Mumbai: India is expected to increase the amount of bonds banks can hold free of mark-to-market rule to help manage record government borrowing, support loan growth and contain rising bond yields that are hitting banks' balance sheets.
The 10-year bond yield has risen by more than 200 basis points in 2009, leaving banks facing large markdowns on the value of their bond holdings and weakening demand for debt at a time the government needs to fund a widening budget deficit.
Banks want a resolution from regulators before the end of the year. Otherwise, they will have to report hefty losses on bond holdings in their end-December accounts because of the spike in yields.
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The win-win solution, banks say, is for the Reserve Bank of India (RBI) to increase the amount of bonds they can put in a hold-to-maturity (HTM) account free of revaluation requirements.
"There is no justification from a system point of view, but RBI might be considering it to alleviate pressure on banks due to the record borrowing programme," said A. Prasanna, economist at ICICI Securities Primary Dealership.
Reserve Bank officials have said the issue is under consideration. The expectation of an increase in the HTM limit helped bonds ease from 10-month highs last month and has kept them below that level since, despite worries of a possible tightening in policy settings.
"There is no volume growth for banks, net interest margins are under pressure because deposits are high, and on top of that if they have to provide for higher mark-to-market losses then it means that their earnings prospects get more depressed," said Rupa Rege Nitsure, chief economist at Bank of Baroda.
Indian banks can put bonds equal to 25 per cent of the value of deposits in their HTM accounts, and traders and analysts think this could be raised by up to 2 per centage points, possibly at a quarterly monetary policy review on Oct. 27.
Banks are currently required to invest 24 per cent of their deposits in approved government securities, so normally these could all be placed in the HTM account.
But with credit growth slowing and the market having to absorb the government's record gross market borrowing of 4.51 trillion rupees ($97 billion) in 2009/10, holdings are higher than required.
RBI data as of end-July showed banks had the equivalent of 28.1 per cent of deposits in approved debt.
Loan growth has slowed to below 13 per cent in annual terms, more than halving from rates of 28 per cent last year and below RBI forecasts.
R.V.S. Sridhar, senior vice-president treasury at Axis Bank, said rising market yields would spill over onto lending rates, and a HTM increase would spark a relief rally in bonds.
"In the lack of credit growth, at least the government security yields should not move up because then credit offtake would suffer even further," Sridhar said.
In August, the Reserve Bank allowed primary dealers, which underwrite government bond auctions, to set aside some of their bond portfolio in the HTM account.
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According to Reuters calculations, a 1 per cent hike in banks' HTM would free up 400 billion rupees of funds, which could be used to support demand for debt.
"We still don't have complete clarity on the borrowing front. Things will become clear only when the rabi (winter-sown) crop output is known in December, so a hike in HTM will provide an incentive for buying bonds," Bank of Baroda's Nitsure said.
