Mumbai: The downward movement of interest rates, windfall gains on account of other income and increased exposure in treasury operations have emerged as major concerns for the Indian banking industry.

Analysts tracking the banking industry say the capital market seems to ignore some of the hard facts of the state of affairs of Indian banking. Credit remains weak with incremental credit during April-August 2003 being negative, which is Rs 20 billion compared to Rs 157 billion during the same period last year, and the gap between long- and short-term deposits has narrowed considerably.

Says First Call India Equity Advisors country head Dr V V L N Sastry: "The increased dependence of banks on treasury operations for their earnings leads one to presume the banks have forgotten their business focus by not concentrating on the long-term growth issues."

Of the total Rs 12,80,600-crore deposits, Sastry says the total bank credit is to the tune of Rs 7,25,400 crore; the remaining money being locked in treasury activities which is to the tune of Rs 5,55,200 crore. "The benefit that banks are getting due to reduced deposit rates are not passed on to the corporate borrowers as there is not much change in the corporate lending rates or there is no revision of corporate lending rates of the borrowings which were taken earlier to the interest rate cut regime."

According to Vinay Kulkarni, a fund manager at UTI Mutual Fund, little growth in credit off-take, higher exposure to treasury operations and cut-throat competition in the housing loans sector continue to remain concerns for the valuations of the public sector bank sector in the short-to-medium term.

The most surprising and worrisome issue is the narrow gap between the long- and short-term deposit rates, giving confusing signals on the very performance of the banks. Though one can argue that the narrow gap is providing an opportunity for these banks to earn more profits, it also gives an indication that these banks are not geared up and are not in a position to service any increase in this gap.

Karvy Securities vice-president Amberesh Baliga says credit operations being the core operations of the banking system from the long-term perspective are not seeing any significant growth, thus making one to wonder how these banks can survive in the long run without any long-term strategies being in place. "The current increased profitability of the banks is due to the treasury earnings. To a certain extent it is fine. But the question is, can these banks depend on these treasury earnings as part of their long-term process by ignoring the credit operations?"

P K Tayal, chairman and managing director, Bank of Rajasthan, has this to say: "It is wrong to believe that interest rates will continue moving southward. The rate trend of WPI [whole price index] inflation is running at over 4.5 per cent with signs of it creeping up to 5 per cent, and one can't expect the short end of the yield curve to have negative real interest rates."

Says R H Sarma, CEO, Indian Institute of Banking and Finance: "With the manufacturing boom set to continue, we should be looking at the beginnings of an investment cycle. Many companies that built capacities in the first half of the 1990s are seeing their surplus capacity squeezed out by growth in demand. To be sure, productivity improvement can raise output without large increases in investment.

"Nevertheless, I expect more than 150 A-1 companies to plan, on an average, something like Rs 250 crore of investment per firm over the next three quarters or Rs 37,500 crore of additional funds requirement. If we add to this the capital needed for infrastructure projects, we could be looking at a hefty growth in investment demand. In such a milieu, I don't expect interest rates to soften and naturally the high income form operations will also come down."