Check out this great article I found on the future of interest rates:
Fall in treasury gains due to rise in interest rates may lead to tough times; tighter liquidity can’t be ruled out.
Mumbai: Large private banks have posted healthy profits for the three months to 31 March, but their public sector peers reported mixed results, indicating, say analysts, that times could turn tough as interest rates rise amid limited upside to credit growth.
The country’s largest private sector lender, ICICI Bank Ltd, posted a 35% year-on-year increase in net profit to Rs1,006 crore for the quarter. HDFC Bank Ltd and Axis Bank Ltd saw net profit rise by 32.6% and 31.5% for the quarter, respectively.
Profit jumped on the back of growth in loans and income from the sale of retail and treasury products as well as measures to cut costs.
Among public sector banks, Bank of Baroda, Mangalore-based Corporation Bank and Hyderabad-based Andhra Bank clocked profit growth of about 20% each. Delhi-based Oriental Bank of Commerce’s net profit growth was a much higher 60%.
But Canara Bank, India’s sixth largest lender, saw profit dropping by 30%. Allahabad Bank’s profit fell by 15% and that of Indian Overseas Bank by 60%.
In all cases, banks booked higher provisions partly due to increasing stress in restructured assets and also because of a Reserve Bank of India (RBI) norm requiring provision coverage of 70% of banks’ bad debts. Treasury income in all cases was muted owing to the hardening of bond yields.
The future may not be all that promising in terms of profitability as treasury gains are expected to decline with a rise in interest rates, analysts said.
When rates go up, the bond holdings of banks depreciate and they need to make good the shortfall by making provisions. Under banking norms, they are required to invest 25% of their deposits in government bonds.
“Despite buoyant loan demand, overall outperformance looks unlikely” as rates are rising due to macro pressures and not loan growth, said a recent research report by Citigroup Global Markets Inc.
Citigroup expects a 2.75 percentage point hike in policy rates over two years.
“Typically, banks’ underperformance has come during periods of rising interest rates due to macro factors and not so much due to an increase in credit growth,” it said.
Keefe, Bruyette and Woods Inc., a financial services specialist, said in another report that the risk to the Indian banking sector includes higher-than-expected inflation and bond yields.
“We estimate earnings would decline by an average of 8% were the bond yield to increase to 9%. We believe State Bank of India (SBI) is most exposed to this risk, due to the relatively long-term duration of its bond portfolio. HDFC Bank, with a small fixed-income portfolio, is the least exposed to bond losses,” said the report.
According to the report, SBI, the country’s largest bank, has the longest duration bond portfolio. This puts SBI more at risk from a spike in bond yields than its peers. “We estimate that a spike in the benchmark 10-year bond yield to 9% could take about 17% off the bank’s earnings,” it said.
The yield on the benchmark 10-year bond is now around 8.07%. SBI will announce fourth-quarter earnings on 14 May.
Credit growth expanded steadily during the second half of the last fiscal from its intra-year low of 10.3% in October to 16.9% by March, signalling economic revival and growing corporate confidence in fresh investment for capacity expansion. RBI has pegged credit and deposit growth at 20% and 18%, respectively.
In its annual monetary policy, RBI pegged the growth forecast for 2010-11 at 8% with an upward bias and increased key policy rates by 0.25 percentage point to tame inflationary expectations, sustain economic growth momentum and accommodate the government’s borrowing plan.
Citigroup said in its report that short-term liquidity in the banking system has been declining steadily over the last couple of years and is currently the lowest in six years.
“With Reserve Bank of India continuing to drain liquidity in the form of higher reserve requirements, risks to a tighter liquidity environment cannot be ruled out, especially if credit growth rises to a stronger pace,” added the report.
Aditi Thapliyal, banking analyst at UK-based investment banking firm Execution Noble and Co. Ltd, said the incremental credit pick-up was still modest, so banks would be reluctant to hike rates in a hurry. This could have an impact on the net interest margin, she said.
-David Baker
http://SayHalo.com