India’s fixed income market has become a pain point for banks amid a tightening monetary policy and elevated inflation. Treasury losses owing to a sharp rise in bond yields have dragged profit sharply lower for most banks in the first quarter.
State Bank of India’s operating profit fell 33 percent year-on-year for the June quarter after the country’s largest lender took a Rs 6,549 crore hit on its bond portfolio. Other banks showed varying degrees of damage to their profitability.
When bond yields rise, their prices move down, causing losses to investors on their portfolio. While a loss can be booked only when the bond is sold, banks are required to mark their bond portfolio to the current market price.
Marking bonds to the market price may result in a notional profit or loss and the lender must provide for any loss. In essence, banks must set aside a portion of their earnings to offset a potential loss on their bond portfolio in addition to booking the loss on sale of their investments.
Banks book their treasury income under non-interest income along with fee income. The non-interest income of 28 listed commercial banks showed a 28 percent sequential fall for the June quarter and was little changed year-on-year. Much of this damage came from the treasury books of banks, besides some slowdown in fee income. In SBI’s case, its non-interest income fell by 80 percent year-on-year.
It doesn’t help that the Reserve Bank of India will continue to hike rates, which in turn will drive up bond yields further. That said, banks may find it easier to tread in the coming months.
The rise in bond yields, if any, is expected to be measured from here on. For perspective, the benchmark 10-year sovereign bond yield is about 7.35 percent after rising more than 100 basis points since April. However, analysts expect the 10-year yield to rise to at best 7.50 percent in the near term.
“Given the uncertainty around the global monetary policy stance amidst inflation-growth trade-off, we expect the 10-year yield (6.54% GS 2032) to trade in a broader range of 7.20-7.45% in the near term,” said analysts at Kotak Securities.
SBI chairman Dinesh Kumar Khara had indicated that the hit from bond yields won’t be much from here on for the bank.
“If the 10-year yield stays where it is now, at around 7.30 percent, we will be able to write back Rs 1,900 crore. If it rises to 7.75 percent, we may have to make another Rs 2,000 crore to Rs 3,000 crore provisions. But with inflation on the way down and the currency also strengthening, we do not expect a sharp jump in yields,” Khara said in his post-earnings press interaction.
That said, treasuries of banks may need some nimble-footed strategy to avoid further portfolio damage.
Strategy mode
By default, 18 percent of the bond portfolio of banks is shielded by regulation because lenders can keep them in a held-to-maturity bucket that need not be marked to market prices. For FY23, this limit was enhanced to 23 percent in April. Further, banks can shift bonds from their trading book to the HTM bucket once in a financial year to avoid a mark-to-market hit.
Besides this, the most common strategy is to increase the duration of bonds during rate-hike cycles. Policy rate hikes and tightening of liquidity tend to drive up short-term rates more than long-term yields. Therefore, banks typically increase the average tenure of the bonds they hold to avoid an immediate hit.
SBI has assured investors that it has taken all precautions to avoid a hit on its bond portfolio.
ICICI Bank was one of the outliers that reported a treasury profit and minimal mark-to-market losses on its bond portfolio during the June quarter.
“In our AFS portfolio, as we may have discussed in the past, we generally carry a very low duration. So, whatever mark-to-market, if at all, would have been there, would have been negligible,” ICICI Bank’s chief financial officer Anindya Banerjee said in a post-earnings interaction with analysts.
To be sure, the private lender’s treasury profit of Rs 36 crore was down massively from a year ago, but avoidance of treasury loss was no mean feat as the direction of bond yields was adverse. The bank is in good company with Canara Bank, Central Bank of India and smaller lenders such as DCB Bank.
The upshot is that a combination of strategy and regulator leeway could help banks get out of their treasury troubles in the coming quarters of FY23.
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