Theoretically speaking, commercial banks can have the best of both worlds. When interest rates fall, they can make money trading government bonds, and when rates are up, money comes from the loan book in the form of higher interest income.

But what happens when interest rates have bottomed out, corporations are still not coming forward to borrow and banks hesitate to trade in bonds because the possibility of prices increasing (and, conversely, yields falling) is bleak?

Prima facie, this is not a happy situation for banks. Since the rates have bottomed out and the bond market is less volatile, their trading profit takes a knock. Besides, they do not earn enough interest income in a low interest rate regime.

Right? Wrong. Even in this situation, Indian banks are making enough money. Sure, the income from trading in government securities has fallen drastically. But this has been compensated by a higher interest income.

In fact, the net interest margin (that is, the interest earned on loan assets minus the interest spent on deposit liabilities) has increased for banks across the board. How has that happened? Banks have cut their deposit rates by a sharper margin compared with the drop in their lending rates.

The findings of a study on the performance of listed commercial banks over the past 12 quarters is startling. It shows a progressive lowering of collective interest income of listed banks, reflecting an overall downward movement of interest rates.

For the quarter ended March 2001 (that is, January to March 2001), the combined interest income of listed banks was Rs 15,622.04 crore (Rs 156.22 billion).

This was 16.11 per cent higher than the interest income of the corresponding quarter of the previous year.

The growth in interest income hovered at 14 to 15 per cent for most of the quarters until the quarter ending June 2003, when it dropped to 3.47 per cent.

In absolute terms, it was Rs 26,463.91 crore (Rs 264.63 billion).

In the July to September 2003 quarter, it dropped further to 1.02 per cent (Rs 27,819.42 crore) and rose marginally by 2.44 per cent in October to December 2003 (Rs 27,597.85 crore).

Despite the progressive drop in interest income, the net interest earnings for these listed banks are on the upswing. For the quarter ended March 2001 (January to March 2001), the net interest earning of listed banks was (Rs 5,407.32 crore).

This was 5.06 per cent higher than the net interest earning of the corresponding quarter the previous year. Since then, the net interest earnings have been sharply on the rise. In the April to June 2002 quarter, growth was 13.20 per cent (Rs 6,963.28 crore).

This growth momentum was sharper in subsequent quarters -- moving to 17.95 per cent in October to December 2002 and 26.66 per cent in January to March 2003. The growth in net interest earnings in the last quarter (October to December 2003) was 24.12 per cent or Rs 11,021.39 crore (Rs 110.91 billion).

How could the net interest earning increase despite a fall in overall interest income? This has happened -- as mentioned earlier -- because banks are driving down their interest expenses (the cost of deposits) fiercely.

Interest expenses, at Rs 12,458.18 crore (Rs 124.58 billion) in January to March 2001, were 21.96 per cent higher than interest expenses recorded in January to March 2000.

Until the last quarter of fiscal year 2003 (January to March 2003), interest expenses were rising.

In percentage terms, the highest growth in interest expenses -- 18.49 per cent -- was recorded in the July to September 2001 quarter and the lowest -- 6.53 per cent -- in the January to March 2003 quarter. Since then, there has been a progressive fall in interest expenses.

In the first quarter of this fiscal year (April to June 2003), interest expenses dropped by 3.93 per cent. The fall in the second quarter was 5.76 per cent and in the third, 7.84 per cent.

In absolute terms, the interest expenses in April to June 2003 were Rs 17,759.32 crore (Rs 177.593 billion), down from Rs 18,486.30 crore (Rs 184.863 billion) in the same period the previous year.

Similarly, in July to September 2003, interest expenses were Rs 17,794.48 crore (Rs 177.944 billion) (Rs 18,882.90 crore (Rs 188.829 billion) the previous year).

In October to December 2003, the fall was sharper at Rs 17,250.21 crore (Rs 172.502 billion) in 2002).

The interesting point to note is that until July to September 2003, interest expenses were falling on a year-on-year basis (that is, comparing one quarter with the corresponding quarter of the previous year).

But in September to December 2003, the expenses fell even on a quarter-on-quarter basis. This shows the aggression with which the banks are cutting down their deposit rates.

The decline in banks' trading profit is reflected in the downward trend of the other income of listed banks. So far, banks have managed to increase other income despite the lower volume of bond trading, but the growth is slowing down distinctly because the rates are bottoming out.

The study shows that in January to March 2001, listed banks' other income increased by a meagre 2.90 per cent but as the rates started dropping sharply, listed banks' other income kitty swelled.

The growth in other income was as high as 76.80 per cent in the July to September 2002 quarter and 55.79 per cent in the April to June 2003 quarter. Since then, the growth rate has slowed down.

In July to September 2003, the growth rate was 28.07 per cent and in October to December 2003 it was only 10.23 per cent.

On a quarter-on-quarter basis too, other income dropped in the third quarter of 2003: from Rs 6,619.46 crore (Rs 66.194 billion) to Rs 4,307.81 crore (Rs 43.078 billion).

With tell-tale signs of rates increasing, the other income may actually start falling over the next few quarters.

Now, let's take a look at some individual banks. A study of the performance of 36 listed banks in the first three quarters of fiscal year 2004 vis-à-vis the first three quarter of fiscal year 2003 shows that gross interest earnings of eight banks have dropped (among the listed banks, Uco Bank has not been considered for the study because it entered the market this year).

In contrast, 28 of the 36 listed banks have shown a fall in interest expenses. The net result of this? Only one of the 36 banks has shown decline in net interest earnings (United Western Bank).

The overall net interest earnings went up by 20 per cent for the group but some of the banks have shown a mind-boggling rise.

Karur Vysya Bank tops the list with 91.76 per cent rise (from Rs 1,191 crore (Rs 11.91 billion) in nine months of fiscal year 2003 to Rs 2,285 crore (Rs 22.85 billion) in nine months of 2004), followed by UTI Bank 85.28 per cent, HDFC Bank (68.29 per cent), Kotak Mahindra Bank (66.45 per cent) and IDBI Bank (61.67 per cent).

State Bank's net interest income went up by 9.53 per cent and that of ICICI Bank by 37.07 per cent.

Overall, the net profit of these 36 listed banks in nine months of fiscal year 2004 went up by 35.46 per cent with the exception of Centurion Bank, which witnessed a 150.62 per cent drop in net profit.

Other income (which includes treasury profits) rose by 33.53 per cent in this period. HDFC Bank, Karur Vysya, ICICI Bank and Dhanalaxmi Banks are four listed entities that have actually shown a decline in other income while the rest has shown an increase.

What conclusion can one draw from all these numbers? The low interest rates regime is benefiting both banks as well as corporations in different ways. Corporations are boosting their bottomlines by saving their interest cost.

In fiscal year 2003 alone, India Inc saved Rs 5,183 crore (Rs 51.83 billion) in interest costs; interest cost savings accounted for 14.5 per cent of the net profit of these companies. The advantage to banks has already been explained.

The only loser in the entire game of low interest rates is the saving community. Savers are earning much less on their financial savings today compared to three years ago. Even the highest deposit rates offered by some banks do not match the wholesale price index-based inflation rates today.

A casualty of this could be consumer spending: typically, Indians tend to save more in a declining interest rate environment so as to maintain the rate of return. This explains why there has been no impact on deposit growth.

In the consumer market, the domestic appliance industry showed a negative growth in 2001 and 2002 before registering 7 per cent growth in 2003. The growth in the white goods sector is also not too impressive.

The personal care segment's business declined by 4.7 per cent in 2002 and 3 per cent in 2003. The first nine months of this year were a little different because banks started aggressively wooing consumers with low interest loans.

Things can look up further if they get decent returns on their savings. Both banks and corporations are feeling good in the low interest rate regime but it's a feel-worse factor that has been killing the saving community.