The concern lies in the fundamentals of the banking sector, such as falling spreads due to drop in lending rates, lacklustre loan growth and rising provisioning requirements, said the report.

However the report said that the provisioning requirement for all bad loans will rise with stipulations regarding defaulting Goverment-guaranteed loans and a general loan-loss provision.

The capital adequacy of banks would also work out lower due to the 2.5 per cent risk weightage on Government securities and Centre-guaranteed loans.

Among the banks HSBC has identified State Bank of India, Corporation bank as outperformer, Bank of Baroda and HDFC bank as market performers and Oriental Bank of Commerce as a underperformer.

The report has said thatthe sentiment for the industry has improved as there has been a liquidity flows into the global emerging markets coupled with the run-up in cyclical commodities and stocks.

The economy has improved and the domestic market is also catching up with the Asian peers on valuations, noted the report.

For financial institution, project-finance prospects appear bleak due to policy hitches, overcapacity and low business confidence. Even if the economy were to rebound strongly, project finance would be the last to pick up, felt the report.

Commenting on the different strategy by financial institutions, the report said that ICICI is desperately trying to diversify into retail, to achieve asset grwoth and risk diversifiaction. The retail scene has also been spoilt by banks who are underpricing. On the resources side, complicating the scenario for financial institutions are tax concession granted to mutual fund which might lead to some fund diversion.

There will be squeeze in spreads as banks have have loweredtheir prime lending rate by 100 basis points and financial institutions by 50 basis points, cautions the report.

The traditional commodity sectors will not see too many new projects. So for financial institutions the business grwoth would be sustained by the infrastructure projects, corportae-finance products and retail (for ICICI). The economy does not appear to be deteriortaing any further, and international commodity prices have bottomed out. This might lend a cyclical boost, but the structural problems will continue, concludes the report.

HSBC has said financial institutions will continue to be underweight and HDFC will be outperform the industry while Industrial Development Bank of India and Industrial Finance Corporation of India will be underperformers.