Banks confident - can handle 250 bps rate rise

Indian banks are confident that they will be able withstand a possible rise in interest rate by 200-250 basis points.

Bankers believe that they have significant cushion available in their bond portfolios for any shocks arising out of rate reversal.

This is even as the Reserve Bank of India (RBI) has cautioned banks to build up their investment fluctuation reserves to offset any rise in interest rates.

In the last three years, interest rates have fallen by over 600 basis points across all asset classes in line with the global trend.

This resulted in huge gains for the treasury operations of the banking sector.

While part of this gain has been capitalised by banks, a recent report by Motilal Oswal on public sector banks stated that banks can withstand a rate reversal of 200-250 basis point as they have significant cushions available in their bond portfolios.

At the same time, the sector report did not anticipate a rate reversal of such a magnitude.

RBI's concern was also shared by the Indian Banks' Association chief executive H N Sinor, who in a recent bank seminar cautioned banks to take a close look at their investment portfolio lest they be badly hit if interest rates firm up.

In the third quarter of 2003-04, several banks registered profits by reduced their dependency on treasury income with appropriate increase in fee-based activity through the sale of insurance, mutual fund products, guarantees, letters of credit, foreign exchange commission as well as brokerage activities, said a bank analyst with a leading domestic broking house.

In RBI's recent Trend & Progress report (2002-03), the central bank in a preliminary internal exercise (using the gap method to calculate the impact of interest rate changes on banks' net interest income) with reference to banks' asset-liability profile as on March 31, 2003, stated that a two per cent rise in interest rates would have a positive impact of 4.9 per cent on the net interest income of the banking system with public sector banks seeing maximum gain.

At the same time, the RBI report stated that a fall of 200 basis points in interest rates would positively impact the net interest income of new and old private banks.

Net interest income of foreign banks on the other hand, would be least impacted be there a rise or a fall in interest rates.