Trump’s fresh tariff moves have put the brakes on markets that were recovering from the lows of March. With the Indian delegation yet to strike a trade deal with the US, markets are feeling the jitters. Geo-political uncertainties have shaken industry confidence in making fresh investments. The outlook for the economy has also been downgraded. According to the RBI, real GDP growth for FY26 was projected at 6.7 per cent in February but has now been trimmed to 6.5 per cent. Despite this, India remains on track to grow faster than any other major economy.
In the broader markets, equities appear to be fully priced, with little margin for error. However, valuations in the financial services space seem otherwise. The Nifty Financial Services index (the index) which tracks companies from sectors such as banks, NBFCs, insurance and capital markets is now trading at a price-to-book value of 2.8 times, down from the 5/10-year average of 3.5 times. Banks, which constitute 31 per cent of the bellwether Nifty50 and a good 20-30 per cent of the AUM of a wide variety of mutual funds, account for three-fourth of the index’s weightage. Add NBFCs, the combined weightage goes up to 93.5 per cent.
The index, though trading just 2 per cent below its all-time high, has been range-bound since the later part of April. This is probably because the index is factoring near-term headwinds to the banking sector, such as slower credit growth and margin pressure. However, when uncertainties clouding global trade recede and the repo rate cuts are transmitted in full, these headwinds could reverse.
Hence, investors willing to look past the short-term headwinds could take sectoral exposure through active funds that have the index as their benchmark. SBI Banking & Financial Services is one such fund, which has consistently beaten the benchmark and its peer schemes across timeframes.
Outlook for the sector
Earnings growth for the banking sector is largely tied to credit offtake, which is slowing down with the economy. Credit growth for all commercial banks combined, stood at 11 per cent year-on-year for FY25, after robust growth seen in FY23 at 15 per cent and FY24 at 20 per cent. The same has fallen to 9.5 per cent for Q1 FY26. Credit growth driven by private sector capex too, have not been remarkable.
Further, with RBI’s 100-bps repo rate cuts since February, margins of lenders would come under pressure. This is because transmission of rate cuts on loans precedes that on deposits. As of May 2025, commercial banks have passed on 18 bps of rate cuts on outstanding loans but have only shaved 2 bps off rates offered on outstanding deposits. Banks have indeed started cutting deposit rates, starting with the ones on savings accounts. However, the rate transmission on deposits will take place only gradually and hence there will be a pressure on margins in the near term.
However, if one were to overlook these short-term hurdles, there are factors in place to drive earnings growth for the sector. One, concerns over asset quality are largely behind. Even in the troubled unsecured lending space, the stress seems to be subsiding, as evidenced by sequential decline in provision cost of most banks that have reported earnings for Q1 FY26. Reduced provisions mean higher profits.
Two, once the tariff situation is crystallised, credit demand from large corporates could rebound. Benign inflation, reduced lending rates, fiscal measures such as ELI and tax cuts and a good kharif harvest are expected to spur growth in consumption-based loans.
Three, there is ample liquidity in the system, only set to be boosted by RBI’s CRR (cash reserve ratio) cuts of 100-bps, effective September. This eases short-term cost of funds for lenders. Finally, regulatory overhangs from RBI’s draft guidelines on project finance, liquidity coverage and gold loans are behind.
Beyond banks and NBFCs, sectors such as insurance and capital markets bring diversification. Despite hurdles such as taxation of ULIPs, life insurers have posted decent growth in earnings in the last 3 fiscals. General insurance companies though, have posted robust earnings growth in the same period. Improving financial literacy works in the favour of long-term investors in insurance. Financialisation of savings, increased appetite for investment products such as mutual funds drive growth for companies in the capital markets space. A cohort of wealth managers too, is riding on the rising affluent class and have shown healthy growth.
The outperformer
We evaluated a set of funds that are benchmarked to the said index. The funds were to have a minimum track record of 10 years. Only direct plans of the funds were considered. These filters pointed to nine funds. Of them, SBI Banking & Financial Services Fund (the fund) has outperformed both the index and its peers across timeframes, on a mean rolling return basis (see infographics). It has also outperformed peers on a 1-year and 3-year rolling basis. The AUM of the fund is about ₹8,500 crore making it the second largest in the category.
Outperformance explained
The outperformance of the fund emerges primarily from the way the fund’s portfolio is constructed. The fund is underweight on banks in favour of other sectors (see chart). Within banks, while the index has SBI as the lone PSU bank, the fund has a negligible holding of SBI, but a sizeable position in Bank of Baroda and Bank of India. The fund’s combined holding of HDFC Bank and ICICI Bank (top 2 stocks by weight in the index) is just 30.5 per cent versus the index’s 54.5 per cent. The fund’s additions of Axis Bank and RBL Bank to its portfolio this year, can be seen as value buys and betting on turnarounds.
In the NBFC space too, while the index has the larger players such as Bajaj Finance, the fund bets on relatively smaller companies such as Aditya Birla Capital, Aptus Value Housing and Manappuram Finance.
This apart, in the past year, the fund has added the following stocks from the capital markets and insurance sector – Credit rating agencies such as Care Ratings, Crisil and ICRA (combined weight of 3.3 per cent while the index has none), HDFC AMC (1.8 per cent versus index’s 1.2 per cent), HDFC Life (3.8 per cent versus index’s 1.9 per cent), Max Financial (5.6 per cent), Star Health (1.2 per cent) and Niva Bupa (0.9 per cent). Max Financial, Star Health and Niva Bupa are not part of the index.
Published on July 26, 2025
