Banks may run out of cover to shield trading losses

May approach Reserve Bank for increase in held-to-maturity cap

Banks are on the brink of exhausting the held-to-maturity (HTM) cap, which protects them from mark-to-market losses, and may approach the regulator for some relaxation, in order to support the government’s high borrowing programme.

According to norms, banks can keep government securities up to 25 per cent of net demand and time liabilities in the HTM category. Securities kept under the HTM category are protected from yield fluctuations and need not be marked-to-market, unlike available-for-sale (AFS) portfolio.

Senior officials from some mid-sized government banks indicate they have already exhausted 24 per cent.

If bonds are kept in the AFS portfolio, banks will incur trading losses as yields are expected to rise during the course of the year. As a result, banks may request the Reserve Bank of India (RBI) to allow them to increase the HTM cap.

Banks are allowed to shift securities to the HTM categories once a year. This exercise is generally done at the beginning of the financial year, after taking into account the borrowing calendar. In April 2011, most banks had shifted bonds to the HTM category on expectations of rising yields. “Yields are expected to go up next financial year. Hence, the situation remains the same,” said a senior treasury official of a large public sector bank. “Banks may wish to shift securities from AFS to HTM again.”

The borrowing calendar for the next financial year, 2012-13, will be announced early next week. The government has pegged Rs 4.79 lakh crore of net market borrowing for next financial year, higher by about Rs 40,000 crore compared with the net amount raised in 2011-12.

Bankers said that open market operations (OMOs) by RBI conducted this year helped create room for excess supply. However, OMOs may not be sufficient next year given the borrowing. In 2011-12, RBI purchased illiquid government securities worth more than Rs 1 lakh crore to offset the impact of higher-than-budgeted borrowing on yields and liquidity.

“RBI has clearly linked OMOs to liquidity conditions. We can expect OMOs only if liquidity situation warrants,” said a bond dealer with a domestic brokerage.

In addition, slower deposit growth in the financial year has compounded the problem as fresh bond issuances may exceed the deposit growth (or net demand and time liabilities) in 2012-13. “Deposit growth will be crucial for banks. Yields could shoot up in absence of substantial inflow of funds,” said a senior official at the State Bank of India.

According to RBI data, deposit growth slumped to 13.7 per cent as on March 9.

Following the Budget announcement, yields on government bonds have risen by 15 basis points on expectation of a lesser magnitude of policy rate cut in 2012 on the back of uncertain fiscal consolidation. The central bank has maintained that to have lower inflation, fiscal prudence is a must and has asked the government for a credible road map to bring down the deficit.

Fiscal deficit for 2011-12 is estimated at 5.9 per cent against the Budget estimate of 4.6 per cent. For 2012-13, the fiscal deficit is pegged at 5.1 per cent.

This is not the first time such a situation has cropped up. In 2009, when the government announced fiscal stimulus to counter the trickle-down effects of the global financial crisis, banks had to subscribe to government securities arising out of a huge borrowing programme, which stood at Rs 4.5 lakh crore (gross borrowing) or 6.8 per cent of GDP.