A day after Reserve Bank Deputy Governor Viral Acharya warned that the bond market risk of banks “cannot be managed over and over again by their regulator”, bond prices tumbled and yields rose sharply on Tuesday, adding to the nervousness in the bond market. The 6.79 per cent 10-year benchmark bond maturing in 2027 slipped to Rs 94.9475 from Rs 95.65 previously, while its yield rose to 7.55 per cent from 7.44 per cent. When bond prices fall, yields move in the opposite direction and rise. The yield on the new benchmark due January 2028 jumped 11 basis points to 7.38 per cent and is up 27 basis points since it began trading on January 5.
The 6.68 per cent government security maturing in 2031 dipped to Rs 91.85 from Rs 92.69, while its yield moved up to 7.65 per cent from 7.54 per cent. The 7.17 per cent government security maturing in 2028 fell to Rs 98.51 from Rs 99.28, while its yield up to 7.38 per cent from 7.27 per cent. Dealers said Acharya’s comments added to the nervousness of an already jittery market.
“The sentiment is already weak due to additional borrowings, the possibility of higher fiscal deficit, uncertainty around the budget and higher oil prices. This will also put pressure on the RBI to eventually hike interest rates,” they said With banks staring at huge losses on their investment portfolios due to a surge in the yield on the benchmark 10-Year Government Security (G-Sec), Acharya on Monday pulled up the banks saying that risk management “leaves a lot to be desired” and asked them to modernise their treasury functions and adopt robust risk controls.
“While duration risk management is constrained by the G-Secs issuer’s choice of maturity structure and liquidity in the secondary bond market, the risk can be managed more nimbly by also availing of hedging markets,” Acharya said.
Bond yields have been rising in the last five months. “My point in showing this time-series and episodic phases of G-Sec yield movements is that banks should not be surprised repeatedly when government bond yields rise sharply and their investment profits drop,” Acharya said.
The RBI’s Financial Stability Reports (FSR) have regularly pointed out the impact of such large interest rate moves on capital and profitability of banks. Banks should know and understand this risk rather well. Perhaps they do, and the issue is really one of incentives that lead to their ignoring this risk, Acharya said while addressing a function organised by the Fixed Income Money Markets and Derivatives Association (FIIMDA).
Rating agency ICRA had said banks may face mark-to-market losses of about Rs 15,500 crore on their investment portfolios in the October-December 2017 quarter due to surge in the yield on the benchmark 10-Year Government Security (G-Sec) by 67 basis points in the said quarter. The share of commercial banks in outstanding G-Secs is around 40 per cent (June 2017). Investment of scheduled commercial banks (SCBs) in G-Secs as a percentage of their total investment was around 82 per cent for FY17. The corresponding figure for public sector banks for FY17 is slightly higher at 84 per cent. This exposure has noticeably increased since 2014.