Mumbai (Maharashtra) [India], July 1 (ANI): India's banking sector is entering a more constructive phase, with future stock re-rating likely to be driven by improving profitability rather than balance sheet repair, according to a report by Kotak Institutional Equities.

The brokerage said the investment case for banks remains intact despite recent boardroom and management changes at HDFC Bank, Axis Bank and Bandhan Bank, stressing that these developments do not alter the sector's underlying fundamentals, which it believes has entered a more favourable phase.

'We are in a more constructive phase of the cycle, where re-rating is increasingly likely to be driven by improving profitability rather than balance sheet repair,' the report said.

Kotak added that the next leg of sector performance is expected to be supported by improving operating metrics rather than clean-up of legacy stress.

The report expects public sector banks to benefit from stronger pricing discipline, while private lenders could gain from access to cheaper funding sources.

'We expect stronger yield discipline from public banks and support from access to lower-cost funding sources, including FCNR deposits for private banks, leading the investment argument,' it said.

On the asset quality front, the brokerage remained optimistic, noting that risks continue to be contained across key lending segments.

'Asset quality risks remain well contained, supported by healthy retail vintages, resilient corporate balance sheets and a benign MSME credit environment,' the report said.

Kotak also believes current valuations leave room for further upside as earnings improve over the medium term. It continues to prefer large, high-quality private sector lenders such as HDFC Bank and ICICI Bank, while State Bank of India remains its preferred public sector banking pick. (ANI)