PSU banks face a bigger risk from bond yields than potential loan waivers
The real problem for PSU banks is not potential loan waivers, but their bond portfolios. As bond yields move up, bond prices fall, leading to mark-to-market losses on the portfolio.
Maharashtra and Karnataka have declared drought in about three-fourths of their respective talukas (tehsils) for the 2026 kharif crop season. More states could follow suit. This could prompt the central or state governments to announce farm loan waiver schemes, weighing on investor sentiment.
As PSU (public sector undertaking) banks have greater exposure to agricultural loans than their private-sector counterparts, they are likely to be more affected by loan waivers. For instance, in FY26, the agriculture sector accounted for 10% of State Bank of India's (SBI) domestic loan book, compared to around 4% for the country's largest private-sector lender HDFC Bank (excluding agriculture-related trading activities). A similar trend is seen at the second-largest PSU and private-sector banks, Punjab National Bank and ICICI Bank, respectively.
Should investors in PSU banks , then, be more worried about likely loan waivers? Not necessarily. While loan waivers could weaken credit discipline, they may not have a significant impact on banks’ earnings.
Loan waivers have a precedent. In 2008, the central government announced a ₹ 52,500 crore farm loan waiver amid severe rural distress, ahead of the 2009 general elections. The government had compensated all banks (public and private) back then, regardless of the quantum of exposure. So, it is not that only PSU banks are asked to bear the burden. Almost 50% of the waived amount in 2008 was released to the affected banks in the same calendar year, with the remainder paid over the next four years. Therefore, banks may incur some loss in the net present value of the loans, but not on the outstanding loan amount.
Under state-specific loan waiver schemes, the respective state governments compensate the banks. For instance, the Uttar Pradesh government had absorbed the entire financial burden of around ₹ 36,000 crore in April 2017 towards state-specific loan waiver.
However, the real problem for PSU banks is not potential loan waivers, but their bond portfolios. As bond yields move up, bond prices fall, leading to mark-to-market losses on the portfolio. As per Bloomberg, India's benchmark 10-year government bond yield has surged - from 6.72% at June-end to 7.17% at September-end.
Recall that SBI incurred a treasury loss of ₹ 1,471 crore in the March quarter (Q4FY26) as bond yields rose 44 basis points (bps) during the quarter to 7.03%. After reporting a treasury gain of ₹ 4,319 crore in Q1FY27 as bond yields softened, the bank could again see a treasury loss in Q2FY27. One basis point is one hundredth of a percentage point.
Treasury gains accounted for nearly 20% of SBI's net profit in both FY26 and Q1FY27. In contrast, treasury gains contributed just 2% of HDFC Bank's standalone profit in Q1FY27 and 6% in FY26, excluding the one-time profit from the offer-for-sale of HDB Financial Services.
The outlook for Indian bond prices, and by extension banks’ treasury income, may remain subdued in the near term. That's because the yield gap between India's benchmark 10-year and US 10-year government bonds has narrowed - from 257 bps at the start of 2026 to 193 bps now, even as the Indian government has sought to attract foreign flows into bonds with tax incentives.
Since treasury gains are volatile and difficult to sustain, investors tend to assign SBI and other PSU banks lower valuation multiples than their private-sector rivals. ICICI Securities’ estimates for FY27 indicate the Street is assigning a price-to-earnings multiple of 7 to SBI versus 11 to HDFC Bank (based on standalone earnings per share and deducting value of subsidiaries from market price).
