Bond yields have dropped by 20-30 basis points after the central bank cut the key bank rate to eight percent from nine and the repo rate to six percent from eight on March 1. It also cut banks cash reserve ratio (CRR) to 10.5 percent from 11.

Yields on the benchmark 10-year bond, the 12.25 per cent 2008 stock, have dropped to around 12.02 per cent from 12.22 on March 1. At the shorter end, the yield on the 11.55 per cent 2001 has dropped to 11.19 per cent from 11.42.

Shares of banking firms have soared since the rate cuts on expectations of improved profits. Shares in the country's largest commercial bank, State Bank of India (SBI), have leapt 39 per cent since the March 1 rate cut to Rs 222 by mid-morning on Wednesday. The Bombay exchange's benchmark index rose 16 percent in the same period.

"Banks can writeback earlier provisions as year-end valuation yields will be lower this year," R. Balakrishnan, general manager at Corporation Bank told Reuters.

Banks have to provide for depreciation in the market values of their investments when yields rise. But when yields fall, the market value of investments rises and results in lower or nil depreciation or a write back of provisions made earlier.

In 1997-98 (April-March), write backs contributed Rs 6.28 billion to SBI's net profit of 18.61 billion. Analysts say SBI could benefit by nearly Rs 1 billion this year from write backs but the bigger gain would come from not having to provide depreciation.

SBI provided Rs 1.8 billion towards depreciation during the first nine months of the current fiscal year, and had estimated full year depreciation provisions at Rs 2.5 billion.

"The upside this year is that banks will not have to provide depreciation at all. The year-end yield curve may not be significantly different from last year," said debt analyst at ICICISecurities and Finance Co Ltd (I-Sec) MR Madhavan.

The Reserve Bank of India (RBI), which sets yields for banks to value their investment portfolios, fixed the 10-year yield at 12.15 per cent for year-end valuations last year.

"This year, the 10-year yield to maturity may be between 12.05-12.10 percent," Balakrishnan said. I-Sec had estimated depreciation losses at around Rs 8 billion in a report released before the rate cuts.

"It will not be like last year when banks had huge writebacks," an analyst with a foreign brokerage said. But analysts warned that while the near term outlook appeared favourable to banks, a drop in banks' lending rates would put pressures on next year's margins.

"It means more problems next year as their spreads fall. Their operating profits will be affected next year," said Sanjay Jain, banking analyst with HSBC Securities.

Analysts say banks would be hampered by constraints in reducing deposit rates in their efforts to maintain spreads. The Government in its 1999-2000budget exempted equity mutual funds from dividend tax which analysts say could lead to a flight of deposits from banks to mutual funds.