BackYear-end rise in bond prices saves banks from booking depreciation
Year-end rise in bond prices saves banks from booking depreciation
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Mumbai: The Reserve Bank of India’s (RBI) aggressive buying of bonds from the market brought down the yield on the benchmark 10-year government paper to 7.01% on Tuesday, the last day of fiscal 2009, sharply down from 7.18% last week.
The Indian central bank also bought bonds on Monday. The demand for bonds push their prices up and yields down as bond prices and yields move in opposite directions.
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With the sharp drop in bond yields and rise in prices in the past two days, commercial banks will be spared from booking huge depreciation in their bond portfolios.
When bond prices drop and yields rise, banks need to book mark-to-market (MTM) losses to take care of the value erosion of their bond portfolio. MTM is an accounting practice of valuing a financial asset by its current price and not the cost at which it was bought.
In the beginning of the last quarter of fiscal 2009, the yield on the 10-year paper was 5.35%. This means the yield on the 10-year government bond has moved 166 basis points in the quarter. One basis point is one-hundredth of a percentage point. The last time when the yields moved sharply, in the first quarter of fiscal 2009, India’s top five banks had booked at least Rs2,000 crore MTM losses even though the yield rose about 80 basis points.
“The spike in bond yields this time was not seen in the last many quarters. The fourth quarter hit in the banks’ portfolio will be significant," said Ravi Sankar, an analyst with Antique Stock Broking Ltd.
Development Credit Bank Ltd’s head of treasury Harihar Krishnamurthy agrees that banks will be hit by MTM losses in the last quarter. “Banks will be affected by the bond movement and MTM losses have to be provided for in this quarter, but nobody knows how much will be the loss because we don’t know at what levels the bonds were bought at and if they have been bought directly at the HTM (held-to-maturity) category," said Krishnamurthy.
Currently, banks’ investments of up to 25% of deposits in government bonds are protected from booking such depreciation if the bonds are kept in the HTM portfolio. The other two portfolios of banks’ bond investment are “available for sale" and “held for trading".
Even though banks are required to invest 24% of their deposits in government bonds, their actual investment is around 28%.
According to analysts and bond dealers, MTM losses of the top five banks could be around Rs3,000 crore in the fourth quarter despite a much sharper drop in bond prices, as most banks have been active in shifting their bond portfolio to the HTM category where they don’t have to book such losses.
Banks are allowed to shift their bonds to HTM category once a year. According to bankers, banks are not taking the risk of keeping their bond portfolio exposed to market risk as oversupply of government papers is pushing bond yields high with every auction that RBI conducts.
The yields on government bonds are unlikely to remain at the current level as the government plans to borrow a record Rs2.41 trillion in the first six months of the next fiscal year beginning 1 April.
The bond market has been volatile for most part of the current fiscal with the yields moving sharply in both directions. For instance, in the beginning of the fiscal, the 10-year yield was veering around 8%; it dropped to a record low of 4.86% in January.
Banks reported heavy profits in the third quarter of the year as the yields dropped and banks rolled back the provisions they had earlier provided for to take care of depreciation in bond value.
“Those banks that wrote back their entire MTM provisions will be badly hit. Those that only partially wrote back their MTM provisions still have cushions left as they don’t have to provide additional amount in the fourth quarter," said Jaiprakash Toshniwal, an analyst with ULJK Securities Ltd.
Graphics by Sandeep Bhatnagar / Mint
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