Ind-Ra: Treasury Losses to Put a Dent on Banks' Re-Cap

India Ratings and Research (Ind-Ra) estimates banking industry's profitability would be affected to the tune of INR305 billion in FY18 with return on assets of around 30bp. Also, public sector banks (PSBs) would continue to report losses in FY18. The large losses emanating out of the quick rise in bond yields especially in the last six weeks will result in large mark-to-market losses on lenders' non held-to-maturity investment holdings. This will lead to a considerable fall in the banking industry's treasury income in 4QFY18 with a spillover effect in FY19. In FY17, banks reported a gain on treasury of INR598 billion.

The agency believes midsized banks would be the worst hit, considering their proportionally swollen treasury books, after a period of muted credit and large deposit growth, and a steeper treasury profit booking in FY17. Out of the total potential loss, the share of PSBs will be INR248 billion in FY18 (FY17: profit of INR427 billion) and that of private sector banks will be INR57 billion (profit of INR201 billion). Ind-Ra believes the resulting treasury loss will impact the renewed vigour post announcement of bank recapitalisation.

After successive fall in bond yields starting from January 2015, rates have hardened from July 2017. The 10-year benchmark yield has moved up to 7.60% in January 2018 from 6.50% as on July 2017, up 110bp in six months.

Excess Statutory Liquidity Ratio (SLR) Investments: The banking systems' investments increased significantly in FY17 and FY18 as banks constrained by capitalisation and low credit offtake parked their deposit accretion in low risk weight government securities. As the yields were falling, some of the banks used realised gains to offset te profitability pressure on the core business. As the interest rate curve shifts, many of the banks, especially mid-sized banks could face large provisioning requirements.

Further, the proportion of investment book that is exposed to mark to market losses has increased significantly over the years as the cap on HTM reduced to 19.5% in FY17 from 22% in 2015. With the rising bond yields, banks will have to provide MTM losses on these.

Mounting Treasury Losses and Other Provisioning: The agency also expects the additional burden emanating from migrations to Ind-AS and step-up in provisioning due to faster resolution of stressed assets would further dent banks' profitability. The agency believes scheduled commercial banks may need up to INR890 billion towards incremental provisioning for advances while transiting to the Ind-AS 109 regime.

Banks to Revive Core Earnings: The agency believes with a recovery in demand for bank credit, banks with better capitalisation may raise lending rates to improve net interest margins. Moreover, the building-up consensus towards a rise in rates by the Reserve Bank of India would entice banks to pre-empt asset repricing decisions. Hence, growth in advances and a likely improvement spreads will aid banks' pre provisioning operating profitability.

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