Select banking PSU stocks were very much in the reckoning today after reports indicated that the government's new formula with respect to return of equity would prove favourable to the concerned banks.

Among the early risers were were Punjab National Bank (PNB) (up 5% to Rs 168), Oriental Bank of Commerce (up 4.6% to Rs 135), Canara Bank (up 4.1% to Rs 112.80), Bank of Baroda (up 3.7% to Rs 113.60) and Corporation Bank (up 3.3% to Rs 163.45).

This is the second successive day that banking stocks have gathered momentum after a free fall in the preceding two sessions. The latter materialised on concerns that the government would charge a premium on returned equity by banks.

Confusion over how the Government of India would price returned equity by state-run banks led to much volatility over the past few sessions. Finance Secretary S. Narayan said on Tuesday that the Centre had not taken any decision on whether banks would have to return equity to the Union Government at a premium or at par.

Banking PSU stocks have been the backbone of a market rally since late November 2002 with the implementation of the Securitisation Act. This was further  given impetus as banks set about making plans to return equity to the government.

A return of equity should result in capital reduction and a surge in financial ratios like return on capital employed (ROCE), return on equity (ROE) and other earnings ratios.

The government is believed to be evolving a formula with respect to return of equity by banks. A number of public sector banks (including Andhra Bank and Bank of India) have returned equity to the Centre in the recent past. Other banks like Punjab National Bank, Bank of Baroda and Syndicate Bank are now planning to return equity to the government.

As per media reports, the Finance Ministry has prepared three alternatives, for consideration by the government, with regard to return of equity - at par or at the price of the IPO (made by the bank earlier) or at historical cost of the equity. The last option is what is currently in parlance with regard to return of equity.

Any of these three options would prove favourable to banks as even the prices at which the banks made IPOs are much below the current ruling market prices and, therefore, the premium involved would not be much, according to analysts.

The market prices of banking shares have risen solidaly of late. Among the major drivers of the rally are the low interest rate regime and improvement in asset quality of banks (with most of them having written off non-performing assets against treasury income).