Banks fear Rs 150-250-bn MTM loss over abrupt bond yield movement

RBI approached for leeway to spread the losses over some quarters

Fearing a mark-to-market loss of something between Rs 155 billion and Rs 250 billion in the third quarter, some banks have approached the Reserve Bank of India for a leeway of spreading the loss over some quarters.

According to Investment Information and Credit Rating Agency of India Limited (ICRA), bank treasuries could be facing losses of Rs 155 billion in the third quarter due to abrupt yield movement.

But, going by the estimates of other organisations, ICRA’s assessment appeared conservative.

Bond market experts have predicted that the losses could be as high as Rs 250 billion. However, the same banks had earned more than Rs 1 trillion in the six months of the fourth quarter of financial year 2016-17 and in the second quarter of 2017-18, the ICRA stated. In the third quarter, ended December, the 10-year bond yields rose 67 basis points. As yields rise, prices of bonds fall. The 10-year yields closed at 7.33% at the end of the December quarter.

It is difficult to estimate without a granular analysis of each bank, but the average duration of the bond holdings by banks work out around four years. In the duration, the rise of one basis point roughly translates into 6-7 paise loss per bond. 

What is Mark-to-Market loss

• MTM is an accounting concept used for valuing bonds in a treasury portfolio 

• A bank has three baskets to keep the bonds:  Held to Maturity (HTM), Available for Sale (AFS) and Held for Trading (HFT) 

• The MTM exercise has to be done for the last two baskets 

• Essentially, a bank has to value its bonds at the existing market price, and not the price at which the bonds were acquired 

• So, if a bond was acquired at Rs 97 and the value of it now has fallen to Rs 95, the bank will have to record a loss of Rs 2 in the trading account to reflect the fair value of the bonds 

• The MTM losses are nominal losses and become actual only when the bank sells the bonds in the market and crystalise the losses

The loss, as calculated by the industry-wide holding, turns out to be as high as Rs 300 billion, said an executive of a rating agency. However, the conservative estimate of losses could be at least Rs 250 billion for the quarter, the executive added.

“With reduced cushion to absorb interest rate movements, the recent surge in bond yields is expected to result in MTM losses on the Available for Sale (AFS) portion of their investment portfolio. The MTM loss for the entire banking sector is estimated at Rs 155 billion during the quarter,” ICRA said in a statement. 

Public sector banks would account for 80% of this loss, considering the fact that their available for sale portfolio is the highest in the banking system.  “With losses before tax of Rs 56.24 billion during H1FY18, MTM losses will further add to losses and erode capital ratios for public sector banks (PSBs). In contrast, private banks (PVBs) are relatively better placed to absorb the MTM losses with profit before tax of Rs 309.94 billion during H1FY18,” the ICRA statement stated, adding that the government may need to increase the capital if it intends to front-load the PSBs by recapitalization of bonds.

Sources in the banking sector said it was unlikely that the RBI would repeat its 2013 stand and provide a window of scope to banks to spread this loss over several quarters.

The central bank had allowed such a forbearance back in 2013 after RBI hiked short-term rates suddenly to stem a rupee rout following tantrum talks by the US Federal Reserve. 

In July that year, short-term rates had spiked 350 basis points in just two weeks, forcing banks to incur huge losses in their bond portfolios.

No such drastic measures were taken this time. 

The central bank has kept its policy rates unchanged since August and the market expects a rate pause to continue for the calendar year 2018. 

“If RBI really accepts the request of spreading out losses, it would create a precedence — so to say. RBI may not want to do that,” said a senior banker.