Nifty PSU Bank index was the largest gainer among sectoral indices, up 0.7% at 10am. By comparison, the benchmark index, the Nifty 50 was trading 0.1% lower at 8,930 levels.

Given the sharp rally in these stocks over the past few months, analysts now are cautious on the banking space, especially the public sector (PSU) banks.

"We believe PSBs are not out of the woods yet and would continue to face asset quality pressures. Even under bull-case assumptions, PSBs are trading at premium valuations for an unappealing sub-10% return on equity (ROE). We maintain our negative stance," Parag Jariwala and Vikesh Mehta of Religare Institutional Research had said in their September 01 report on the sector.

As regads the banking sector, G Chokkalingam, founder and managing director, Equinomics Research & Advisory advises a stock specific approach given the recent rally. At the current levels, he recommends a buy on Karur Vysya Bank (KVB) and South Indian Bank (SIB).

"We find KVB as the most attractively valued banking stock with impressive asset quality as compared to majority of the banks in India," he says.

Adding: "South Indian Bank (SIB) stock trades at 1.2x current adjusted book value, which is quite cheaper compared to most mid-sized banks. Comparable banks like Lakshmi Vilas Bank trades at 1.9x and City Union Bank trades at 2.8x. Of course, the net NPA of SIB stands at slightly elevated level of 2.89%. Some of the mid-sized PSU banks trade at even 3 to 4 times their adjusted book values. However, we believe that SIB, more than 8-decade old bank, can improve its quality of assets going forward."