Banks nearing limit to buy bonds; RBI meeting bankers ahead of H2 calendar

Banks are nearing their internal limits on state bond purchases amid rising supply and widening spreads, prompting RBI consultations ahead of the H2 borrowing calendar

Many commercial banks are nearing their internal limits for buying state government bonds amid higher supply of such securities — a message likely to be conveyed to the Reserve Bank of India (RBI) during interactions with bankers ahead of the bond issuance calendar for the second half of the financial year. The RBI is separately meeting public sector banks, private banks and primary dealers this week to discuss the H2 calendar.

 

The internal limit could be linked to the held-to-maturity portfolio, the government securities book, or the overall investment portfolio. Some banks also set specific limits for individual states.

 

According to treasury officials, banks bought state government papers in the first few months of the financial year when the spread between state papers and central government securities was around 30 basis points (bps) for comparable tenures. Since June, however, the spread has widened to about 75–80 bps, as scope for further policy repo rate cuts has diminished. As a result, banks have had to book mark-to-market losses on their bond portfolios.

 

At Tuesday’s state bond auction, the cut-off on 10-year state bonds was set in the range of 7.63–7.69 per cent, compared with the previous week’s 7.27–7.49 per cent.

 

Eleven states sought to raise a record Rs 31,650 crore, against Rs 34,150 crore the previous week. However, Maharashtra did not accept any bids for its reissuance of two 2025 bonds worth Rs 750 crore each. States eventually accepted Rs 29,082 crore, with the yield spread between 10-year state bonds and the benchmark 10-year government bond climbing to 109 bps, compared with 80 bps the previous week. The average tenure of state papers has also lengthened in recent years.

 

“Demand was very good at the auction. I believe everybody in the market was there, including nationalised banks, insurance companies, provident funds and mutual funds. Cut-offs were slightly higher, but post-auction state bonds were well bid,” said a dealer at a primary dealership.

 

Discussions with the RBI may revolve around issuance composition, particularly as the yield curve has steepened.

 

“The yield curve is bear-steepening, meaning long-end rates are rising faster than short-end rates, reducing appetite for long-tenure papers. Earlier, states restricted themselves to 10–11 years. Now, they are issuing 25–30-year bonds, which has substantially increased long-end supply,” said a treasury head.

 

Consequently, appetite for long-end papers from both state and central governments has diminished. Market participants may request the RBI to issue more short-tenure securities — two-, three-, four- and five-year papers — to flatten the curve.

 

Market participants also pointed out that demand is largely saturated in the 7–15-year segment. Demand from pension funds and insurance companies, traditionally active buyers of state bonds, has been tepid so far in the current financial year for various reasons.