Major private sector banks such as HDFC Bank, ICICI, Yes Bank have reported their numbers for the first quarter of FY 16. Their bottom line was mainly boosted by higher other income. Other income mainly compromise of treasury income and fee income. Treasury income is the returns a banking company earns by investing their surplus funds in government bond. For instance HDFC Bank, Yes Bank, Axis Bank's other income grew by 33%, 31.8%, 36% respectively as compared to the corresponding quarter last year led by treasury gains. There is an inverse relation between the bond prices and the bank rates.
The prices of bonds which banks had bought when interest rates were high will rise. As the government securities are shown in the book of accounts at current market value i.e mark to market their profit would increase. In spite of reducing the lending rate by 15-30 bps the companies posted a healthy Net Interest Margin (NIM). The main reason behind it was that the lenders had started reducing the deposit rates some time before they started reducing the lending rates.
Yet another factor that is worring is that the higher other income is helping the bank cover up the higher provision costs. It is encouraging that the banks and RBI are together taking precautionary measures to stop the piling up of bad loans. However, with sectors like telecom, infrastructure and power far from recovery, banks will continue to feel the stress on asset quality.
As and when the growth in other income dwindles, banks have to provide for bad loans will feel the pressure on profits. Investors should therefore be very cautious about selecting entities with a track record of good credit history.