India's public sector banks are expected to continue their strong performance, led by higher margin, sustained loan growth, and improving operating leverage over the next few years, according to brokerage firm Morgan Stanley.

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The firm has raised earnings estimates, valuation multiples and price target for most PSU Banks and highlighted Bank of Baroda and Bank of India as the names with the best relative risk-reward.

“We compare these banks on capital, asset quality, profitability and liquidity. Bank of India and Bank of Baroda offer the best risk reward, followed by SBI (State Bank of India),” their note said.

The global research firm also said that it expected the credit cycle to remain benign and sees credit cost undershooting in the coming years.

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Morgan Stanley said that it was ‘overweight’ on Bank of India and raised its price target to Rs 125 from Rs 95 earlier.

The global investment bank was also ‘overweight’ on Bank of Baroda as well, with a new target price of Rs 220 compared with Rs 195 earlier.

Talking of SBI, Morgan Stanley said the bank had already built these benefits given a better balance sheet and execution over the past two years. Amid a sustained cyclical recovery, it believed that benefits should now percolate to non-SBI state-owned banks.

Also Read: The PSU Bank index is set for its best year since 2014 but still away from its peak

India's largest lender also commands an overweight rating from Morgan Stanley. However, its price target was unchanged at Rs 715.

However, the brokerage is underweight on Canara Bank but raised its price target to Rs 345 from Rs 280 earlier.

The firm cited the lender's high exposure towards the MSME, agri and BBB-and-below rated corporates as the reason behind its underweight stance. Although it called Canara Bank's valuations to be inexpensive, it chose to go with banks with better balance sheets and profitability.

Reacting to the development, shares of most PSU banks are trading with gains on Tuesday. The PSU Bank index is up 1.7 percent and is outperforming the benchmark indices.