ING (NYSE:ING - news) on Thursday reported a 16 per cent drop in third-quarter profits as the Dutch banking and insurance group grappled with the effects of declining long-term interest rates.

Michel Tilmant, chief executive, acknowledged that the decline in long-term interest rates during the third quarter and the flatter yield curve - which limits the scope to benefit from differences in interest rates - had depressed margins.

However, he insisted that the benign interest rate environment had benefited other ING businesses, and that the group would continue to grow despite the more difficult conditions.

The figures, which were at the low end of analysts' expectations, disappointed investors. Shares in ING, which have risen by more than 35 per cent in the past year, dropped almost 2 per cent to EU34.69 in early morning trading in Amsterdam.

The flatter yield curve particularly affected ING Direct, the group's fast-expanding internet banking division, which reported pre-tax profits of EU175m ($223m), down 11 per cent on the second quarter and slightly below the figure for the same period of 2005.

But Mr Tilmant said ING Direct's results were evidence that its business model could work in even the most difficult circumstances. "A year ago I don't think many observers believed ING Direct would be able to maintain such profitability and performance in this interest rate environment," he said.

ING Direct, which lures savers with offers of high interest rates, is highly sensitive to changes in long-term interest rates. It recently started offering mortgages in the United Kingdom, and is also examining the possibility of launching its service in Japan.

Overall profits were hit by a EU196m swing in the value of derivatives contracts ING has in place to hedge cash flows from its US insurance business and liabilities in its wholesale bank.

Excluding the effects of the sale of a business last year, pre-tax profits in ING's banking division were EU833m in the third quarter, down 9 per cent on the same period of last year.

Meanwhile, ING's insurance business in Europe and Asia continued grow, but profits at its US insurance division fell 10 per cent year-on-year, reflecting an absence of large contracts to provide retirement planning to all the employees of a company.

In the third quarter, pre-tax profits were EU1.57bn, compared with EU1.84bn in the same period of last year, though the 2005 figures were boosted by a EU278m gain on the sale of Deutsche Hypothekenbank, the German mortgage lender. Earnings per share were 73 cents (86 cents).

In the nine months to the end of September, ING reported pre-tax profits of EU7.47bn, up from EU6.74bn in the same period of 2005.