Twelve of the 16 listed public sector bank stocks hit their all-time highs on the bourses this month. With the exception of Bank of Maharashtra [Get Quote], prices of all bank stocks in this pack have zoomed over the last one year.

Between mid-March last year and now, the Allahabad Bank [Get Quote] stock appreciated by over 250 per cent, that of Union Bank by over 160 per cent, and Andhra Bank's [Get Quote] by over 140 per cent.

Another six banks' stock prices went up between 52 per cent and 86 per cent.

Almost all these banks are being wooed by the foreign institutional investors. FII holdings have touched the maximum permissible limit of 20 per cent in at least two banks -- Bank of Baroda [Get Quote] and Punjab National Bank [Get Quote].

In another half-a-dozen banks, the foreign holding is around 15 per cent or more. These are Union Bank, Oriental Bank of Commerce [Get Quote], Canara Bank [Get Quote], Corporation Bank [Get Quote], Vijaya Bank [Get Quote] and Andhra Bank.

The combination of global depository receipts holders and FIIs have all along been holding close to 20 per cent in SBI [Get Quote]. In another two banks, Bank of India and Indian Overseas Bank [Get Quote], the foreign holding is hovering at around 10 per cent.

The rise of stock market prices and foreign stakes in Indian public sector banks is spectacular by any standard. Only a month back people were ready to write off the industry and with good reason.

Nine in the pack of 16 listed PSBs posted drop in net profits in the October-December 2004 quarter, and another two actually posted net losses. The net loss of Bank of Maharashtra was Rs 57.33 crore {Rs 573 million (against a net profit of Rs 53.14 crore (Rs 531 million) in the corresponding quarter of last fiscal year)} and that of Syndicate Bank [Get Quote] Rs 78.11 crore {Rs 781 million (against Rs 89 crore)}.

The drop in net profit for six banks was quite sharp -- between 50 per cent and 77 per cent. This was largely on account of a sharp erosion in their treasury income.

With the rise in interest rates, the party on the bond street was over and these banks started to feel the heat. Eleven of the 16 banks saw their treasury incomes being eroded by a huge margin.

For instance, Corporation Bank recorded a 52 per cent drop in its treasury income while Allahabad Bank, Canara Bank, Bank of India, Dena and Vijaya Bank posted a drop of over 25 per cent.

So, what happened between January and now that has led to a re-rating of PSBs? The most important trigger is possibly the Reserve Bank of India guidelines on private banks ownership and foreign banks' role on Indian turf, released hours after the presentation of the Union Budget by Finance Minister P Chidambaram.

Prima facie, the guidelines had nothing to do with the public-sector banking industry and yet, the maximum impact has been felt on this segment.

How? The banking sector regulator has said that foreign banks will not be allowed to gobble up a private Indian bank [Get Quote] till at least March 2009.

Ideally, this announcement should be lapped up by the private banks. So why is the market cheering the PSBs. That's because for at least the next four years, there will not be any competition for the PSBs! The Citis, HSBCs and Stancharts of the world will not breathe down the neck of the home-grown SBIs, PNBs and Canaras.

In other words, the PSBs can continue to enjoy accounting for 75 per cent of the total assets of the banking sector, 82 per cent of the deposits, and 88 per cent of the branch network.

When the economy is growing at a pace of 7 per cent and more, the biggest beneficiary of the growth will be these banks. Anyone who wants to bet on Indian economy has no choice but to bet on the public sector banks.

Naturally, when an FII finds his entry blocked in SBI because of the regulations on foreign holding, the entity picks up stocks of other PSU banks.

This play will continue till most PSBs reach the permissible 20 per cent limit for the FIIs.

There are other reasons, too, for the euphoria over the PSBs. In the third quarter of the current fiscal year, the interest rate outlook was quite bleak and the widespread perception was that rising rates will knock the bottoms out of the banks.

It has changed since then. The yield on the benchmark 10-year government paper that climbed to 7.30 per cent in October last year, has subsequently come down to 6.60 per cent.

The pace at which the rates were expected to go up has slackened, giving much relief to the banks.

Between June 2004 and now, the US Federal Reserve has raised its base rate from 1 per cent to 2.5 per cent through six hikes of a quarter percentage point each.

During the comparable period, the Indian Central bank hiked the short-term repurchase (repo) rate by a quarter percentage point to 4.75 per cent.

The Reserve Bank of India Governor Y V Reddy has made it clear that the interest rate trajectory in India may not necessarily follow the US way and it will be determined more by domestic compulsions and less by the international trend.

This means that banks' bond portfolios are relatively safe at this juncture.

Besides, most of the PSU banks have already shifted bulk of their SLR holdings into the held-to-maturity category and thereby insulated part of the investment portfolio from the impact of rising rates.

Banks are required to mark to market those bonds that are available for sale and available for trading (AFS). However, there is no mark to market requirement for the bonds held under the HTM segment.

So, the fears of being terribly hurt by the rising rates are misplaced at this point. To complement this, the credit offtake of the banking industry has broken all records.

Large PSBs will reap the maximum benefit on this count as their interest income will swell.

In this context, agriculture loans -- which has been the bane of public sector banking industry -- has overnight turned into a boon. While loans to a triple-A rated corporations only fetch 6 to 6.5 per cent, the yield on farm loans are anywhere between 10 and 12 per cent.

In an inverse way, farmers and small and medium enterprises are subsidising the big companies since whatever "losses" banks are making by lending to top-rated companies are more than compensated by high interest rates paid by this segment.

So, nobody is complaining about the finance ministry's directive on agricultural lendings. Given a choice, they would lend more and more funds to this sector.

This is one segment where there is no competition. Foreign and private banks are fighting it out with the PSBs on the retail loan turf in metros, but they cannot do so in agriculture loans since they do not have the distribution network in rural India.

Finally, the net non-performing assets of these banks are coming down substantially. Over the past few years, PSBs took advantage of the downward movement of interest rates, made money on bond trading and used the income to provide for their NPAs.

The net result? Thirteen of the 16 listed PSBs had less than 3 per cent net NPAs in December 2004. Seven of them had their net NPAs less than 2 per cent.