Bank books see red on rising yields

Yield on 10-year govt paper at 16-month high on inflation worries.

Banks may have to take a further hit on their bond portfolio with the yield on 10-year government securities hitting a 16-month high today.

The yield on the 10-year paper due 2020 rose to 7.97 per cent, as government data showed that inflation based on wholesale price index touched a 15-month high. In January, inflation was estimated at 8.56 per cent, higher than the Reserve Bank of India’s (RBI’s) forecast of 8.50 per cent at the end of March 2009.

Prices hit a low of Rs 89.06, but rose later in the day to close at Rs 89.60, and the yield at close of trade was 7.88 per cent, marginally higher than the Friday close of 7.86 per cent.

Bond yields and prices have an inverse relationship. A fall in prices results in banks having to mark-to-market their portfolio. Banks use the yield on the last day of a quarter to arrive at the value of their portfolio, where it is classified as held-till-maturity and is free from mark-to-market accounting rules.

“I have a feeling that bond yields may not go beyond 8 per cent for the time being. We have to wait and see on what happens on February 26, which is not far off. The direction on interest rates will be known only after the presentation of the budget. The strategy on any kind of treasury activities can take place only after that. The total amount of borrowing that the government will have to do and the perception of the market to what extent the liquidity will be available will determine the future course of bond yields,” said Indian Overseas Bank Chairman & Managing Director SA Bhat.

Market players said they had already seen the adverse effects of rising yields in the quarter-ended December 2009. The high borrowing programme and rising prices, reflected in rising inflation number, had impacted yields, traders said.

The yield on the benchmark 10-year government paper increased by 49 basis points during October-December, as the expectation of RBI’s policy tightening measures gained momentum in December after the November inflation figures shot up.

Yields on government bonds across maturities hardened in this quarter. The closing yield on the 10-year paper on December 31, 2009, was 7.68 per cent, about 50 basis points more than the closing yield of 7.19 per cent on September 29.

According to an analysis of the third-quarter (December 2009) results of banks by Sharekhan, treasury gains were limited during the quarter owing to firm bond yields. At an aggregate level, public sector banks witnessed a 47 per cent decline in the treasury gains, while the private players experienced a 91 per cent fall.

The treasury head of a small private sector bank said his bank was covered for yield of 7.92-93 on the 10-year government paper. If yields remained consistently high and closed beyond 8 per cent at the close financial year in March, the impact of investment portfolio would be “quite adverse”.

“Booking losses and higher provisions can hit the overall bottom line,” said a private bank executive.

Higher provisioning on account of investment depreciation as against a write-back in the year-ago quarter coupled with higher non-performing asset (NPA) provisions suppressed the bottom line of banks in the third quarter.

While treasury heads were trying various ways to minimise the impact of higher yield, time was short and options were limited to reshape the investment portfolio, market players said.

A senior public sector bank executive said the choice was between selling securities and booking losses as prices had eroded substantially or make provision by keeping it on books till the year-end and then take a call in the new financial year. “Given the prospects of low interest income, the latter option makes sense,” he added.