Falling bond yields may spare banks from booking depreciation losses

Falling bond yields may spare banks from booking depreciation losses

Mumbai: The sharp fall in bond yields over the past week is good news for Indian banks as they prepare to close their books for the September quarter.

Banks will not only be able to bring down their depreciation losses—which they incur when the market price of the bond they are holding falls below its purchase price—but also in some cases book profits, said analysts and bond dealers.

The yield on the benchmark 10-year paper, which touched almost 7.5% a week ago, is now close to 7% as the market expects the Reserve Bank of India (RBI) to let banks carry more bonds in their held-to-maturity, or HTM, category where they don’t have to provide any depreciation.

“In past two-three days, the RBI governor has said that stimulus measures will not be withdrawn till growth is clearly visible. That has brought in a lot of comfort to the market," said G.A. Tadas, managing director of IDBI Gilts Ltd, a company that trades in government bonds.

“The market is also taking notes of RBI’s displeasure about the spike in yields and are factoring in the probable rise in the HTM category," he said.

Also see Sharp Fall (Graphics)

There are three categories of bonds in a bank’s bond portfolio—HTM, available for sale (AFS) and available for trade (AFT).

While bonds kept under HTM are not affected by volatility in interest rates, banks need to provide for depreciation for bonds kept under the other two categories.

Under current norms, Indian banks are required to invest at least 24% of their deposits in government bonds but up to 25% of their deposits can be kept under HTM category.

Even this does not cover their entire bond portfolio as the average bond holding of the banking sector right now is about 28% of deposits.

This is because of the government’s massive borrowing programme. The government plans to borrow a record Rs4.51 trillion from the market to bridge a fiscal deficit that is estimated at 6.8% of the gross domestic product.

So far, it has borrowed Rs2.72 trillion.

Banks are demanding an increase in the HTM limit by at least 2 percentage points to protect their bond portfolio from the impact of rising rates. If RBI agrees to that, it will cover about Rs81,000 crore worth of bonds.

“The biggest beneficiary of the yield movement will be public sector banks as about 15-20% of their bond portfolio is in AFS and is growing due to the lack of room in the HTM category," said Jaiprakash Toshniwal, a banking analyst with ULJK Securities Pvt. Ltd.

Another banking analyst from Centrum Stock Broking Pvt. Ltd, Saikiran Pulavarthy, said the fall in yields will give “some kind of sanity to the interest rate scenario".

“If you look at the yield curve, it is very steep. The gap between the short-term rates and the long term rates have widened to an almost ten-year high level. If the yields come down a bit, we will get a clear picture as to what is the right short-term and longer term interest rates," said Pulavarthy.

While the yield on the one-year bond is at 3.5%, the yield on longer term bonds, 20 years and above, are now around 7.5%.

While falling yields will protect banks from booking depreciation, it is unlikely that banks will be able to book huge profits as the 10-year bond yield had closed at 7.012% in the last quarter, almost at the same level or even a tad less than what the bond dealers are expecting the yields to close this quarter. The public sector banks bought heavily when the yield was at the 7.45% level and now they are selling the high-yield bonds and booking profits. The trading volume in bond market has risen to Rs20,000 crore on Wednesday, more than three times the volume seen a month ago.

“The fall in yields have come as a good news for us. If the momentum continues, we may not have to recognise any additional provision on our bond portfolio," said S. Rajendran, general manager, treasury and international division, at Union Bank of India. Rajendran does not see a sharp downward movement in yields this month.

According to Tadas of IDBI Gilts Ltd, the bond market is witnessing some tough resistance at 7% level, but if it manages to breach this level, the 10-year benchmark yield could go down to 6.95% before the end of this quarter, helping banks book profits.

But the yields will spike again if RBI is slow in allowing banks to keep more bonds in the HTM category, said bond dealers.