The investment bank, in a report on March 10, said it expects a re-rating across the sector as the bad-loan cycle could be "close to the end" if the economy remains stable.
Morgan Stanley forecasts an improving economy, as indicated by a narrowing current account deficit and a stable currency, while also noting that liquidity has improved and real deposit rates have turned positive.
Expectations for an improving economy and a pause in the RBI's rate-hiking campaign have sparked a rally in the sector. After falling 10% in January, NSE bank sub-index has surged 5.2% in February and 11.7% so far in March.
The Sensex briefly hits a record high on the back of continued strong foreign buying in blue chips such as HDFC Bank, but edges lower soon afterwards on profit-taking and because of falls in regional shares.