Banking stocks are the flavour of the market today with the Nifty Bank clutching lifetime high and contributing most to the record gains in Nifty50.

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The rally came following the news reports that the government is mulling over raising the FDI limit for private banks and  public sector banks to 100 per cent and 49 per cent, respectively. 

Currently private banks can have 74 per cent FDI under government approval route and 49 per cent under automatic route. For PSU banks, the limit is capped at 20 per cent.

Reacting to the rumours, The Nifty bank index gained as much as 2.3 per cent to hit a record high of 26,887.65, the fourth time it has done so this week.

The rally in banks was also supported by the government’s decision on Wednesday to trim additional market borrowing by 60 per cent for the ongoing fiscal year ending March.

HDFC Bank rallied as much as 3.4 per cent to touch an all-time high of 1,954 on the NSE. The stock also saw its market capitalisation (market-cap) crossing Rs 5 lakh crore mark, the third firm after Reliance Industries (RIL) and Tata Consultancy Services (TCS) to achieve this milestone.

ICICI Bank and State Bank of India also gained 2.9 per cent and 3.5 per cent, respectively.

"If implemented, this would be a significant positive for the banking sector. While not all stocks are at the foreign limit, this would still imply a significant increase in the banking sector weight in MSCI given higher foreign headroom. One of the key potential beneficiaries could be HDFC Bank, which is restricted for foreign buying currently as foreign ownership (74%) is close to the regulatory limit," said Global brokerage Morgan Stanley in a research note.

Brokerage Edelweiss Securities also noted it would raise the probability of inclusion in MSCI and higher weights for private banks, which were near the FII threshold limit.

The brokerage further said the move could provide access to growth capital. Banks, which are in the process of raising capital, will have an option to go for higher proportion of American depository receipts (ADR) issue, Edelweiss said in a note.

"Allowing entry to foreign banks through inorganic route—will act as acquisition trigger for regionally-focussed banks, though there is a cap in shareholding for a single entity and will not be an easy process," it added.

Meanwhile, experts believe investors should stay cautious for even if the reports are true, the process will be long drawn as it will involve parliamentary nod/approvals and big structural change in bank’s ownership, while banking associations may also oppose the move. 

We would also need to see whether the RBI would be comfortable with the proposal. The RBI had previously rejected such a proposal by the government.