Rate volatility may hit bank profits, says Fitch

The recent volatility in interest rates, which have resulted in a reduction in Indian banks' trading profits, may further hurt their earnings and profits, said Fitch Ratings on Thursday.

However, the interest rate volatility is unlikely to impair the capital base of the banks, the rating agency said.

The mark-to-market provisions due to the rise in market rates have substantially eroded the unrealised gains on the banks' government securities portfolio.

There is a possibility of the rates rising further and turning the unrealised gains into losses, Fitch said in a report on "Market risk for Indian banks: profits under pressure but capital should stay intact".

The increase in interest rates has highlighted the inherent market risk that exists in the balance sheet of Indian banks, but Fitch feels interest rates will likely rise gradually, rather than in sudden violent surges.

The incidence of market risk has again brought attention to the relatively low level of capitalisation of most Indian banks.

In view of the increased regulatory capital allocation for market risk in future, Indian banks' capital base would appear even less satisfactory, although most banks are exploring various options to boost their capital position, Fitch said.

The focus on market risk has also drawn attention to the quality of earnings of Indian banks, even as they seek to replace their depleted trading profits with lending-related and non-interest income.

The report said banks will need to more actively manage their investment portfolio through better risk measurement and monitoring systems.

At some stage of the cycle, the rising interest rates should reflect in higher net interest margins. Until then, profits of most Indian banks will likely be under pressure.