The net interest margins of Indian banks are expected to shrink in 2011, despite an estimated growth of 20-22 per cent in loans, due to a rise in interest rates and lenders will be forced to raise deposit rates to manage liquidity.

Rating agency Fitch's report on the 'Indian Banks Outlook, 2011' said while banks have the contractual ability to pass on such hikes to borrowers, they may prefer to absorb part of this increase at the cost of NIM margins in the face of competition.

"Further, strong loan growth, together with tight rupee liquidity, is likely to increase the proportion of higher cost wholesale funding, putting further pressure on margins," Fitch Senior Director Ananda Bhoumik said.

"Retail deposits and customer current accounts will, however, remain the dominant funding sources, together accounting for about 65 per cent of total deposits," he added.

However, the impact of lower NIMs in a rising interest rate scenario will be partly balanced by subdued credit costs as non-performing loan accretion from restructured loans subsides, Fitch said.

The report said additional provisions for new pension schemes in government banks may be routed directly through equity or amortised and early estimates suggested the impact on tier 1 capital ratio could be up to 50 basis points.

The long-term outlook of Indian banks is likely to stay stable, the report said.