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India Ratings in its latest report has said banks are unlikely to take a big hit on profitability this quarter due to rising bond yields, which may eat up 5.3 per cent (Rs 11,790 crore) of their net income in the worst-case scenario. It stated in the worst-case scenario, banks may see a profit erosion of 2.6 per cent of their pre-provisioning operating profit and 5.3 per cent of their post-tax profit from treasury losses in Q1.

It mentioned during the first quarter, the bond yields rose 61 bps, peaking at 7.5 per cent. This is because a 100 bps year-on-year upward shift in the yield curve can impact the system-wide pre-provisioning operating profit by 4.5 per cent and return on assets by just 9 bps. It said banks will continue to face headwinds in the current upward interest rate cycle. But it argued that the impact is likely to be lower than the past cycles because banks can utilise their investment fluctuation reserve, reclassify their trading portfolio between the held-to-maturity (HTM) and available for sale (AFS) and also further calibrate the modified duration of AFS portfolios.

Further, it argued that banks will gain from lower pension costs, higher interest income from bond purchases with higher yields, and resetting of interest rates on floating rate bonds (although in limited quantum), offsetting the treasury losses. With an expected overall improvement in the profitability of banks in FY23 and select banks already providing for higher movement in yields (up to 7.5 per cent), according to it, the impact on return on assets can be as low as 9 bps if none of the aforementioned offsets is in place.