Spike in bond yields to hit banks’ profits in FY18

An India Ratings estimate has pegged that the banking industry’s profitability would be hit to the tune of a hefty Rs 30,500 crore in FY18 owing chiefly to huge losses emanating from the sudden spike in bond yields.

This sudden spike, the ratings agency estimates, will result in large mark-to- market losses on the banks’ non held-to-maturity investments. This will result in a considerable fall in the banking industry’s treasury income in Q4 FY18 and a spillover effect in FY19, India Ratings adds. Banks reported a gain on treasury of Rs 59,800 crore in FY17.

Public sector banks (PSBs) are also expected to report losses. Mid-sized banks would be the worst hit by the treasury problem, the agency estimates, owing to what it calls their “proportionately swollen” treasury books, after a period of muted credit and large deposit growth and steeper treasury profit booking in FY17.

Of the potential loss of Rs 30,500 crore, the PSBs’ share is expected to be of around Rs 24,800 crore in FY18. This is against a profit of Rs 42,700 crore in the previous fiscal. The losses to be taken by the private sector banks are estimated at Rs 5,700 crore against a Rs 20,100 crore profit the previous fiscal.

What is worse, Ind-Ra feels the treasury loss will impact the renewed vigour which followed the announcement of bank recapitalisation. “After successive fall in bond yields starting from January 2015, rates have hardened from July 2017. The 10-year benchmark yield has moved up to 7.60% in January 2018 from 6.50% as on July 2017, up 110 bp in six months,” the ratings agency says.

The reason behind the increase in investments by banks isn’t far to seek. The banking systems’ investments increased significantly in FY17 and FY18 as banks constrained by capitalisation and low credit offtake parked their deposit accretion in low risk weight government securities, the agency points out. “As the yields were falling, some of the banks used realised gains to offset the profitability pressure on the core business. As the interest rate curve shifts, many of the banks, especially mid-sized banks could face large provisioning requirements.”

Further, the proportion of investment book that is exposed to mark-to- market losses has increased significantly over the years as the cap on held-to- maturity (HTM) reduced to 19.5% in FY17 from 22% in 2015. With the rising bond yields, banks will have to provide mark-to- market losses on these, it adds.

The agency also expects the additional burden emanating from migrations to Ind-AS and a step-up in provisioning due to faster resolution of stressed assets would further dent banks’ profitability. “The agency believes scheduled commercial banks may need up to Rs 89,000 crore towards incremental provisioning for advances while transiting to the Ind-AS 109 regime.

According to India Ratings, with a recovery in demand for bank credit, banks with better capitalisation may raise lending rates to improve net interest margins. Moreover, the building-up consensus towards a rise in rates by the Reserve Bank of India would entice banks to pre-empt asset repricing decisions. “Hence, growth in advances and a likely improvement in spreads will aid banks’ pre-provisioning operating profitability,” it says.