The combination of persistent sluggishness in the Indian economy, banks' soaring non-performing assets (NPAs) and higher cost of funds forced foreign institutional investors (FIIs) to reduce their exposure in banking stocks during the July-September quarter of this year, fresh stats revealed.

The adverse economic conditions prompted FIIs to reduce their holdings in both public and private sector banks.

A total of 18 banks have so far disclosed shareholding pattern for the September quarter, of which 16 banks suffered a decline in shareholding by foreign investors.

FIIs reduced their stake holding in HDFC Bank, Canara Bank, Karnataka Bank, IndusInd Bank, IDBI Bank, Indian Bank and Andhra Bank, in the range of 1 per cent to 6 per cent during the September quarter.

Analysts at Bank of America Merrill Lynch said, "Q2FY14 will be a very different quarter versus last few quarters, with asset quality issues persisting for government banks, but banks also to see elevated margin pressures yoy / qoq due to rise in short-term rates."

In HDFC Bank, the country's largest private-sector lender, FIIs declined their stake holding by around 1 per cent, from 34.49 per cent in the June quarter to 33.61 per cent in the September quarter.

In Karnataka Bank, they reduced their stake by 6.4 per cent, from 22.83 per cent to 16.45 per cent.

Most analysts believe that the performance of Indian banks will likely remain bleak even in the second quarter of next year.