Mutual Funds Trim Stakes in Private Banks for Second Month, Long-Term View Remains Positive

For the second consecutive month, mutual fund houses decreased their exposure to private sector banks in June 2025, which suggests a tactical portfolio move rather than a long-term strategic shift. The weight of private banks in domestic mutual fund portfolios decreased by 50 basis points (bps) to 17.9% in June, according to the most recent Motilal Oswal Financial Services (MOFSL) Fund Folio report. Allocation is still 70 basis points greater than it was during the same time last year, despite the decline.

The move follows a peak allocation in April, which marked a 20-month high. Fund managers attribute the recent cut to short-term adjustments, driven by market opportunities in other sectors rather than a loss of confidence in private banks.

Tactical Shift, Not Structural Exit

Elara Securities’ liquidity tracker showed that several major asset management companies (AMCs) like ICICI Prudential, Axis, Kotak, and HDFC AMC scaled back their exposure. HDFC AMC remained 8.4% overweight on the sector, while Quant Mutual Fund was underweight by 7.7%. On the contrary, Mirae and Franklin Templeton slightly increased their allocations to private banks. Meanwhile, holdings in public sector banks (PSBs) remained stable or declined across most AMCs.

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Fund managers point out that slower deposit growth and higher credit-deposit ratios have already caused liquidity issues for private banks. However, liquidity conditions have improved after the latest rate reduction. Despite these advancements, it seems that some capital has momentarily moved to industries with potential for short-term growth..

Margin Pressure to Persist Temporarily

One of the concerns leading to cautiousness is the likely pressure on net interest margins (NIMs) in the short term. The impact of a 100 bps rate cut cycle has been more immediate on lending rates than on deposits, causing temporary margin compression. Nonetheless, experts believe this phase is transitory.

Shibani Sircar Kurian of Kotak Mahindra AMC stated that lower funding costs will eventually benefit banks. She also noted that private banks continue to gain market share in both loans and deposits, with FY27 expected to be a strong year for the sector. Christy Mathai from Quantum Mutual Fund echoed similar optimism, highlighting that their investment outlook typically spans two to three years, allowing them to look beyond short-term pressures.

Steady Performance and Valuations Remain Favourable

Despite reduced mutual fund exposure, banking stocks remained resilient in June. The Nifty Bank index closed the month marginally higher, supported by treasury income from PSBs and stable operational metrics.

Preliminary Q1 FY26 results show mixed signals—net interest income (NII) rose just 4.3% year-on-year, marking its slowest growth in recent quarters, while sequentially it declined 1.3%. However, operating profit jumped 24% YoY and 13% QoQ, signalling improved cost control and operating leverage.

Fund managers remain optimistic about valuations. Most private banks are trading between 1.5x to 2.2x of their FY26 book value—levels that are either aligned with or below long-term averages. The asset quality has also held steady, with strong capital buffers and adequate provisioning.

Conclusion

The recent reduction in mutual fund allocations to private banks appears to be a tactical response to evolving market conditions, not a sign of deeper concerns. With improving liquidity, stable asset quality, and attractive valuations, fund managers remain confident about the long-term prospects of private sector banks. Short-term margin compression is seen as a temporary headwind, with recovery expected as the lower cost of funds takes effect in the upcoming quarters