Banks likely to lose Rs 11,790 cr in Q1 on bond rally, says report

Banks are unlikely to take a big hit on profitability this quarter due to rising bond yields, which may eat up 5.3 per cent (Rs 11,790 crore) of their net income in the worst-case scenario, according to a report.

In the worst-case scenario, banks may see a profit erosion of 2.6 per cent of their pre-provisioning operating profit and 5.3 per cent of their post-tax profit from treasury losses in Q1, India Ratings said in a note on Friday.

During the first quarter, the bond yields rose 61 bps, peaking at 7.5 per cent.

This is because a 100 bps year-on-year upward shift in the yield curve can impact the system-wide pre-provisioning operating profit by 4.5 per cent and return on assets by just 9 bps, the agency said.

Banks will continue to face headwinds in the current upward interest rate cycle, the agency said but argued that the impact is likely to be lower than the past cycles because banks can utilise their investment fluctuation reserve, reclassify their trading portfolio between the held-to-maturity (HTM) and available for sale (AFS) and also further calibrate the modified duration of AFS portfolios.

The report further argues that banks will gain from lower pension costs, higher interest income from bond purchases with higher yields, and resetting of interest rates on floating rate bonds (although in limited quantum), offsetting the treasury losses.

With an expected overall improvement in the profitability of banks in FY23 and select banks already providing for higher movement in yields (up to 7.5 per cent), according to the agency, the impact on return on assets can be as low as 9 bps if none of the aforementioned offsets is in place.

Also, there has been a moderation in yields of the benchmark 10-year G-Secs from a peak of 7.62 per cent in June to around 7.45 per cent this month after the Reserve Bank unveiled a series of steps to contain the rupee.

Ankit Jain, a senior analyst at the agency, said that banks are in a much better position to absorb the impact of upward movement in G-Sec yields compared to the past cycles.

"We believe that the treasury losses in 1Q can impact the pre-provisioning operating profit (PPOP) by 2.6 per cent and post-tax income by 5.3 per cent of Rs 11,790 crore because a 100 bps on-year upward shift in the yield curve can impact the system-wide PPOP by 4.5 per cent and return on assets by just 9 bps."

Mark-to-market losses across banks will be at Rs 11,790 crore on a post-tax basis, of which state-run banks' will be Rs 8,630 crore and Rs 3,160 crore by the private sector ones.

However, the mark-to-market impact can be minimised by utilising the investment fluctuation reserve, which is a minimum of 2 per cent of their AFS and HFT investments and is solely created to manage higher volatility in yields.

Public sector banks lose slightly higher in terms of PPOP at 6.7 per cent and private sector banks will have a lesser impact at 2.4 per cent. The impact on the common equity tier 1 (CET1) of state-run banks will be 21 bps and that of private banks by 10 bps and at the system-wide it will be 16 bps, the report said.