Caught between RBI-rupee cross fire, banks bleed

Mounting MTM losses to erode profitability

Banks were reasonably happy till the middle of July when they were finalizing the April-June quarter despite rising bad loans amid slowing credit growth. As the first quarter results of the banks show, most banks have reported high non-performing asset numbers and seen erosion in the loan book. It was treasury operations that had saved the day for banks in first quarter which helped them to show growth in profit.

Banks are allowed to reshuffle their investment portfolio once in an year, which they usually do at the beginning of the financial year when they shift securities from held to maturity to available for sale /held for trading and vice versa depending on the interest rate outlook. Typically, when interest rates are expected to soften more securities are kept for sale/trading and the opposite when interest rates are expected to go up. Banks need to make their investments mark-to-market for their trading portfolio.

With RBI cutting repo rate twice till April, banks thought interest rate cycle would move downwards and most banks held more papers in trading portfolio in 2014 as compared to 2013.

However, the interest rate took a U-turn in mid July when the central bank started tightening liquidity to arrest the fall in rupee by curbing speculation. The yield on the 10 year benchmark bond shot up 180 bps since the beginning of the quarter.

Analysts suggest, a 100 bps rise in goverment bond yields will led to roughly Rs 33,000 crore mark-to-market provision in one quarter – which is almost the double of first quarter profit of all banks put together (which was Rs 19,849 crore) or close to half of the yearly profit of 2012-13 (Rs 77,045 crore).

State Bank of India's – the country’s largest lender – provisioning requirement for mark-to-market has already gone up to Rs 1,500 crore, its chairman Pratip Chaudhuri said while announcing the bank's first quarter earnings last week.

“If bond yields do not come down from where they are, there will be MTM losses,” said HSU Kamath, chairman and managing director, Vijaya Bank.

Though initially it was felt that the central bank’s measures are temporary but now the thought is slowly sinking among the market participants that RBI is not in a hurry to withdraw the liquidity tightening measures.

Investors also noted the stress with the BSE Bankex shedding 31.5% since May 17, which was the 2013 high for the index.

Banks have requested the central bank to allow them to shift their trading portfolio to held to maturity for one more time this year, but there is no indication on what the central bank does.

“We have called data from banks to understand the magnitude of the problem,” said B Mahapatra, executive director, RBI in a recent interaction with the media.

What is a double whammy for the banks is an earlier directive of central bank which reduced the ceiling on the proportion of securities that could be kept for held for maturity to 23%, from 25% of the net demand and time liabilities. Banks were given time to reduce it by 50bps in each quarter so that they can abide with the new ceiling in four quarters.

In a note to RBI, the Indian Banks' Association, while advocating for dispensation to banks on shifting securities from AFS to HTM, estimated MTM loss to the tune of Rs 15,000 crore due to the cut in the ceiling.

"Banks were hoping that the loan loss due to impaired assets would be compensated by treasury gains. But that is not going to happen now," said a top public sector bank official.