September 28, 2022
  • September 28, 2022

Banks may not need special treatment to improve bond portfolios

By on August 11, 2022 0
Banks are asking for a waiver for their bond portfolios that lose value as interest rates rise. This affects their earnings and, naturally, their stock price. Suggested options include staggering provisioning requirements, calculating cash losses after reaching operating profits and extending the deadline to lower the cap on the proportion of bonds they can hold until l ‘deadline.

There is precedent for the first course, and the Reserve Bank of India (RBI) has given banks more than a year to increase the proportion of gilt holdings that must be marked to market. Banks have made significant cash gains when bond yields have been low for the past two years, and special treatment of cash losses during a tight liquidity phase may not be in the shareholder’s best interest. .

Moreover, with inflation peaking in the first quarter, subsequent central bank action on interest rates may be less aggressive. The worst could be behind the banks in terms of the notional impact on their bond portfolios.

Demand for bank credit exceeded supply, with loan rates rising almost twice as fast as term deposit rates. Banks fuel credit demand with liquidity injected into the system from the central bank‘s expanded balance sheet. Shaktikanta Das stressed that banks will have to adapt to policy normalization by raising their own money to lend.

The central bank is pushing the system to reassess credit risk as it drains liquidity. This is essential to the policy normalization process, which requires liquidity management to complement changes in interest rates. As the terminal interest rate approaches, systemic liquidity should also head towards a slight surplus.

With fiscal support on supply shocks, RBI must take into account underlying inflation. This requires a responsive transmission mechanism for monetary contraction. Financial markets tend to adapt better to quantitative easing than to tightening. Central banks must correct this behavioral anomaly.