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Banks alerted to gilt rate swings

Mumbai, Nov. 17: The Reserve Bank of India (RBI) today alerted banks against the possibility of an interest rate risk on the massive pile of government securities they hold above statutory requirements. They have been asked to make provisions and build up reserves to fortify themselves against the pitfalls on this count.

In its Trend and Progress of Banking in India, 2002-03, the central bank said the macro-economic performance of the banking system in the long run would hinge on its ability to fund industrial and other enterprises.

Pointing out that efficiency in Indian banking has improved after reforms, the report brought into focus the rigidities that emanate from low productivity and overhang of non-performing assets (NPAs) of the past. These, it said, continue to impede flexibility in lending rates.

The central bank wants banks to enhance productivity, stressing that to move to a more efficient, productive and competitive set-up, local banks would need to grapple with challenges of transformation in a number of areas. These include corporate governance, economic value added and technology upgradation.

The report projected that the future profitablity of nationalised banks will depend on their ability to generate greater non-interest income and control operating expenses.

But a key remark pertained to the possibility of an interest rate risk. Even as much of the recent increase in banks’ profits emanates from trading income, the RBI warned that banks’ excess investment in such securities exposes them to risks related to repricing yields.

“The RBI has been emphasising that high profitability emerging from gilt trading should not lull banks into a state of complacency. There is a need to recognise the potential interest rate risks,” the report states.

The report also said a preliminary exercise within the RBI to calculate the impact of interest rate changes on banks’ net interest income showed that banks is likely to have a positive impact of 4.9 per cent on NII if there is a rise in interest rates by 200 basis points. Among the bank groups, the positive impact of such a rise would be largest in case of public sector bank group.

While private sector banks would benefit in a falling interest rate regime, foreign banks would face the least impact on their NII in a rising or falling interest rate regime.

On efficiency in the Indian banking system, the report highlights improvement between 1992 and 2003, though it says pace of these changes has not been high enough.

An analysis here revealed that public sector banks and private sector banks in India did not differ significantly in terms of their efficiency measures while foreign banks recorded higher efficiency as compared with their Indian counterparts. “While sustaining the current trends in efficiency, there remains scope for banks to expand their asset base relative to their input usage by adapting innovations in production technology,” the report opined.

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