Renewed hopes of monetary easing by the Reserve Bank of India (RBI), combined with the growing pace of reforms and improvement in banks? asset quality, saw foreign institutional investors (FIIs) raise their stake in the banks and financial services sector during the first three months of 2013.

Overseas fund managers sequentially increased their stake in 10 banks and two non-banking finance companies (NBFCs) in the quarter ended March 2013. That accounts for more than 70% of the 17 banks and NBFCs within the BSE 100 index that have announced their latest shareholding, according to data collated from Capitaline.

More importantly, FIIs continued to increase their stake in all private sector banks. Federal Bank saw the biggest gain (2.39 percentage points) in FII shareholding during January-March, followed by Kotak Mahindra Bank (1.73 percentage points), IndusInd Bank (1.44 percentage points) and Axis Bank (1.38 percentage points).

Among NBFCs, housing finance company HDFC and financial services major IDFC saw an increase in FII holding of 0.5 percentage points and 0.07 percentage points, respectively. Overall, FII shareholding in the banking and financial services space within the BSE 100 universe grew an average 0.36 percentage points in the March quarter. Macquarie Equity Research had called a ?bottom? on the banking sector and upgraded the sector to neutral. ?After years of pessimism, it?s time to call the bottom for the sector as incremental stressed asset formation will slow down. Better liquidity, falling interest rates and recovery in the economy (albeit at a slow pace) give us confidence that NPLs (non-performing loans) will peak out in a couple of quarters and FY14 is likely to be a better year,? said analysts Suresh Ganapathy and Parag Jariwala.

All in all, FIIs increased their stake in 46 out of 70 companies that have so far announced their March shareholding, Capitaline data show. In addition to banks and financial services, FIIs were bullish on consumer staples and pharmaceuticals. As per exchange data, overseas fund managers had pumped in a record $10 billion in Indian equities during the quarter.

Moreover, FIIs aggressively increased their stake in oil refinery companies as fuel reforms by the government got overseas fund managers excited. Many foreign institutions upgraded oil & gas companies on expectations of 20-50% increase in industry profits, and a 40-60 bps drop in India?s fiscal deficit. FIIs increased their stake in HPCL by 2.44 percentage points, 0.53 percentage points in Indian Oil and 0.32 percentage points in BPCL during the March quarter.

The government announced a string of reforms ? moving towards fully market-determined pricing of diesel, gas price hike, and limit on the number of subsidized LPG cylinders per household ? after its share of fuel subsidies rose from 0.2% of the gross domestic product (GDP) in FY10 to a record 0.93% in FY13. ?We believe the government is committed to fuel price reforms as it has likely noted the risks from a possible credit rating downgrade,? said Morgan Stanley analysts Vinay Jaising and Rakesh Sethia in the February 5 research note.

While FIIs remained optimistic on Indian equities, domestic institutional investors (DIIs), such as insurance companies and mutual funds, took a contrarian call on banks, refinery and pharmaceuticals sectors. Insurance companies cut their stake by an average 0.28 percentage points in banks and NBFCs, 0.47 percentage points in refineries and 0.75 percentage points in pharmaceutical companies. In addition, domestic institutions also decreased their stake in sectors like IT services, FMCG and power generation & distribution companies.