Rising bond yields squeeze banks, hold back cheaper loans

Global uncertainty, no hopes of further RBI rate cuts this year has pushed up bond yields

Indian benchmark government bond yields have hardened back to January levels despite three interest rate cuts this year, a shift that is eating into banks' profits and hampering efforts to get them to pass on lower lending rates.

"This is a very anomalous situation where rates are getting cut and yields are hardening," said Arundhati Bhattacharya, chairman and managing director at state-controlled State Bank of India, India's largest bank.

The benchmark 10-year bond saw its yield jump to a six-and-a-half month high of 8.12% on Tuesday, although it has since eased 18 basis points to 7.94%.

In contrast, when the RBI cut its policy rate by an equivalent 75 basis points over the early months of 2013, 10-year bond yields dropped 60 basis points - encouraging banks to pass on the cut faster.

"Transmission will take time. In 2013, when rates came down, at that point in time credit growth was 20-24%. So banks could make up in volumes what they lost in the margins," Bhattacharya told Reuters. "Banks don't have the volumes today to make it up."

Since January, the Reserve Bank of India has cut its policy repo rate by a total of 75 basis points, but most banks have so far lowered their base lending rate by only about 25 basis points, a major concern for the RBI.

DRIVING UP COSTS

Typically, the Indian bond market mirrors the central bank's policy stance. But a combination of global uncertainty and stern RBI statements on inflation have dimmed hope of further cuts this year, pushing up yields.

Slowing foreign investment has also driven borrowing costs up, for both the government and corporate borrowers.

The AAA-rated 10-year corporate bond yield has risen closer to its January level at 8.55% after falling to nearly an 18-month low of 8.19% in early March.

India's banking sector, dominated by state-run lenders, is struggling under a bad debt load that continues to grow, forcing many banks to take increased provisions against losses, adding to pressure on bank profits.

But banks will continue lending to the government by buying its bonds. SBI says government securities make up roughly 28% of its book, well above government prudential requirements, given weak overall lending.

"It's a vicious cycle for banks," a senior trader with a state-run lender said, estimating a loss of around 50 billion rupees ($785 million) on government securities trading for the largest state-run banks in April-June.

($1 = 63.6391 rupees)