State Bank of India (SBI) and ICICI Bank Ltd, the two largest Indian lenders, are the worst affected in the credit default swaps (CDS) market in March, a situation that will push up the cost of overseas borrowing for these banks.
Spreads on the CDS of ICICI Bank have widened by 277 basis points in March from last July and those of SBI by 194 basis points. The only bank whose CDS has seen wider spread this month is South Korea’s third largest bank, Woori Bank.
Credit analysts say Indian banks are among the underperformers because of the two largest Indian banks’ indirect exposure to subprime assets in the form of investments made by their international subsidiaries.
Though the widening of CDS spreads is not reflective of the inherent health of Indian banks, international investors are viewing this as a fallout of the global subprime problem emanating from troubled mortgage lending in the US.
The widening of spreads on CDS is indicative of rising risk perception of the buyer of such instrument. CDS are the most popular form of a credit derivative, used by financial entities to hedge against default. It works as a bilateral contract between two counterparties who agree to trade the credit risk of a third party. The current outstanding in the CDS market is $50 trillion.
Credit spread or spread is the difference in interest rates (or coupon rates) between government bonds or treasury securities and non-treasury securities that are similar except for their credit rating. Companies usually offer a higher return or coupon rate because their rating is lower than the government’s.
Widening of spreads is indicative of waning investor interest in such bonds.
ICICI Bank has recently reported around $264 million mark-to-market losses on account of its exposure to credit derivatives as well as an erosion in value of investments made by its subsidiaries in the UK and Canada. Marking to market is an accounting practice of valuing securities at their market price and not the cost at which they were bought.
State Bank of India chairman O.P. Bhatt said his bank’s mark-to-market losses are around Rs1 crore. “This is minuscule as our total business is worth around $186 billion,” Bhatt said.
Korean banks have seen the spreads of the CDS widening because of their large reliance on wholesale funding. According to analysts, they rely on borrowing from capital markets instead of retail deposits to lend.
Ananda Bhoumik, senior director at credit ratings agency Fitch Ratings India Pvt. Ltd, said though Indian banks may find other means to raise money overseas, the fact that the cost of raising money has increased “is a reality they cannot escape”.
Still, credit experts do not see any immediate worry for Indian banks as they do not look at the bond market alone when it comes to raising resources.
Vivek Ramakrishna, head of fixed income credit analysis at Standard Chartered Bank India Pvt Ltd, said: “Large Indian banks have already started looking at cheaper pockets of liquidity and tapping the Malaysian ringgit market. Others may just wait and watch till the dust settles.”
SBI has said it is considering raising $200-500 million in bonds denominated in Malaysian ringgits to broaden its resource base, private sector lenders such as ICICI Bank are raising deposits by issuing special deposit schemes for Indian ethnic groups overseas.
International investors such as banks, hedge funds and insurance companies, however, feel investments in Indian banks are now turning riskier compared with their Asian peers.
Other emerging market peers of ICICI Bank and SBI, such as China Export and Import Bank and Maybank of Malaysia have seen their CDS spreads widen by less than 150 basis points.
N.S. Venkatesh, managing director and chief executive officer at IDBI Gilts Ltd, a firm that buys and sells government bonds, however, said Indian banks will not be deterred by widening spreads on CDS. “While international investors are jittery, Indian banks are buying each other’s CDS,” he said.
Under Indian law, an issuer of CDS cannot buy back its own CDS unlike bonds, but they can subscribe to CDS of other banks. Such buying is shown as an investment in a bank book.