Editorial: Banking on RBI

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SummaryPSU banks would have seen large erosion in profits

Though RBI’s Tuesday’s announcements didn’t help save either the rupee or the Sensex on Wednesday even though they displayed relative calm in the morning, bank stocks managed to end the day up—the Bankex was up 51 points while the Sensex was down 340 points. And with good reason, since RBI allowed banks to transfer bonds from the available-for-sale (AFS) category to the hold-to-maturity (HTM) category at prices prevailing on July 15, albeit within limits. Given how steeply yields on bonds have risen since July 15—the jump has been some 130 basis points to 8.9% on Tuesday—banks were staring at large mark-to-market losses on their investment books. That would have caused serious damage to banks’ bottom lines. Were 10-year yields to settle at 8.7% at the end of September, analysts estimate the hit to banks’ earnings at anywhere between 5% and 40% while book values could be lower by 1-10%. Given that banks would make no-profit or no-loss at yields of around 8.1% going by estimates, if yields had risen to 9% by the end of September, this would have wiped out a full year’s profits for some banks. Not surprising then that RBI has allowed banks to not just transfer bonds from the AFS portfolio to HTM but to also hold 24.5% of their net liabilities in the HTM category—they were earlier asked to bring this down to 23%. And after this has been done, banks are to be allowed to spread the losses across three quarters—the losses could be devastating and particularly painful for lenders like Canara Bank or Union Bank that are not so well-capitalised. Given how state-owned banks in particular are starved for capital and also have the largest amount of restructured loans, the mark-to-market losses would have been crippling.

While such special dispensation creates a moral hazard—after all, banks have made profits as yields have come down in the past—this particular case looks different. While bank treasuries should have anticipated a turn in the interest rate cycle especially given the recovery in the US and the near certainty the US taper will begin some time soon, the dramatic hike in yields was not something anyone could have anticipated and was a direct result of a misdirected RBI-government policy. Indeed, from RBI’s Wednesday’s announcements, it appears RBI itself was taken by surprise since the stated purpose behind its moves the past month has been to increase only yields

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