PSU Bank Stocks Slide as Union Budget 2026 Outlines Record Borrowing

Shares of India's public sector banks (PSBs) faced intense selling pressure on Sunday, February 1, 2026, following the presentation of the Union Budget. The Nifty PSU Bank index tumbled 5.6 percent as investors reacted to a combination of record government borrowing targets and the announcement of a high-level committee to review the banking sector. The sell-off was broad-based, with some individual stocks sliding as much as 8.6 percent during the special Budget day trading session.

Bank of India emerged as the steepest decliner among the major state-run lenders, closing nearly 9 percent lower at 150 rupees per share. Other significant losers included Indian Bank, which fell 8 percent, and Bank of Baroda, which dropped 6.9 percent. The heavy selling reflected market concerns over the government's fiscal roadmap and its immediate implications for bank treasury portfolios.

The Record Borrowing Program and Yield Pressure

The primary trigger for the downturn was the government's market borrowing programme for the 2026-27 financial year. Finance Minister Nirmala Sitharaman announced a gross borrowing target of 17.2 lakh crore rupees. This figure exceeded market expectations, which had generally hovered between 16.3 lakh crore and 16.5 lakh crore rupees. A higher borrowing target typically increases the supply of government securities, putting upward pressure on bond yields.

For public sector banks, rising yields are a significant concern. These institutions hold vast portfolios of government bonds in their treasury books. When yields rise, the market price of these bonds falls, leading to mark-to-market (MTM) losses. Investors aggressively priced in this risk during the Sunday session, even as bond markets remained closed. The impact on treasury income is expected to be a key headwind for PSB profitability in the coming quarters.

Uncertainty Over the Banking Sector Review

Adding to the volatility was the proposal to form a high-level committee for a comprehensive review of the banking sector. The Finance Minister stated that the committee would assess the sector to align it with the 'Viksit Bharat' vision, focusing on financial stability and consumer protection. However, the lack of specific details regarding the committee's mandate created a vacuum of uncertainty.

Market participants interpreted the 'comprehensive review' as a potential precursor to structural changes, such as further consolidation, changes in governance frameworks, or new capital norms. Historically, bank mergers have led to short-term operational drags, and the possibility of a new wave of reforms prompted investors to reduce their exposure to the sector until more clarity emerges.

Comparative Performance of PSU Banks

The following table summarizes the performance of key public sector banks during the Budget day session:

Macroeconomic Targets and Fiscal Consolidation

Despite the sell-off in banking stocks, the government maintained its commitment to fiscal consolidation. The fiscal deficit for the current year was pegged at 4.4 percent of GDP, with a target to reduce it further to 4.3 percent in FY2026-27. The government also projected a GDP growth rate of 7.4 percent for the current financial year, supported by a significant push in capital expenditure.

Capital expenditure was increased to 12.2 lakh crore rupees for the next fiscal year, up from 11.2 lakh crore rupees. While this infrastructure-led growth strategy is expected to support long-term credit demand for banks, the immediate market focus remained on the fiscal deficit and the resulting debt supply. The government aims to bring the debt-to-GDP ratio down to 55.6 percent in FY27, with a long-term goal of reaching 50 percent by FY31.

Impact of STT Hike on Market Sentiment

The broader market sentiment was also dampened by the increase in Securities Transaction Tax (STT) on derivatives. This move, aimed at curbing excessive speculation in the futures and options segment, led to a sharp correction in capital market-linked stocks. As trading costs rise, market participants expect a decline in volumes, which indirectly affects the overall liquidity and sentiment in the equity markets, including the banking sector.

Market Impact

The sharp correction in PSU banks contributed significantly to the wider market downturn, with the Nifty 50 falling below the 25,000 mark. The banking sector's health is often viewed as a proxy for the broader economy, and the sudden shift in sentiment has prompted a reassessment of the risk-reward profile for state-run lenders. The Nifty PSU Bank index had gained over 30 percent in 2025, making it vulnerable to profit-taking once the borrowing figures were announced.

Analysis Section

The reaction to Budget 2026 highlights the sensitivity of PSU banks to interest rate dynamics and fiscal policy. While the operational fundamentals of these banks—such as asset quality and capital adequacy—have improved significantly over the last few years, their treasury books remain a point of vulnerability. The record borrowing target suggests that the era of easy treasury gains may be concluding, shifting the focus back to core lending margins and fee income.

Furthermore, the proposed banking review committee introduces a regulatory overhang. Until the terms of reference for this committee are made public, the sector may continue to trade with a risk discount. Investors are likely to favor larger banks with stronger balance sheets and better technology integration, which are better positioned to navigate potential structural changes.

Conclusion

The Union Budget 2026 has reset expectations for the public sector banking space. While the government's focus on infrastructure and 7.4 percent GDP growth provides a positive backdrop for credit expansion, the immediate challenges of high bond yields and regulatory uncertainty dominate the narrative. Market participants will now look toward the resumption of bond market trading on Monday and further government clarifications regarding the banking review committee to determine the next direction for the sector.