Bond yield spike may hit banks' treasury profit

Rise in yield due to a combination of factors including a cut in SLR and sticky inflation outlook

The sharp rise in yields on the new 10-year benchmark government bond has raised the risk of banks taking a hit on their bond portfolio and consequent pressure on treasury profits in the year’s second quarter.

The possible mark-to-market losses (writing down assets in line with changed values) would add to the pressure on the bottom line at a time when the growth in income from credit has been subdued, treasury executives and bankers said.

The rise in the yield is due to a combination of factors, including a cut allowed by the Reserve Bank of India (RBI) in the statutory liquidity ratio (SLR) for banks and the sticky inflation outlook. The yield on the new benchmark 10-year paper (8.40 per cent 2014) has moved up by 23 basis points in two weeks. The yield closed at 8.63 per cent, according to Clearing Corporation of India data.

Vibha Batra, senior vice-president of financial sector ratings at Icra, said the hardening of yields does increase the risk of mark to market losses on the bond portfolio. But with a buoyant capital market, banks might see gains on the equity portfolio. So, the effect might not be so bad.

The situation was bad in the second quarter of last year (FY14). The intense volatility in the bond markets after Reserve Bank’s strong steps to curb the rupee’s slide impacted the treasury earnings, said Batra.

“The profits of banks are likely to be hit due to losses on the bond portfolio even in this quarter. The losses might be similar to those in the last quarter. A recovery in profits is seen in the third quarter with credit pick-up.

However, that time, too, bond yields could be on the higher side. But due to credit pick-up, the impact of losses on account of the bond portfolio will be mitigated,” said a senior treasury official of a public sector bank.

T S Srinivasan, head of treasury with Karur Vysya Bank, said in the current environment when the central bank was cutting the SLR, the yield would only move up. If the current trajectory continues, the yield on the new 10-year benchmark might hover around 8.8 per cent by the end of next month.

Beside sticky inflation, a pick-up in credit demand on the back of economic recovery would also impact bond yields.

Foreign institutional investors (FIIs), which have been very active in bond markets, have sold part of their portfolio after the rupee weakened against the dollar. ‘The currency risks were not hedged and when the rupee began to lose strength, some FIIs resorted to bond sales, depressing prices,” said dealers.