Rising interest rates to hurt banks' profit: RBI

The Reserve Bank of India (RBI) today cautioned rising interest rate and high cost of funds could hurt the profitability of the banking sector.

"Going ahead, with hardening interest rates and the imminent increase in cost of funds, the credit growth is expected to slow down, which could adversely affect the profitability," the RBI said in Financial Stability Report released today.

The hike in savings account interest rate, amortisations of pension liabilities and potentially enhanced provisioning requirements for NPAs may also impact profitability, it said.

The report noted that banks' profitability improved, buoyed by increased net interest income (NII) though non-interest income remained stagnant.

An increase in NII facilitated growth of around 20% in aggregate net profit of the banking system, even with an almost stagnant non-interest income and increase in risk provisions, it said.

Interest income increased by 18.6% over 7.5% last year and interest expense increased by 10.1% as against 4.0% last year, it said.

There was improvement of 34.9% in the NII of the banks during 2010-11 despite little change in non-interest income, increase of 49% in risk provisions and 24% increase in operating expenses.

The growth in interest income by 18.6% was, however, not in tandem with the growth in loans and advances which grew by 22.6% during 2010-11, it said.

However, it said, the public sector banks registered a lower growth in profits – mainly due to reduction in trading profits, increase in provisions towards staff expenses (including those for pension liabilities) and towards impaired assets.

Under stress conditions based on NPA shocks, it said, the profitability of the banks was seen to be affected significantly though the capital adequacy position appeared to be reasonably resilient.

The study indicates that some banks may face extreme liquidity constraints, under severe stress scenario. Overall, the results of the macro-stress tests using different scenarios, suggested that the banking sector would be able to withstand macroeconomic shocks though the prevailing inflation and interest rate situation is expected to have an adverse effect on the asset quality of banks, it said.