The surprise rate hike last week by the Reserve Bank of India (RBI) has raised worries about banks having to set aside higher amounts from profit for erosion in value of government bond portfolio.
Just as the banks were heaving a sigh of relief on easing of yields on government bonds, industry says RBI’s announcement on Friday to increase short-term policy rates by 25 basis points could push up yields.
“It would put a strain on their (banks’) bottomline as they have to make provision for erosion in value of securities,” said an industry source. This comes at a time when the interest income from lending is not growing much due to slow pick-up of advances and effect of cut in lending rates.
Bond dealers say yield on the benchmark government bond (6.35 per cent 2020), which eased to 7.82 per cent on Friday from a 17-month high of 8.02 per cent previous week, could harden in the days ahead. This raises concerns over having to make extra provisions for fall in value of bonds. O P Bhatt, chairman of State Bank of India, says his bank may have to make provision for Rs 200-300 crore for value erosion.
Banks could keep 25 per cent of their government bond portfolio into the Held to Maturity (HTM) bucket. These investments are not marked to market, protecting from vagaries of market trend (ups and down). And the advantage is banks do not have to make provision for them. The treatment for securities held in the available-for-sale (AFS) basket is different from held-for-trading (HFT). The former is marked-to-market and banks have to make provision for fall in value of securities. Government bond portfolio in excess of 25 per cent ceiling is also marked to market.
Bipin Kabra, chief financial officer with Dhanlaxmi Bank, says RBI announced rate hike when the yields had eased after touching eight per cent mark. “Hence, even if yields harden, the impact on bond portfolio will be less as against the adverse fallout if RBI were to increase policy rates when yields were ruling at 8 per cent,” he added.
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Banks that have bought bonds in the last one year are in a loss since the bond prices have declined below their purchase value. Kabra says bank may have to book a small loss on part of securities portfolio. The size of a portfolio is small as the credit-to-deposit ratio is around 75 per cent.
Rating agency Icra in a recent banking sector review says the rising interest rates (yield) will impact a bank’s profitability. “The impact will be higher for most public sector banks as they have a higher proportion of government bonds, and also, with a relatively higher duration on such investments,” the report added.
Punjab National Bank Chairman and Managing Director K R Kamath said: “The hardening of yield in the light of hike in key short-term policy rates may not impact us a lot. This has been factored in.” The Delhi-based public sector bank is covered till 7.56 per cent (on a 10-year benchmark).
In the case of IDBI Bank, though it’s a public sector, the situation is different. Its Chief Financial Officer P Sitaram says IDBI has been building up an HTM portfolio till September 2009, as RBI gave IDBI five years to reach 25 per cent mark after converting into a commercial bank from being a development finance institution. “The bank has just about begun to grow its portfolio of securities, which are for sale and trading,” added Sitaram.