The issue of return of capital can easily lead to large appreciation in values of stocks such as Punjab National Bank, Canara Bank and Bank of Baroda. The stocks of smaller banks — Oriental Bank of Commerce, Union Bank of India, Andhra Bank, Syndicate Bank and Indian Overseas Bank — also stand to benefit. However, the issue of pricing of the capital to be returned to the government is yet unresolved. If the issue is taken to Parliament for consideration, it could be interminably delayed.

A more important factor is the reduction of government equity in banks to 33 per cent. This will remove the control of Parliament over the banks.

That could unleash a wave of consolidation in the banking sector. Many suitors from both abroad and within India are likely to emerge. Of course, obtaining Parliamentary approval for the stake reduction will prove tricky.

However, hope stems from the fact that a Standing Committee of Parliament has approved the reduction in government stake in principle.

If both these factors materialise, the value of banking stocks could rise substantially higher. However, if both these catalysts do not materialise then there will be some downside to the stock price. The downside is unlikely to be uniform. It is more in the case of stocks such as Oriental Bank of Commerce and Punjab National Bank.

In the case of SBI, issues such as return of capital and reduction in government stake to 33 per cent is not applicable. However, if FII holding is excluded from the limit for foreign direct investment in the stock, there could be some upside still left in the stock.

In terms of valuing the stocks based on fundamental strength alone (without considering the impact of the above mentioned catalysts), the stock of State Bank of India stands out. It is four times larger than the second biggest bank in the country and the possibility of merging with its associate banks gives the bank unprecedented reach and potential. Then come the stocks of Punjab National Bank and Canara Bank. Any benefit from the potential growth for Indian banking sector would be better derived from investments in these three stocks. These three stocks need to be considered as the pick of the lot.

As regards IOB and Vijaya Bank, investors can consider entering the stock after the contemplated public offers are over.

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