FIIs build a new Banking XI without the usual heavyweights. Will the big banks return?

India's banking sector is witnessing a subtle shift in foreign investor preferences. Foreign institutional investors (FIIs) reduced stakes in 36 of the 50 Nifty companies in the first quarter of FY27 amid a host of sentiment dampeners, including soaring oil prices, rising inflation concerns, a weakening rupee and the absence of an AI-driven market rally.

But the selling has not been indiscriminate. Shareholding data for the June quarter suggests overseas investors have become increasingly selective, rotating within the banking space rather than exiting it altogether. While exposure to several large private sector banks has come down, FIIs have simultaneously increased stakes in a number of mid-sized and smaller private lenders, indicating a preference for banks with specific growth triggers and attractive fundamentals.

Data from the June quarter shows FIIs pared holdings in large private lenders such as HDFC Bank, ICICI Bank, Axis Bank, Kotak Mahindra Bank, Yes Bank and RBL Bank, among 17 banks where overseas ownership declined.


The sharpest reduction was seen in HDFC Bank, where FII shareholding fell by 2.18 percentage points to 41.82%, according to ACE Equities data. Axis Bank followed, with holdings declining by 2.09 percentage points to 42.05%. ICICI Bank, the country's second-largest private lender, saw FII ownership reduce by 0.69 percentage points to 33.79%.

Also read: AI trade unwind, FII inflows brighten August outlook for Indian stocks

On the other hand, FIIs raised stakes in 11 mid-sized and small private banks. Federal Bank saw the biggest increase, with foreign ownership rising by 1.66 percentage points to 27.71%. Karnataka Bank, South Indian Bank, Jammu & Kashmir Bank, Equitas Small Finance Bank, DCB Bank, Tamilnad Mercantile Bank, Utkarsh Small Finance Bank, ESAF Small Finance Bank, Suryoday Small Finance Bank and Capital Small Finance Bank also witnessed an increase in FII holdings, ranging from 1.32 percentage points to 0.04 percentage points.

Why are FIIs rotating within the banking sector?

Shrikant Chouhan, Head of Research at Axis Securities, said select smaller private banks have started attracting incremental foreign investor interest as many of them have steadily strengthened their liability franchise, improved their loan mix towards higher-yielding segments and maintained healthy asset quality.

He added that the Indian banking sector continues to benefit from strong balance sheets, benign credit costs and a long structural runway for credit growth driven by the under-penetration of financial products, which continues to support the investment case.

However, it must be noted that financials account for a significant weight in the Nifty 50 and have historically formed a large part of FII portfolios. Over the past period, FIIs have remained net sellers in Indian equities because of global macro uncertainty, relatively better opportunities in overseas markets and the premium valuation of Indian equities. Given their sizeable exposure to financials, this broader selling naturally translated into lower holdings in large private sector banks.

Why are smaller banks attracting interest?

Rajesh Palviya, Head of Research at Axis Direct, said large private banks continue to offer industry-leading asset quality, adequate capitalisation and sustainable profitability. However, he believes smaller and mid-sized banks currently offer a better growth trajectory, with multiple earnings drivers supporting improvement in return on assets.

He added that these banks have delivered strong credit and deposit growth while broadly maintaining or improving margins during the first quarter. Asset quality trends have also remained favourable, with credit costs staying well contained, supporting the ongoing earnings recovery.

Read more: FIIs cut stakes in 7 Nifty IT stocks. Then the index surged 16% in July

Can large private banks regain favour?

Market experts believe the recent shift in FII ownership should not be viewed as a negative call on large private sector banks. Instead, they see it as a combination of portfolio rebalancing and stock-specific opportunities.

"We remain constructive on frontline private sector banks, given their strong franchises and reasonable valuations alongside improving operating fundamentals," Chouhan said.

Aishvarya Dadheech, Founder and CIO of Fident Asset Management, said larger banks reported robust advances and deposit growth in Q1 FY27, with AUM growth of 15% for HDFC Bank and 19% each for Axis Bank and ICICI Bank. He added that early signs of net interest margins bottoming out, coupled with valuations that remain well below their historical averages for HDFC Bank, Kotak Mahindra Bank and Axis Bank, could shift investor preference back towards larger lenders over the near to medium term.

Dadheech also said much of the recent FII and private equity investments have flowed into undervalued private banks such as IDFC, Federal Bank and Yes Bank, which were trading close to book value despite strong growth. With valuations of these banks now largely converging with those of larger peers and medium-term exit return on equity constrained at around 15%, he believes the structural re-rating of mid-sized private banks is nearing its end.

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The June-quarter shareholding data suggests foreign investors are not moving away from the banking sector but are becoming more selective in their allocations. While recent flows have favoured smaller lenders with improving earnings profiles and valuation comfort, analysts continue to see merit in large private banks, pointing to their strong franchises, improving operating trends and reasonable valuations.

Whether this rotation continues or reverses is likely to depend on how earnings and valuations evolve over the coming quarters.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)