Key Takeaways
- PSU banks fell between 2.5% and 9% on budget day, dragging the Nifty PSU Bank index down 5.6%.
- Record government borrowing of Rs 17.2 lakh crore is expected to push bond yields higher, hurting banks' treasury books.
- Mark‑to‑market losses on existing bond holdings could erode profitability for SBI, Canara Bank and peers.
- Historical budget shocks in 2020 and 2019 produced similar sell‑offs, followed by a rebound once yield pressure eased.
- Investors can hedge with short‑duration bond funds or look for upside in private lenders that benefit from higher rates.
The Hook
You missed the warning signs on budget day, and your portfolio paid the price.
Why the Budget's Record Borrowing Squeezes PSU Bank Margins
The finance ministry announced a historic borrowing target of Rs 17.2 lakh crore for FY 2026‑27. Such a massive issuance inevitably lifts sovereign yields. PSU banks—whose treasury desks hold sizable government‑bond inventories—face immediate mark‑to‑market write‑downs. When yields rise, the market price of existing bonds falls, creating unrealized losses that must be reflected in quarterly earnings.
For a bank like SBI, whose bond portfolio exceeds Rs 2 lakh crore, a 50‑basis‑point rise in yields translates into a potential hit of around Rs 10 billion on paper. The market priced this risk aggressively, driving the 5%‑plus slide across the sector.
How Rising Yields Threaten Treasury Portfolios of SBI and Peers
Yield spikes affect two key balance‑sheet items:
- Net Interest Margin (NIM): Higher funding costs erode the spread between loan rates and the cost of funds.
- Capital Adequacy: Mark‑to‑market losses shrink risk‑adjusted capital, tightening regulatory buffers.
Bank of India, which posted the steepest drop of 9%, had the highest proportion of long‑dated bonds, making it the most exposed. Conversely, UCO Bank limited its fall to 2.5% by maintaining a more balanced short‑term portfolio.
Historical Parallel: 2020 Budget Shock and PSU Bank Fallout
In the 2020 Union Budget, the government announced a Rs 5 lakh crore borrowing plan to fund pandemic relief. Yields spiked, and PSU banks collectively lost around 4% in a single session. Within three months, the Reserve Bank of India intervened, buying government securities and stabilising yields. Banks recovered, posting a 3%‑5% rebound in earnings as the bond market normalized.
The current scenario differs in scale—borrowings are more than three times larger—but the mechanics are identical. History suggests that once the bond market settles, the same recovery pattern could re‑emerge, albeit with a longer adjustment window.
Sector Landscape: Private Lenders Responding to Rate Upside
Private banks such as HDFC and ICICI have lighter exposure to sovereign bonds and more flexible funding structures. As yields rise, they can reprice loan products faster, improving NIMs without the same mark‑to‑market drag. Consequently, investors are reallocating capital toward these peers, widening the performance gap between public and private lenders.
Moreover, non‑bank financial companies (NBFCs) that specialise in short‑term credit are benefitting from higher interest income, creating a secondary shift in capital flows.
Technical Insight: Mark‑to‑Market Impact on Bank Balance Sheets
Mark‑to‑market (MTM) accounting requires banks to value their securities at current market prices, not at purchase cost. When bond yields climb, MTM adjustments become negative, reducing the fair value of assets. This effect is reflected in the “Other Comprehensive Income” line of the profit‑and‑loss statement, directly influencing reported earnings.
Regulators mandate that banks maintain a minimum Capital Adequacy Ratio (CAR) of 12.5% including buffers. Large MTM losses can push the CAR below the threshold, forcing banks to raise fresh capital or curtail lending—both of which can further depress stock prices.
Investor Playbook: Bull vs. Bear Cases
Bull Case: Yield volatility subsides within two quarters as the market absorbs the borrowing programme. PSU banks' bond portfolios stabilise, MTM losses reverse, and NIMs improve with the resumption of credit growth from the infrastructure push. In this scenario, stocks could rebound 10‑15% from current levels, rewarding long‑term holders.
Bear Case: Yields continue to climb, forcing deeper MTM write‑downs and pressuring CARs. The government may need to issue more debt to fund the Rs 12.2 lakh crore capex plan, extending the yield‑rise cycle. Persistent pressure could trigger a downgrade of PSU banks, leading to a further 5‑10% slide over the next six months.
Strategic options:
- Short‑term: Reduce exposure to the most vulnerable PSU names (Bank of India, Indian Bank) and add short‑duration debt funds that benefit from higher yields.
- Medium‑term: Tilt allocation toward private lenders with lower bond exposure and higher loan‑growth flexibility.
- Long‑term: Hold a core position in robust PSU banks like SBI, using the current dip as a buying opportunity if you believe the fiscal deficit will eventually narrow and the bond market will stabilise.
Stay vigilant on daily yield movements when bond markets reopen on Monday; the direction of 10‑year gilt yields will set the tone for the next round of price action in the PSU banking sector.