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Banking On Bonds

The RBI observes that banks are overexposed to bonds. Cause for worry?

Debt Trap: Smell of trouble

When the RBI Governor, Bimal Jalan, warned banks against deploying most of their investible surplus in government securities (G-secs, as they are known), was he merely warning banks against putting all their eggs in one basket?

Was risk-diversification the underlying suggestion in his words? It could certainly be seem that way, particularly since banks have become unusually comfortable with G-secs. Not just as a statutory measure, but as an investment.

With money 'flying to safety', G-sec prices have been rather buoyant. Each time someone says that prices can't go much higher, they do. No wonder so many treasury operations across the country have made money on G-secs.

Today, estimates suggest that banks in India have as much as -- hold your breath -- Rs 500,000 crore invested in G-secs. This is nearly 40 per cent of their total deposits, compared to the mandated 25 per cent. No wonder G-sec yields (inversely related to price) have fallen by a good 400 basis points over the past two years.

That banks like G-secs is obvious. But why is Jalan bothered by the preference?

Ah, simply because everyone seems to be ignoring the downside risk. What is the trend -- of falling yields -- were to suddenly get reversed for some reason? Things could really take a turn for the worse if yields turned around. Today, the yield on a 10-year-bond is around 7.06 per cent, and analysts wonder if it can go much lower.

As Rajat Rajgarhia, banking analyst at Motilal Oswal Securities, puts it: "In case, the yields on G-secs were to harden, then most of the banks would take a significant hit on their profitability, and more so the banks that have been very very aggressive in churning their portfolio in the last two years.''

Banks, of course, complain that there's very little else that they can do with the money that would be within their safety limits, given the worsening economic conditions.

So -- will yields harden?

Not immediately. Not until there's an economic recovery, that is, which would increase the demand for funds. As things stand, businesses that can get money see little need for it.

But that's if everything stays normal. A sudden shock or some sort or the other, could do it too. Maybe the question to ask is this: assuming that there were no capital controls in India, would the bond market still behave the way it's doing?

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