The rising cost of funds is likely to hit margins and impact the profitability of the Indian banking sector in 2011, according to a report by global credit ratings agency Fitch.
"Narrowing NIM (net interest margin) in a rising interest rate regime will likely moderate profit growth," the Fitch analysis said, pointing out that profitability of the Indian banks will exhibit "neutral to negative growth" during the year.
The funding profile of the India banks, according to the report, will "deteriorate slightly amid tight liquidity conditions".
Noting that inflationary pressures were likely to persist globally, the report said, "In India, the current tight liquidity scenario in the system is unlikely to ease significantly."
The Reserve Bank's decision to raise key interest rates for the seventh time since March, 2010, has raised the cost of funds for the banking sector.
Moreover, on the back of rising demand for credit, several banks have raised their fixed deposit rates, adding to the cost of funds.
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The report, titled, 'Outlook: Asia Pacific Banks', further said that higher pension provisions could hypothetically be a drag on the profitability of government banks, although the quantum and the accounting treatment are yet to be announced.
It also said the NPL (non-performing loan) ratio could peak around March, 2011, when most of the restructured loans are due for redemption, at which point of time some of them might be found to be non-performing.
"The strong growth environment and the improved corporate credit profile is likely to ease asset quality concerns for a large part of banks' loan portfolio, although a few vulnerable sectors, including commercial real estate and some of the export-oriented sectors, may see a rise in delinquencies," it added.