The Hindu Business Line : PSBs: Capital needs force rethink

BONDS continue to be volatile. After the giddy rise from 5.25-per cent levels to 6.7 per cent in about six weeks, 10- year yields crashed to 6.05 per cent in just five trading sessions last week. This despite the none-too-friendly data last Friday, when inflation was reported at 7.94 per cent against 7.96 per cent the previous week.

As far as the RBI is concerned, bond market players are the new kids on the block. It is right.

A speculative frenzy drove 10-year yields below 5 per cent in the latter half of 2003. It took strong words from the central bank to bring the market back to saner levels. Yields appeared to stabilise in the 5.25-per cent range when casual remarks from the governor that Indian interest rates have international linkages caused panic in the market. As players headed for the exits, yields soared close to 6 per cent. The relentless rise in world crude prices pushed them further to the 6.75-per cent region.

The trigger for last week's sharp drop in yields was the turnaround in the oil market where prices started retreating from close to $50. It was helped in no small measure by the Finance Minister and the RBI governor's hints that there were no provocations to increase interest rates. The reported moves to relax the valuation and provisioning norms for banks' investment portfolios also boosted sentiment.

There is little doubt that the severity of depreciation of bonds is a grave matter for all involved: banks, the RBI and the Government. The bottomline of most banks will shrink considerably; some will even go into losses. Given the tardy growth of and attention paid to traditional lending, it was only the gains from investments at high interest rates that enabled banks to report high profits in recent years.

The whole thing could not have happened at a worse time. For, the RBI has asked banks to prepare a "roadmap" to achieve the (tighter) capital standards of Basel II by 2006. Before that, staring in the face is the capital provision required for market risk in investments in March 2005 and 2006. Even the strongest banks would be hard put to meet these entirely from internal resources.

Inevitably, the government would be called upon to shore up the capital of weak public sector banks to the minimum levels. Possibly, as a way out, it recently started thinking aloud about consolidations and mergers of strong and weak institutions. The banking landscape will look very different some years from now.

But the public sector will continue to dominate the scene. Barring the offshoots of erstwhile FIs, none of the new private sector banks or many old ones inspire trust and confidence.

More Stories on : Insight | Public Sector Banks | Debt Market | Financial Scan

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