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Letters to BS on how uncertain bond market casts shadow on economy

Lower credit offtake has forced the banks to move their exposure from loan book to investment book

Business Standard 

This is with reference to “casts shadow on economy” (March 14). As the recent of headline inflation for February 2018 stands at 4.4 per cent, a tad lower than the Reserve Bank of India’s (RBI) forecast of 5.1 per cent for March 2018, the RBI may not ease the policy rate of interest and hence, a further spike in bond yield cannot be ruled out.

Lower credit offtake has forced the banks to move their exposure from loan book to investment book. As a result, a bank’s treasury holds, on an average, more than 10 per cent investment in G-securities. These excess G-securities are in AFS (available for sale) portfolio on which the bank has to provide mark to market (MTM). Due to an increased bond yield, the value of the holding portfolio will come down. This may affect the struggling public sector banks in the last quarter of the FY18. To avoid that, the RBI should allow one-time switchover of AFS portfolio to HTM (held till maturity) so that the banks can get relief from providing MTM in the last quarter. The switch of portfolio from/to AFS/HTM is allowed normally in the first quarter.

Another concern for bank G-securities holding is the higher duration. Higher the duration, higher the volatility of the bond prices, in response to the interest rates. Bond prices have an inverse relation to the interest rates. The banks have to try reducing their duration of bond holding by offloading higher-duration bonds from the portfolio. Banks have been replacing perpetual AT1 bond by recap bonds, issued by the government, due to the higher cost of servicing interest. These recap bonds have 10-15 years of maturity. Banks have to be judicious in replacing those maturing early say in 2020-21 with long-duration recap bonds because such replacement may result in higher duration of bond portfolio and add MTM pressure to their balance sheet. Overall, it is the situation of a tough bond market in line with a vulnerable banking space.

Ravi Kant

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First Published: Wed, March 14 2018. 21:35 IST