Banks warned about rate hit on gilts portfolio

Vinod Rai, additional secretary (banking), ministry of finance, Government of India, today warned bankers against the hit that they may have to take on the gilts portfolio in case of rise in interest rates.

"If interest rates harden, banks will have a problem in their hands," Rai said on the banks' high exposure to government securities.

Rai was speaking on Profit Pools: Emerging Trends at the 25th Bank Economists' Conference in Mumbai on Friday. He asked banks to be on the lookout for signals on hardening interest rates as it will affect their profits.

He said intermediation costs of banks are high at around 200- 300 basis points, which is equal to the interest rates in some of the developed countries.

He also said that food credit for a large number of banks is an assured profit source and this may disappear.

Rai pointed out that one of the fallouts of the increasing profits of banks was that various industries were asking for hair cuts and wanted interested interest rates of 6 to 7 per cent.

Banks would be affected if this hair cut continues. Canara Bank CMD R V Shastri said once liquidity disappears, interest rates would rise.

"The average exposure of banks to gilts is at around 40 per cent of their total assets. As interest rates rise this will be a cause for concern. However, there will not be a further slide in interest rates," he said.

Interest rates will continue to be soft for the next three to four years and there is enough liquidity in the system, he said.

HDFC Bank managing director Aditya Puri said that banks will have to price products to overcome the loss of float funds on the back of implementation of Real time gross settlement (RTGS).

"Banks have invested in technology. Unless they get to charge customers, RTGS will kill the profitability of banks. Somebody will have to pay for the cost of technology etc. The banking system needs to price it."

RTGS will kick off in January on a standalone basis with full-fledged services to kick off in June. In RTGS banks will be able to get their funds immediately.

According to The Boston Consulting Group vice president and director Janmejaya K Sinha, corporate banking has destroyed a lot of value.

"However, the top banks have been making a lot of money. With the large companies banks will have to focus on fee based income, with the mid-sized companies it will have to be disciplined credit management while for small companies banks will have to look at the cost to serve," he said.

Sinha also added that for public sector banks, larger corporates are loss-making.