State govt bonds to yield better returns under new investment regime

The higher yield on state government bonds compared to central government securities is expected to make the former a “major draw” for banks for their investment book under the new portfolio norms, which kick in from April 2024.

Treasury officials said while the central government paper would continue to have the largest share in the portfolio, the state government bonds would give comfort of better returns to manage any pressures from adjustments in the months ahead.

Under the new norms, banks must categorise bonds as “held-to-maturity” on a permanent basis, with the exception of 5 per cent of the portfolio that can be withdrawn throughout the year.

Any deviation from this rule requires approval from both the bank's board and the Reserve Bank of India (RBI).

Earlier, banks were allowed to reclassify their investments between categories once a year on the first day of the financial year, through which they used to book capital gains.

“The character of demand for government bonds may go under change. Overall demand from banks, especially from public sector lenders, will not decline. The higher premium on state government paper will remain a draw for banks for their SLR book,” said the head of treasury with a large public sector bank (PSB).

Another treasury head of a mid-sized PSB said under the revised rules, there would not be any limit of holdings of paper in the ‘Held-to-Maturity’ category. “So, this could drive the effort to have high-yielding paper like state government bonds, subject to liquidity requirements of banks,” the person said.

On Tuesday, 12 states raised ~32,800 crore through state government securities (SGS), marking a 27 per cent decrease from the highest-ever weekly auction target of ~45,200 crore specified for this week in the auction calendar. The weighted average cut-off eased to 7.44 per cent, down from 7.46 per cent in the previous week.

Furthermore, the spread between the cut-off of the 10-year SGS and the benchmark 10-year government bond yield narrowed to 37 basis points (bps), compared to 41 bps in the previous week.

State borrowings, though less than the central government, are significant in terms of amounts.

While gross market borrowings of the central government stood at ~15.13 trillion till mid-February 2024, states raised ~7.53 trillion during the same period, according to RBI data.  

The revised norms permit banks to categorise their entire bond investment portfolio into three classifications — held-to-maturity, available-for-sale, and fair value through profit and loss (FVTPL). The new regulations integrate the existing sub-category of held-for-trading (HFT) into the last category.

After transitioning to this framework, banks are not allowed to reclassify investments between categories without the approval of the boards and RBI.

The norms mandate that securities that are classified under the HFT sub-category within FVTPL should be fair valued on a daily basis, whereas other securities in FVTPL will be fair valued at least on a quarterly, if not on a more frequent basis.

“The impact of market movement on treasury books will be through reserves and not the profit and loss accounts. This will reduce the volatility of the flow of income from treasury and enhance transparency,” said the chief financial officer (CFO) of a PSB.

Banks have also started preparing in terms of technology upgradation, and modification for a smooth transition to the new regime.

“Banks have been working on upgradation of the current technology to ensure smooth transition to the new investment portfolio norm. Everybody is working on modification,” the treasury head at a private bank said.