Bond yields spike 11 bps on Viral Acharya's interest rate risk remarks

Acharya's criticism on interest rate risk has not gone down well among public sector bankers

Reserve Bank of India (RBI) Deputy Governor Viral Acharya’s criticism on managing interest rate risk in banks has not gone down well among most treasurers, who termed his speech as too constricted in its approach.

Bond yields spiked 11 basis points (bps) to close at 7.38 per cent, from its previous close of 7.27 per cent on Monday as the markets interpreted the central bank won’t extend support, either by allowing spreading of losses over few quarters, or through liquidity support, to ameliorate the pain faced by banks due to adverse movement of yields.

As yields rise, bond prices fall.

Acharya said in his address to Fixed Income Money Markets and Derivatives Association (FIIMDA), most of the members of which are bank treasury officials.

“Interest rate risk of banks cannot be managed over and over again by their regulator,” said Acharya in his speech, adding: “It appears that for most banks investment activity essentially consists of two steps – buying and hoping for the best. But hope should not be a Treasury desk’s primary trading strategy.”

Asking the regulator to help banks in terms of distress is “akin to the use of steroids.”

“They get addictive and have long-term adverse effects in the form of frequent relapse even though their use may be justified to relieve occasional intense pain,” Acharya said, while nudging banks to improve their risk management practices and manage duration risk better.

Clearly the bankers were not amused. Under condition of anonymity, bankers say the RBI, including Acharya himself, cannot abdicate themselves from the present mess in the market.

“When RBI expects banks to reduce the interest rate, it is expected that RBI manage the market interest rate efficiently. After demonetisation, banks were forced to keep the excess fund in instruments yielding not more than 6-7 per cent in the absence of poor credit pickup,” said a senior public sector banker.

“The poor credit pickup, current state of the economy, bank NPA … for all these RBI is partly responsible. We had not asked them to waive off the loss, we had just asked to allow us to spread the losses and that is not akin to administering steroids. If we really have to manage our risks, we have enough and more surplus bond holding, and we can very well stop buying bonds. None of the auctions will succeed,” the banker said, requesting anonymity.

In the December quarter, the 10-year bond yields had risen about 70 bps, resulting in a mark-to-market loss of Rs 15-25 billion.

 

The RBI generally doesn’t allow spreading of losses, and only in mid-2013, it granted banks that option after yields spiked up on taper tantrum talks by the US Federal Reserve.

However, RBI has time and again helped banks through other measures, such as allowing banks to transfer their market portfolio to permanent basket on an ad hoc basis (and thereby not incurring mark-to-market losses). In 2013, the RBI allowed deferment in recognition of valuation losses by six months. And, of course, the central bank does manage the yields through open market sales or purchase of bonds.

 

But banks still run to the RBI for relaxation is things go wrong, which the RBI deputy governor criticised harshly. And to some extent, Acharya has got supporters among bankers.

“He is right. Banks cannot be running with a begging bowl to the regulator every time. You have to manage your own market risk. And this time the yield movement was 70 bps, which is not unusual. Truth is, not all banks approached RBI,” said another senior banker.

Another banker said the RBI had given warning to bank repeatedly about the prospect of inflation spiking up in the second half, along with its policy announcements that liquidity would move to neutral. Banks should have been more cautious in handling their bond portfolio, he said.

But the banker also maintained that blaming banks for concentrating on dated bonds is not valid as without banks buying the instruments, government won’t be able to function.

“Government owned banks are also helping the government, and the success of the borrowing programme is largely because of us,” said another treasurer.

 

“If banks refused to buy the papers, the situation would be similar to what state governments are facing now. There are no takers and yields have shot up to eight per cent. Surely, government won’t want to borrow at high coupon,” said the treasurer.  

Banks are the largest buyer of government bonds. The share of commercial banks in outstanding government securities (G-Secs) was around 40 per cent at the end of June 2017, Acharya said.  For public sector banks, the share of investment in G-Secs as a percentage of total investments was at 84 per cent in FY2016-17. The corresponding figure for private sector lenders was at 82 per cent.

 

According to bond dealers, yields have moved too fast in too short a period, and the RBI actions are partly responsible for that. The RBI sold Rs 900 billion worth of bonds through dated securities and sold another Rs 1 trillion worth of special bonds to remove excess liquidity. And then, the government said it would borrow another Rs 50,000 crore through dated securities from the market. These pushed up yields even further.

Meanwhile, rupee jumped about 55 paise to close at 64.04 a dollar level as trade deficit widened and crude prices rose to near three year high. Importers were seen hedging their positions, instead of the recent past trend of seeing exporters hedging, said Harihar Krishnamurthy, head of treasury at First Rand Bank. 

 

“Rupee should be under pressure, but it will stabilise soon, as exporters would be selling at 64.25-50 a dollar level. There is very little incremental space left for foreigners to put money in debt segment, and that’s why dollar flow would be limited. However, the fundamental story is still strong and fiscal deficit would unlikely cross 3.5 per cent (of GDP) level for the next fiscal,” said Krishnamurthy.