Rate rises may weigh on banks after strong Q2

Rate rises may weigh on banks after strong Q2

Mumbai: Leading Indian banks are set to report quarterly profit grew by up to a third, helped by robust credit growth and rising fee income, and that rising interest rates pose a challenge.

Demand for loans in Asia’s third-largest economy, which the International Monetary Fund has forecast would expand 9.7% in 2010, is expected to remain strong in the coming quarters.

“The credit growth in the sector will continue to move up in tandem with the economic activity and that will support the profitability of the banks," said K.K. Mital, head of portfolio management services at Globe Capital.

“But interest rate hike concerns will hover over the banks in the near future as inflation continues to remain high."

State Bank of India, the country’s top lender, and rivals ICICI Bank and HDFC Bank are seeing an improvement in asset quality on strong revival in business and consumer confidence in India.

Bank credit in India increased an annual 19% as at end-September, according to the central bank’s data, from a low 9.7% in October last year and compared with 16.7% at end-March.

The central bank sees non-food credit growth of banks at 20% in 2010-11, still a far cry from growth rates of above 30% in the pre-crisis period.

Brokerage Motilal Oswal said strong factory output growth, order backlog of engineering companies, investment on infrastructure projects and increase in demand for consumer finance would boost loan growth in this fiscal year.

Inflation Threat

However, rising interest rates are a concern as they may put the brakes on the rapid loan demand growth, especially from retail borrowers, and thereby weigh on the profitability of banks. India’s banks make the bulk of their profits through pure banking activities.

The central bank has raised key policy rates five times by a total of 125 basis points since mid-March and expectations for another hike have strengthened after the inflation rate rose an annual 8.62% in September, above the central bank’s comfort zone.

A majority of investors expect the Reserve Bank of India to raise rates by a quarter of a percentage point by the end of 2010 to curb inflation expectations, and once more by the end of the fiscal year in March.

Banks such as ICICI and HDFC should report a reduction in bad loans in the September quarter with the pickup in industrial output growth and strong consumer sentiment, analysts said.

The 10-yr benchmark bond yield rose 30 basis points in the quarter, which may result in a drop in treasury gains from a year earlier for banks that are required to hold at least 25 % of their deposits in government securities.

Bond yields move inversely to prices. The year-ago profits of the top banks were boosted by treasury income thanks to 140-basis-point drop in yields.

The Basel III proposals are unlikely to impact the finances of Indian banks compared to their global peers and they will not need recapitalisation, analysts said, while capital strength would return to dominate Q3 European bank results.

Shares of State Bank of India, which the market values at more than $45 billion, are up 41% so far this year and HDFC Bank’s are up 42%. ICICI has risen 28%, while the main market has climbed about 16%.