Banks rush to bonds as credit offtake falls

Banks rush to bonds as credit offtake falls

With a Reserve Bank of India-inspired slowdown in demand for bank credit, India’s commercial banks, flush with deposits, are rushing to buy government bonds.

Through 30 November, these banks have invested close to Rs2 trillion in bonds, the highest ever in the past decade and some nine times more than their investment in such bonds in the year-ago period, which was a mere Rs23,579 crore.

After growing by more than 30% for two consecutive years, bank credit growth has slowed to 22.3%. But since their ability to collect deposits hasn’t slowed, most Indian banks are saddled with huge liquid cash and are now using that money to buy bonds.

“Now that the credit growth is relatively slow and bonds are giving reasonably good returns, banks are finding (the) bond market attractive," says M.D. Mallya, chairman, Bank of Maharashtra .

According to Mallya, banks are also buying bonds to maintain their depleted bond portfolio as they were aggressively liquidating their position in the government securities market in the past few years when demand for bank credit was growing at more than 30% each year.

Under India’s banking law, commercial banks are required to invest 25% of their deposit liabilities in government bonds.

Credit growth within India has slowed sharply as bankers are deliberately going slow in sectors such as retail and consumer loans, home mortgages and loans to real-estate developers.

RBI’s insistence on higher provisioning as well as additional capital requirements at these banks for loans to such sectors makes such loans less profitable for the banks now as their own lending costs have gone up. The central bank did this because it was worried about the rampant growth in loans being taken by such sunrise sectors and the possible overheating of the Indian economy.

“We are not unhappy with the fall in credit growth," said a senior RBI official who does not wish to be quoted.

Banks are also seeing an increase in non-performing loans in some of these categories, a result of their over-aggressiveness to lend in the past. Such troubled loans, as a percentage of advances, are at least 5% in these segments, according to some bankers, although no official figures are available as yet to corroborate this data. This has also led to a voluntary pull back in such loans.

RBI has projected a 24% growth in credit for year ending March. Since the loan portfolio of banks normally swells in the second half of the fiscal year, analysts expect overall credit growth for the year to end up in line with the RBI forecast.

Meanwhile, another reason why banks are rushing to buy bonds, says a bond dealer at a new private bank who didn’t want to be identified, is their anticipation of a rate cut by RBI.

“The market expects a cut in interest rates next year," the bond dealer said. “If that happens, bond prices will go up and yield will go down, attracting more investors. Some of the banks are building their position in the government securities market."

Bond yields and prices move in opposite direction. The yield on the 10-year benchmark, which hit a record low of 4.97% in October 2003, is now at 7.88%. One percentage point cut in three stages between September and now in American interest rates by the US Federal Reserve has not had any real impact on Indian bond yields. However, some government bond dealers are betting that the Indian banking regulator will cut its policy rate next year, bringing down bond yields.

The latest surge in bond buying is a throwback to the period just a few years ago before India’s soaring economy created a renewed appetite for credit, when slowing credit growth led banks to heavily invest in bonds, pushing up their investment in government bonds to more than 40% of their deposit liabilities.

“We are seeing a surge in bond purchases because banks are again building their SLR (statutory liquidity ratio) portfolio as their deposit base is going up," says Arun Kaul, general manager, treasury, at Punjab National Bank.