Banks Log Negative Spreads

Analysts are finding the current interest levels not sustainable as banks' incremental cost of funds is exceeding the yield on incremental investment, translating into negative spreads.

The yield on the 30-year (7.95 per cent 2032) paper that was auctioned by the central bank yesterday rose by a fraction today. Trading in the security though weak, saw yields rise marginally from last evening level of 7.92 per cent to 7.93 per cent. Volumes were, however, thin -- about Rs 50-60 crore.

The current interest rates, which are at a historic low, are not seen to be sustainable especially in light of banks witnessing negative spreads "It will be difficult to push interest rates further down due to fundamental factors unless fundamentals change," pointed out market analysts.

The key factors preventing a further drop in interest rests are banks' inability to drop their deposit rates further and the bulk of non-performing assets on which they do not earn any interest income, analysts point out. The cost of funds is in the region of 8.05 per cent. This is less than investment yields, which have fallen below 8 per cent.

As the banks have adequate buffer in terms of long-dated securities bought at higher yields, this concern over the asset-liability mismatch is not likely to manifest itself till the beginning of the coming fiscal.

The two key riders that could backfire the easy interest rate scenario are the rising inflation of over three per cent on the short end and the state of government finances on the longer end.

"There is no sign of moderating the number of state government issues coming into the market, and the size keeps on increasing," said analysts. However, the key concern expressed by the market has been the cost of funds for the banking system.

With incremental investment by banks today showing negative spreads, there is a need for rectification, pointed out analysts. Banks will have to improve on their efficiency in dealing with NPAs and drop deposit rates. Otherwise, it will be difficult to push interest rates lower due to fundamental factors.