Treasury operations to boost bank bottom lines in third quarter

The economic slowdown has bankers worried about the moderation in credit demand and rising defaults and rightly so. But in the short term, they are looking to make tidy profits from treasury operations, taking the benefit of plummeting yields on government bonds.

The yields on 10-year government bonds, the most frequently-traded paper, have crashed from 9.5 per cent in the second quarter to around 5.5 per cent now. This is a response to drastic rate cutting that central banks across the world, including the Reserve Bank of India, are engaged in to tackle the financial meltdown and also the sharply falling inflation.

Bankers say falling yields has meant a surge in the treasury income by selling of bonds in buckets such as Available for Sale (AFS) portfolio.

Also, the reversal of provisions made in previous quarters for hardening of yields (drop in bond prices) on securities are expected to contribute substantially to bottom lines in the third quarter ending December 2008.

Bond yields on government bonds could fall to the range of 4 to 4.5 per cent and those on corporate bonds could also come down accordingly, ICICI Bank chief executive designate and chief financial officer Chanda Kochhar said.

The larger part is expected to come from trading profit – buying and selling of securities – in the third quarter than reversal of provisions, said a treasury official of Union Bank of India said.

In its recent update, ICICI Securities said the free fall in bond yields from 9.5 per cent has led to huge mark-to-market (MTM) gains on held-to-maturity (HTM) and AFS portfolios. While gains in AFS portfolio could help offset NPL-related provisions to some extent, there is little scope for gains being realised on the HTM portfolio.

While large benefit will accrue from the buying and selling of bonds when the market has seen sharp drop in yields accrue, there are also two other streams which will add to treasury income. First, the gains from positions in the foreign exchange market. And second, churning of equity portfolio when the sensitive index has rallied above 10,000, State Bank of India (SBI) treasury official said.

However, the extent of benefit from equity will be much less compared to gains banks made in October-December 2007 when the Sensex was hurtling towards peak.

In this quarter, banks have seen moderation in demand and some adverse effects of slowdown but it is unlikely to lead to sharp rise in provisions for non-performing assets. The provisioning for bad loans may move up only from the next quarter (Q4).

SBI may not see much benefit from the reversal of provisions made for securities portfolio. It wrote back provision in the second quarter ending since yields were lower at end of September compared to end of June 2008.