Informist, Thursday, Sep 14, 2023
By Nishat Anjum and Aaryan Khanna
MUMBAI/NEW DELHI – The new investment norms for banks unveiled by the Reserve Bank of India on Tuesday may not provide a fillip to the bond market as the initial enthusiasm suggested, according to bank treasury officials.
The revised framework, which will come into force from the next financial year starting April, updates the two-decade old regulatory guidelines in line with global standards while introducing a symmetric treatment of fair value gains and losses.
It removes the 90-day ceiling on holding period under held-for-trading books and the statutory ceiling on held-to-maturity bonds.
As per the revised norms, banks should classify their entire investment portfolio under three categories–held-to-maturity, available-for-sale, and Fair Value through Profit and Loss. The held-for-trading subcategory would be included in the last category, the RBI said.
Structurally, the measures add transparency to banks' balance sheets and get rid of an unpopular risk management measure with a more popular one, the officials said.
Immediately, the norms do signal an expanded appetite for gilts as banks have more room to add to their gilt holding, safe from the fluctuations of market prices.
At the same time, in the revised norms, banks will lose one of the key drivers of treasury profit–shifting of bonds from 'held-to-maturity' to 'available-for-sale' category.
Under the current system, commercial banks are annually allowed to shift their bonds designated as 'held-to-maturity' to their 'available-for-sale' books. This one-time adjustment happened in early April, and includes gilts and state government securities.
Banks are now required to designate bonds as "held-to-maturity" permanently, except for 5% of the portfolio that can be pulled out through the year. The exception to it can be taken only with the permission from their boards and from the RBI's Department of Supervision–difficult hoops to jump through for traders unused to such stringency.
Any further dip into the portfolio and justifications to the central bank are only likely to get tougher. With the ceiling removal from the held-to-maturity portfolio in the backdrop of lack of flexibility of reclassification, banks would have to be careful in expanding their HTM portfolio, officials said.
April onwards, as this flexibility gets out of the picture, banks would only have two options. Either they hold the bonds till maturity, as the name suggests, or sell the bond in the 5% sale from the portfolio. This has made overloading in the held-to-maturity portfolio risky.
"The new norms are not very punitive, they give banks room to hedge," said Ashhish Vaidya, managing director and head – treasury and markets, DBS Bank India. "I think banks will be able to align their HTM holdings with their capital structure, without going overboard."
The final calls will likely be taken in consultation with accounting departments, discussions that are yet to start as treasury officials are still digesting the changes.
The initial reaction was one of exuberance for long-term bonds across the board, before settling on bonds maturing in three to seven years that better match banks' liability.
But banks will likely binge on illiquid papers to park in the held-to-maturity book across tenures, which trade at a premium and offer higher yields than the often-traded securities in similar tenures. On-the-run securities may not enter the held-to-maturity book at all, beyond a 5% allocation that could be justified to extract from the portfolio.
This makes the new norms favourable for piling into bonds issued by states and corporate houses, where higher coupons can be locked in to maturity on an ever-expanding basis. These bonds also offer fewer opportunities to book profits due to their thin volume in the secondary market.
"State and corporate bonds are going to be the biggest gains (of the HTM change), the entire credit substitute book can now be put in HTM," a treasury head at a private bank said.
"Spreads may collapse so much that I start giving more money to the credit side to lend, instead of investing in corporate debt with the same credit risk."
Trading calls are likely to be taken closer to the Apr 1 deadline for implementation. While technological challenges may not be widespread, banks may take a call to expand their HTM portfolios to the 23% limit by Mar 31 to better capitalise on the quantum of withdrawal if interest rates are seen falling in 2024-25 (Apr-Mar), officials said.
In fact, after the new norms come into play, the usual quarterly churn of the held-for-trading book may die down. This would in turn mean that the trading volume in the secondary market may dry up, they said.
This may cause wilder price swings than those currently seen in the market.
"The volatility (in the secondary market) may in fact increase, because your impact cost will go up when there are lesser people in the market to absorb the impact," Vaidya said.
Public sector banks, the largest bondholders among banks by the size of their balance sheets, are often seen as the stabiliser in a volatile market. Given the size of their trading portfolios, they are often expected to step up purchases when yields fall, or sell and book profits at the bottom of a trading range, creating resistance at key yield levels.
With gilts likely to be out of favour to stock in the expanded HTM portfolio, their activity is expected to be in line with the rest of the market instead of a counterbalance.
The largest state-owned bank, State Bank of India, alone had an excess statutory liquidity ratio holding worth 4 trln rupees as of Aug 4. Union Bank of India had around 600 bln rupees excess SLR as of May 6, according to comments by the banks' management.
While the revised norms on held-to-maturity portfolio may not influence the trading picture, it is the 'available-for-sale' norms that banks have been waiting for.
For Available-for-sale category, now the net appreciation or depreciation will be directly credited or debited to a reserve named AFS Reserve without routing through the profit and loss account. This was one of the feedback given by the banks, as it would provide cushion to the profit and loss account from the volatility.
"Even with the 90-day ceiling removed from the HFT (held-for-trading), it has to be routed through the profit and loss account," a treasury official at a private bank said. "Whenever there will be uncertainty, they will take more position through available for sale. Their (banks) major concern was the marked-to-market on the profit and loss account."
The removal of the 90-day ceiling would be beneficial for banks, especially foreign banks which hold a sizeable amount in their held-for-trading portfolio, dealers said. However, as the bonds in held-for-trading portfolio have to be marked-to-market through the profit and loss account, this may discourage traders to take more risky bet through this book.
Meanwhile, the new framework may allow for an expansion of the derivatives market in line with the current development of the market, officials said. The norms will also facilitate the use of derivatives for hedging, and strengthen the overall risk management framework of banks, the RBI had said.
"In the new guideline, the netting off option is available. Now, it will be like an enabler for doing more FRAs (forward rate agreements)," the private bank official said. "FRA volume may increase going forward." End
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