The benchmark 10-year bond yield touched 9% on Monday at 12.30pm, a level last seen on 25 August 2008.

The banks will have to make good the depreciation in their bond portfolio by setting aside money. In accounting parlance, this is called mark to market (MTM), or valuing a financial asset in accordance with their market value and not the price at which they are bought.

By a Reserve Bank of India (RBI) estimate, a 100 basis points (bps) rise in bond yield on banks bond portfolio is close to 30,000 crore. One basis point is one-hundredth of a percentage point. That was the depreciation loss that was staring at Indian banks at the end of June. At the current level, the yield on the benchmark 10-year paper has risen close to 150 basis points. This means, the impact of the rise in bond yields of the entire banking industry at this juncture could be around 45,000 crore.

This is roughly about 5% of Indian banks’ total capital base. In other words, 5% of capital will be eroded by making good the depreciation losses.

Banks need to book depreciation for the bonds kept in the so-called available for sale (AFS) and held for trading (HFT) categories. The banks do not take hit on the bonds that are part of held-to-maturity (HTM) basket even after their value depreciates but for the HFT category, the MTM loss or gain is calculated daily, and for the AFS category, once in every quarter.

Bond yields dropped in April and the first half of May and eager to take advantage of the falling yields, public sector banks increased the size of their tradable portfolio from close to 29% of their bond portfolio in March to over 34% in June. That has exposed them to interest rate risk and depreciation loss. For the entire industry, the rise has been from 38% to 40.66%.

Since 22 May, when US Federal Reserve chief Ben Bernanke first hinted at bringing to close monetary easing that led to the flight of money from equities and debt, the 10-year benchmark yield has risen 183 basis points—from 7.167% to 9%.

Only once did Indian banks faced this kind of hardening of bond yield—in January 1998, when RBI announced a 2 percentage points hike in its bank rate (from 9% to 11%) as well as repo rate (from 7% to 9%) and half a percentage point hike in banks’ cash reserve ratio (CRR), or the portion of deposits that commercial banks need to keep with RBI (from 10% to 10.5%) to protect the local currency that was falling fast, suffering from the contagion of East Asian currency crisis.

On 18 January 1998, then RBI governor Bimal Jalan announced rupee-support measures which also included hike in export credit and general refinance rate, cut in export refinance and general refinance limits, and doubling the interest rate surcharge on import finance.

Banker’s Trust Realtime is a frequent blog by Tamal Bandyopadhyay, who writes a popular weekly column Banker’s Trust.

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