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Falling bond value to hit bank profits

Banks are set to feel the heat of continued policy rate hikes on their profitability, more so because of a fall in the valuations of their investments in government securities, in the next few quarters.

B.S. Srinivasalu Reddy | May 28, 2011 | Updated 09:02 IST

Banks are set to feel the heat of continued policy rate hikes on their profitability, more so because of a fall in the valuations of their investments in government securities (Gsecs), in the next few quarters.

Though the relationship between high interest rates and lower treasury profits is well documented in the past, even currency exposures are set to singe their treasury profits in a big way, with dollar weakness surprising the market during the last few weeks.

Though banks take exposure to equities too, through investment in corporate debt or swapping stocks for unpaid loan dues, this exposure is not big enough to affect them much, experts said.

"Not much treasury income can be expected in the coming quarters. Interest rates on the uptrend are set to have a negative impact for two quarters (till September, 2011). However, yields are unlikely to go up much from here," said Vaibhav Agrawal, banking analyst of Angel Broking.

Yields of the benchmark G-Sec - 7.80 per cent 2021 bond - rose to 8.45 per cent on Friday, from 8.01 per cent on March 31, 2011. Given that the rise has come within a short span of six weeks, it is considered a big negative for banks as the price of the bond is inversely related to the price it fetches.

However, for most private sector banks, the impact is not expected to be too severe, as their treasury profits as a percentage of their profit before tax (PBT) is not as high as in the January-March 2011 quarter (Q4). "Only G-Secs will underperform, mainly on account of rising interest rates. But that has been there for the last two quarters as well. But customer (service) revenues will continue to be buoyant," said P. Mukherjee, president-treasury, Axis Bank. Even interest rates would hurt only the banks that have huge portion of their bond investments in the Available For Sale (AFS) and Held For Trading (HFT) categories.

"AFS bonds may see some pain (suffer some losses in their values) when they are marked to market (MTM), while HFT category bonds are only floating investments (of a day or two)," said a treasury head of a public sector bank, who wished not to be quoted. Another category of bonds, HTM (Held Till Maturity), are not shown in the books at market value.

More pain is also expected to be felt on the currency front, in which many big banks invest in billions of dollars in the futures market. These banks are already in a state of shock with forward premia for the dollar for six months slipping from Rs 3.27 per dollar on May 3, 2011 (when RBI announced its annual policy) to Rs 2.01 now - in a mere three weeks.

"The bets taken based on high inflation and interest rates have gone awry, forcing many banks to cut their exposures in the recent weeks," said Paresh Nayar, headforex and money market treasury of FirstRand Bank (India).

However, the banks may not get affected much in the currency spot market as their investments in this segment are not high. Responding to a query, Agrawal of Angel said that for banks the pressure on margins would continue for three to four quarters, while the pressure on treasury profits would last only for a couple of quarters.

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