You missed the fine print on FY27 borrowing, and it could rewrite PSU banks’ profit playbook.
- Government’s FY27 borrowing target tops expectations at ₹17.2 lakh crore.
- 10‑year G‑Sec yield surged to an 11‑month high of 6.7% despite 125 bps of repo cuts.
- PSU banks face mark‑to‑market (MTM) pressure on their Available‑for‑Sale (AFS) bond books.
- Stronger credit growth and higher HTM buffers cushion overall earnings.
- Valuation dip appears sentiment‑driven rather than earnings‑driven.
When the Union Budget 2026 unveiled a record ₹17.2 lakh crore borrowing plan, markets reacted instantly—pushing the 10‑year government‑security (G‑Sec) yield to a one‑year peak. While the yield has eased slightly, it still hovers at 6.7%, a level not seen in eleven months, even after the Reserve Bank of India (RBI) trimmed the repo rate by 125 basis points.
Why FY27 Borrowing Keeps Yields Elevated for PSU Banks
The sheer scale of the fiscal deficit means the government must fund a massive issuance pipeline. More bonds on the market translate into higher demand for cash, which in turn pushes yields up. For public‑sector banks (PSU banks) that traditionally hold large portfolios of government securities, a higher yield creates a two‑fold challenge:
- Mark‑to‑Market (MTM) losses on securities classified as Available‑for‑Sale (AFS) or Held‑for‑Trading.
- Potential volatility in treasury income, the line‑item that captures gains or losses on these holdings.
In contrast, bonds classified as Held‑to‑Maturity (HTM) are insulated from daily price swings, as they are measured at amortized cost. The more a bank leans on AFS, the more its earnings can jitter quarter‑to‑quarter when yields move.
How PSU Banks Are Structurally Better Equipped Than in Past Cycles
Three structural upgrades differentiate today’s PSU lenders from their 2013‑16 counterparts:
- Higher Capital Adequacy Ratios (CAR): Post‑Basel III reforms pushed banks’ Tier‑1 capital well above the regulatory minimum, offering a thicker buffer against MTM shocks.
- Expanded HTM Buffers: Many PSU banks deliberately shifted a larger slice of their G‑Sec holdings into the HTM bucket, limiting daily valuation volatility.
- Tighter Duration Management: Treasury desks now employ stricter duration matching, reducing exposure to steep yield curves.
These enhancements mean that while treasury volatility will surface, it is unlikely to erode the core profitability of the banks.
Impact on Net Interest Margins (NIM) and Core Earnings
Yield hikes first affect the balance‑sheet side—bond valuations—before they filter through to the income statement via NIM. Here’s the transmission path:
- Asset side: A sizable portion of PSU loan books are floating‑rate, allowing loan pricing to adjust upward as market rates rise.
- Liability side: Deposit costs lag behind loan repricing because retail deposits are sticky; however, competitive pressure on term deposits may eventually push funding costs higher.
Consequently, any compression of NIM is gradual. The immediate earnings impact is therefore dominated by treasury swings rather than a sharp NIM hit.
Why the Recent Stock Sell‑Off Is More Sentiment Than Substance
Following the yield spike, PSU bank shares fell sharply, prompting headlines of “earnings risk”. A deeper look shows the sell‑off is largely a reaction to perceived Treasury volatility:
- Investors are pricing in short‑term MTM losses that may appear in quarterly results.
- Fundamentally, credit growth remains robust, asset quality has improved, and provisioning buffers are healthy.
- Historical patterns suggest that after an initial correction, valuations tend to revert as earnings normalize.
Thus, the price dip creates a potential entry point for investors who can separate the temporary treasury noise from the longer‑term earnings story.
Investor Playbook: Bull vs. Bear Cases for FY27
Bull Case
- Continued credit expansion across retail, MSME, and corporate segments fuels loan‑book growth.
- Improved asset quality reduces provisioning, boosting net profit margins.
- Higher HTM cushions and strong CAR protect against any further yield surprises.
- Even modest NIM recovery as loan repricing outpaces deposit cost lag.
Bear Case
- Prolonged high yields keep treasury income volatile, denting quarterly earnings.
- If deposit repricing accelerates faster than loan rate adjustments, NIM could compress.
- Any unexpected fiscal shock that forces the government to issue even more debt could push yields higher.
Given the current risk‑reward balance, a cautious long‑position in well‑capitalized PSU banks—especially those with larger HTM holdings—offers an attractive risk‑adjusted upside.
Key Takeaways for Portfolio Construction
- FY27 borrowing lifts yields, but PSU banks’ stronger balance sheets dampen systemic risk.
- Focus on banks with high HTM ratios and robust capital buffers.
- Expect quarterly earnings volatility from treasury MTM, not a permanent earnings downgrade.
- Credit growth and improving asset quality remain the primary profit engines.
- Current market pull‑back may present a valuation sweet spot for long‑term investors.