The hit for banks could be much bigger than expected
Over the last few years the focus of banks has been entirely on getting over the NPA problem. Most of the measures of the government have also been focused on attacking NPAs and boosting the capital of banks. But a new problem may have cropped up for banks in the last couple of months. That is the challenge of bond losses in the bond portfolios of banks. What is this risk and how big could it really get?
Story of bond losses
The first signs of higher bond yields came after the Union Budget when the government made a conscious decision to overshoot on its fiscal deficit target by 30 basis points. The higher inflation trajectory was also responsible for the rise in bond yields in the Indian market. In addition, bond yields globally started rallying in the last couple of months after it became clear that Fed would resort to 4 rate hikes instead of just 3. In the Indian bond markets the 10-year benchmark bond yields gained nearly 125 basis points from 6.43% in August 2017 to 7.68% in March 2018. In fact, since August last year the bond yields on the benchmark 10-year has been going up one way. That is obviously not great news for bonds because the prices of bonds are inversely related to the bond yields. So a 125 basis rise in bond yields will lead to bond losses for the holders and that will have to be provided for. But how big could this problem actually get in reality?
Volumes as an indicator
One of the best indicators of the robustness of the bond markets is the volumes. Interestingly, the bond volumes on the RBI bond platform have fallen by nearly 50% on a YOY basis. It is estimated that Indian banks may be sitting on bond losses to the tune of Rs.20,000 crore ($3 billion), according to an estimate put out by Credit Suisse Research. Normally, the RBI intervenes in these circumstances and offers buying support at lower prices thus putting a cap on bond yields. However, despite requests from bond traders the RBI has not really intervened and supported the bond markets. As of now, it is not clear if the RBI intends to offer support or will let the bond yields find their own equilibrium level.
What are banks doing?
Large PSBs like SBI, PNB and BOB are among the largest participants in the bond market. But in the last 2-3 months, all these banks have been net sellers on Indian bonds. That is not great news for the government which will be counting on the bond markets and the participation of banks to push its borrowing program through in a big way. With higher MSP to farmers, steady oil prices and the Fed threat, banks may soon have a new problem to worry about. For confirmation one only needs to look at the huge loss reported by SBI. That is not a good portent! ©