Diminishing lure for perpetual bonds is likely to prompt Indian state-run banks switch to the equity market for raising funds in coming months, five banking sources told Reuters this week.

Indian banks, including top lender State Bank of India, have raised around 87 billion rupees ($1.05 billion) through perpetual bonds so far this fiscal, just about a quarter of fiscal 2023, with most struggling to raise even the targeted amount at auctions.

"With deposit rates inching higher, banks will have to pay a higher coupon on their debt securities, especially with mutual funds staying away from investing in perpetual debt," a senior official at a large state-run bank said.

Market regulator Securities Exchange Board of India had in March 2021 said that additional Tier 1 bonds would be considered to have a deemed maturity of 100 years, starting April 2023.

"This move has literally ended mutual fund investments in such papers, making fundraising more difficult," a trader with a private bank said.

Demand for these bonds fell further last year, after Credit Suisse wrote off around $17 billion of its additional Tier 1 debt amid its rescue merger with UBS.

"There is a possibility that banks may tap the equity route more for fundraising as valuations will improve further, while getting large quantum with AT-I bonds has become difficult," another banker said.

The sources asked to remain anonymous as they were not authorised to speak to the media.

Last month, state-run lenders Bank of India and Indian Bank raised 45 billion rupees and 40 billion rupees, respectively, via qualified institutional placement (QIP) of shares.

A QIP enables fundraising by offering equity shares to qualified buyers without a public offering.

Union Bank of India had raised 50 billion rupees through a QIP in August.

Last week, Punjab National Bank approved raising aggregate 75 billion rupees via equity.

The Nifty PSU Bank index rallied 32.30% in 2023, outperforming the bank index and financial services index.

"State-run banks have cleaned up their balance sheets well and their valuations are still at a discount," said Vinod Nair, head of research at Geojit Financial Services.

($1 = 83.1650 Indian rupees) (Reporting by Siddhi Nayak and Dharamraj Dhutia; Editing by Swati Bhat and Varun H K)