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In a dramatic U –turn, the Reserve Bank of India (RBI) on Tuesday relaxed its tight money policy adopted a month ago. In a move to comfort the government bond market after a sharp spike in long-end yields, the central bank has decided to infuse liquidity in the market.
RBI said it will buy long-dated government bonds worth Rs 8,000 crore through an open market operation on August 23 and thereafter decide on the amount and frequency as warranted.
The central bank also relaxed rules for banks on their mandatory bond holdings, known as the statutory liquidity ratio, which will help banks protect their bond portfolios from large mark-to-market losses.
In contrast to an earlier rule asking banks to reduce their hold-to-maturity bond holdings gradually to 23% of deposits, RBI has now allowed banks to retain those holdings at 24.5% of the total. "The hardening of long term yields has resulted in banks incurring large mark-to-market (MTM) losses in their investment portfolio," the RBI said.
On July 15, RBI had increased the marginal standing facility rate by 200 bps to 10.25% and capped bank’s borrowing under the liquidity adjustment facility, along with sale of government bonds to tighten liquidity. As a result, short term rates increased to the MSF rate.
The collateral damage was, however, in the bond market which saw yields jumping to 9.48% (intra-day) – almost 200 bps rise since the start of the quarter. The rise in bond yields hurts government’s borrowing programme, apart from forcing banks to provide for mark-to-market losses.
Though the central bank did not cut the MSF rate, it on Tuesday softened its tone considerably as it said “it is also important to ensure that the liquidity tightening does not harden longer term yields sharply and adversely impact the flow of credit to the productive sectors of the economy.”
The bond and equity market will rejoice the central bank’s announcement when the market opens tomorrow. The banking regulator entertained banks’ request for a one time dispensation to shift securities in the held-to-maturity and also gave banks the option of valuing these securities for the purpose of transfer as of July 15 – the day on which the liquidity tightening steps were announced.
Banks were starring a huge mark-to-market loss on their bond portfolio with the yield on 10-year benchmark bond shooting up 146 bps during the quarter.
Analysts suggest a 100 bps rise in government bond yield will led to roughly Rs 33,000 crore mark-to-market provision in one quarter – which is almost the double of first quarter profit of all banks put together (which was Rs 19,849 crore) or close to half of the yearly profit of 2012-13 (Rs 77,045 crore).
For State Bank of India, the country’s largest lender, provisioning requirement for mark-to-market has already gone up to Rs 1,500 crore, its chairman Pratip Chaudhuri said while announcing the bank's first quarter earnings last week.
Provisioning requirements for the bond investment portfolio of banks, financial institutions and mutual funds are already Rs 1.2 lakh crore, according to rough estimates.
Investors also noted the stress with the BSE Bankex shedding 31% since May 17, which was the 2013 high for the index. The Sensex fell 10% during the same time.
In a note to RBI, the Indian Banks' Association, while advocating for dispensation to banks on shifting securities from AFS to HTM, estimated MTM loss to the tune of Rs 15,000 crore due to the cut in the ceiling.
