Rising rates won't hurt banks' equity, says RBI

Allaying fears of rising interest rates affecting banks the Reserve Bank of India (RBI) today said the gradually rising interest rates were unlikely to adversely affect the equity of commercial banks due to prospects of improvement in net interest income.

"Though financial media and some academic circles have been portraying an overly alarming and pessimistic picture regarding potential interest rate risk, our analysis reveals that gradually increasing interest rate regime is unlikely to erode banks' equity," said RBI deputy governor V Leeladhar today at Dena Bank's 68th foundation day.

The rapid and relatively substantial rise in rupee interest rates in recent months has brought into focus the market risks faced by Indian banks, said Leeladhar.

"The benchmark 10-year yield on government securities has risen from 5.2 per cent in May last year to around 7.2 per cent at this point. The spike in interest rates has affected the trading profits of banks," he added.

Aided by a good macro economic environment, banks' bottom line has improved significantly over the last three years.

The windfall gains have been treasury profits, fuelled by a secular decline in interest rates during the three years period from 2001 to 2004 and consequent profit booking on sale of government securities, said Leeladhar.

However, from the current year, with the hardening of interest rates, this trading component of profits is no longer going to shore up banks' profitability. Most banks have been required to provide for the decline in the market value of their investment portfolio, he added.

One offsetting factor has been the strong pick up in the credit off-take due to buoyant demand in the economy and revival of industrial activity. This, said Leeladhar, has resulted in substantial increase in banks' core interest income.