Rate reversal will hit 'gilty' banks, says The Asian Banker

The Indian banking sector could be hit hard in case of a rate reversal on account of over investment in government securities.

The Asian Banker, in its research to determine the best retail banks in the region, has pointed that banks in India tend to over invest in government securities, believing that interest rates will continue to fall, an unexpected rise in interest rates will lead to substantial depreciation charges.

US short term rates are expected to rise by around 1.5 per cent over the next 12 months.

Since, India's three-months inter-bank rate has a 75 per cent correlation with US short term rates, a future increase in Indian interest rates seems entirely possible, said Michael Araneta, senior research analyst of The Asian Banker.

The possible reversal of trends in interest rates may put a dampener on a potential loans expansion, he added.

Rather than relying on the holdings of government securities, bank in India should diversify their asset portfolio and consider expansions into non-traditional areas of lending and fee-based income, said Araneta.

The Asian Banker also added that Indian banks need to invest considerably in technology to be able to tap fee based potential in the bancassurance business.

With only 39 per cent of the expanding middle class insured, this segment presents a huge potential. But because of antiquated technology, banks in India are hardly tapping this segment said The Asian Banker.

In the last five years retail lending has increased more than three times, from $11.91 billion to $36.88 billion.

This surge in consumer lending couple with banks efforts to generate new sources for fee based income has transformed the Indian banking sector into one of Asia's most dynamic one, said Araneta.

Though there has been a rise in retail lending the consumer credit market in India is underdeveloped said The Asian Banker.