Mood also remained positive on expectations that EPFO will start investing in the equity market this week, brokers said.

"Banking stocks led the rally on the benchmark indices on hopes of a rate cut by the RBI in the policy tomorrow. Strong rupee and continued fall in crude prices lifted the sentiment," said Gaurav Jain, Director at Hem Securities.

Weak Asian cues tried to spoil the party, but sentiment remained positive due to rally in banking stocks on government's move to infuse capital into state owned banks.

The BSE banking index spurted by 0.99 per cent. Continuing its upward journey for the fourth straight day, the 30-share BSE barometer rose 72.50 points to close at over one-week high of 28,187.06.

Intra-day, it shuttled between 28,263.35 and 28,071.37. The gauge has gained 727.83 points in four days.

The 50-share NSE Nifty settled higher by 10.20 points or 0.12 per cent at 8,543.05. During the session, it moved between 8,563.95 and 8,508.10.

Even as the Reserve Bank is expected to keep policy rates unchanged at its review tomorrow, some investors remain hopeful that the fall in oil prices and slowing core sector growth may lead to a surprise cut.

Moreover, a healthy sales growth in July posted by major car makers, including Maruti Suzuki and Tata Motors, coupled with better earnings by some blue-chips, came as a positive.

Maruti Suzuki climbed 2.29 per cent after the company said its domestic sales rose 22.5 per cent last month to 1,10,405 units as against 90,093 in July last year while Tata Motors surged 0.99 per cent after it reported 1.32 per cent increase in total sales in July.

Asian markets closed lower after China manufacturing activity dropped to a two-year low in July, while the European markets were down in their early trade. 

Markets in France and Germany were up 0.2 per cent to 0.35 per cent while the UK's FTSE was off 0.13 per cent.

In Greece, the Athex Composite index tumbled after trading on the Greece stock market resumed today after a five-week shutdown. The Athex Composite was trading down by 18.5 per cent at 649.38 points.

Asian stocks ended lower amid signs of a deepening slowdown in China's economy, the world's second-largest economy. Key benchmark indices in China, Hong Kong, Japan, Singapore, South Korea and Taiwan fell by 0.18 per cent to 1.11 per cent.

Pramit Brahmbhatt, Veracity Group CEO said: "Indices gained mainly with the help of the blue-chip cos, which looked attractive after a recent fall. FIIs also looked confident and were the net buyers of shares worth over Rs 2,298 crore in last month. Though for the day the local markets were seen cautious ahead of the RBI credit policy due for tomorrow which would show the road ahead to the investors."

Out of 30-share Sensex pack, 18 stocks ended higher. Major gainers were SBI (3.94 pc), ICICI bank (3.40 pc), Maruti (2.29 pc), Dr Reddy's (2 pc), BHEL (1.58 pc), ITC (1.56 pc), Tata Motors (0.99 pc) and Sun Pharma (0.95 pc).

However, Vedanta fell 2.50 per cent, M&M 2.04 per cent, Coal India 1.96 per cent, Lupin 1.93 per cent, HDFC Bank 1.49 per cent, HDFC 1.29 per cent and HUL 1.24 per cent.

Among the BSE sectoral indices, Consumer Durable rose by 1.37 per cent, followed bankex 0.99 per cent, auto 0.73 per cent and power 0.73 per cent, while metal fell by 1.08 per cent and IT 0.53 per cent.

The market breadth remained positive as 1,797 stocks ended higher, 1,129 close lower while 107 ruled steady. Total turnover moved down to Rs 3,727.57 crore from Rs 3,927.59 crore on Friday.