How banks will benefit from bond yield fall: Moses Harding

Saikat Das
moneycontrol.com

The 10-year bond yield hit three year low at 7.35 percent from its September, 2012 high at 8.28 percent. This dip catered to a fertile ground wherein banks have multiple options to book trading profits, according to Moses Harding, head of asset liability committee and economic research at IndusInd Bank.

"The sharp fall in the bond yields will not only boost trading income from huge excess SLR portfolio at over Rs 4 lakh crore or 6-7 percent of net demand and time liabilities but also improve the mark-to-market of HTM (held to maturity) category," he told moneycontrol.com in an exclusive interview.

Despite repeated cuts in the policy (repo) rate, banks are yet to reduce their lending rates. Repo is the rate at which banks borrow money from the Reserve Bank of India (RBI). Lending rates will drop once the operating policy rate shifts from repo rate to reverse repo rate (at which banks park their excess liquidity with RBI), Harding observes.

Also read: Here is how bad loans affected banks in Jan-March quarter

With the introduction of inflation index bonds (IIBs), retail investors should invest 25 percent of their savings, suggests the banker with nearly 30 years of experience.

Below is the edited excerpt of the interview:

Q. With WPI inflation falling below 5 percent, do you expect RBI to soften its policy stance?

A. The inflation adjusted return for one year funds is good if inflation remains stable at or below 5%. RBI also tracks retail consumer price index (CPI) which continues to remain high close to double digit (at 9.39 percent).

The worst is clearly behind on inflation front but it is not driven by demand-supply dynamics. The sharp reversal in inflation is mainly triggered by subdued growth and tight liquidity. There is bound to be pressure on inflation into the short to medium term on growth uptrend and improvement in system liquidity.

Q. What is your outlook on interest rates?

A. RBI may continue to see limited bandwidth on rates but may go aggressive on cash reserve ratio (CRR) cuts. I see an extended pause of repo rate at 7%. The central bank may reduce another 25 bps in July. However, CRR is expected to cut from the current 4 percent to 3 percent during 2013-14.
 
Q. How effective is a repo rate-cut to any bank?

A. Repo rate cut benefits the most to banks which fund long term assets with short term liabilities and not to those who are seen lenders in this shorter end time buckets.

Most nationalised banks are cash surplus in the shorter end. They are seen as lenders in the (inter bank) call market. Others (other than those state-owned banks) fund longer term assets through short term liabilities. They are seen as borrowers in the call market.

The benefit of repo rate cuts mainly accrue to banks, which stay dependent on short term funds (between 1-90 days). Repo rate cut obviously provides more benefit to non-PSU banks/institutions. That is the reason why PSU banks do not see business case to cut lending rates while interest income from lending in the shorter end gets squeezed.
 
Q. Why are banks not cutting rates?

A. Lending rates will drop once the operating policy rate shifts from repo rate to reverse repo rate. It means that the system liquidity should shift from deficit to surplus. When banks get the fear of lending their surplus funds to RBI at reverse repo rate, lending rates will drop. This will also lead to pick-up in investments.
 
Q. What is your assessment of liquidity situation?

A. The liquidity squeeze is largely driven by high twin-deficits and shift of savings (and investments) from financial assets to non-financial assets. During this time, assets in RBI's balance sheet have shifted from US dollars to Indian rupees. The central bank is expected to continue releasing liquidity through CRR cuts, Open Market Operations (OMOs) and dollar purchases.

On the other side, banks hold huge excess statutory liquidity ratio (SLR). Sale of excess SLR and being less dependent on deposits (to expand credit) will establish downtrend on deposit rates.

Q. RBI is introducing inflation index bonds (IIBs) linked to WPI. How relevant are those for investors?

A. Given the range of wholesale price index (WPI) inflation trend at 3-8%, it is not bad for retail investors to allocate 25% of savings to IIBs. Consumer price index is relevant to a layman. However, there are some data collection deficiencies to measure CPI inflation. RBI has already hinted to linking IIBs in future.

The intent of IIBs is to provide real rate of return to savings and investments and arrest flow of funds to non-financial assets (like physical gold and silver). The product features of IIBs such as market linked coupon, adjustment of the principle to inflation trend and 10Y tenor will attract wholesale investors. The launch when headline WPI below 5% will mean limited downside risks.
 
Q. RBI has given SLR status to IIBs. Your comments....

A. There is no reason to differentiate IIBs and other government securities (gilts) when issuer's status is the same. So, it is logical to provide SLR status to IIBs treating it at par with other gilts which has fixed coupon without inflation hedge.
 
Q. The fear of rating downgrade still looms large. Do you expect India to attain more than 6% GDP in FY14?

A. Global rating agencies do not seem to be confident on the significant improvement in macroeconomic dynamics. Their main concerns are of growth, fiscal consolidation, current account deficit, sustainability on overseas flows and supply side bottlenecks.

There seems to be no political convergence to resolve conflicts in key reforms such as land, tax and legal issues to ensure pick-up in growth. Robust domestic demand is not being matched with capacity expansion in domestic supplies. While the situation has improved to remove the risk of downgrade, there is lot to be done to expect stable outlook and upgrade.
 
Q. The fall in 10-yr bond yields will help banks earn treasury gains. How will it impact Q1 earnings?

A. The 10-year yield is at three year low at 7.35 percent; sharply down from September 2012 high of 8.28 percent. The sharp fall in the bond yields will not only boost trading income from huge excess SLR portfolio at over Rs 4 lakh crore (6-7% of net demand and time liabilities) but also improve the mark-to-market of HTM (held to maturity) category.

Banks have the option to take the money off the table from AFS (available for sales)/(held for trading) HFT and HTM categories. It means that banks SLR investment portfolio will be deep in the money with opportunity to book significant profit from sale of investments.

saikat.das@network18online.com