is healthy. These are good businesses available at reasonable valuations.”

According to Moneycontrol data, the average trailing price-to-book value (PB) ratio for large listed banks—excluding those in the Nifty Bank—is 1.8x, while the one-year forward PE averages 2x. The Nifty Bank index trades at 2x trailing and 2.5x forward—still below historical averages for many private lenders.

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