The Hindu Business Line : Banks face year-end valuation blues

FACED with a steep fall in bond prices banks are faced with the year-end valuation blues and some of them face the prospect of large contraction in bottom lines.

The ten-year Yield to Maturity (YTM) was expected to be fixed at 6.65-6.67 per cent range for valuation purposes on the last trading day, up from the March 31, 2004 level of 5.15 per cent. Yet, despite this sharp rise in the ten-year YTM, not many banks are expected to see redlined net earnings on account of depreciation of investments.

One major reason was that most of the banks had made excess provisions for depreciation.

Mr K.V. Hegde, General Manager (Treasury), said: "Most banks have already fully provided for their deprecation in the first half of the year itself. So not many banks are likely to be affected by the higher year-end YTM."

During the first half of the financial year, the ten-year YTM had tested even 6.75 per cent. As a result, bankers said that banks had taken the hit at that point of time.

In fact, during the first and second half of the year several banks had opted to show losses, on account of the large depreciation charges on their investment portfolios, in particular in their categories marked to the market.

These include securities held-for-trading and in the available-for-sale categories.

Besides, bankers had also taken a large hit, when some of them were given a one-time reprieve of when changes were made in the nomenclature, which allowed them to have securities up to 25 per cent of their demand and time liabilities as part of the held-for-maturity holdings.

Yet, despite this reprieve some of the smaller banks are still likely to face large depreciation charges. In fact, some of them even face a redlined balance sheet.

Part of the problem, bankers said was on account of RBI's refusal to permit banks to take recourse to the investment fluctuation reserve (IFR).

Under the current guidelines banks are expected to create a reserve equivalent to 5 per cent of the investments. Most banks have reached this limit.

"If IFR is allowed to be utilised for depreciation, none of the banks would face such problems," the bankers said.

Moreover, bankers said that in a bid to cut possible losses on account of depreciation, most banks have begun de-risking their portfolios.

This de-risking involved shrinking the maturity of the investment portfolios. In fact, most of the banks now reduced the average maturities for their investments to less than five years.

In the case of the new private sector banks, the average maturity is now down to a year. This was because shorter maturities are seen as far more liquid.

Besides, bankers said, with credit growing at over 30 per cent on a year-on-year basis, most banks preferred to sell their securities despite the possibility of losses. In fact, most of them preferred to liquidate their high coupon securities to life insurance companies where the possibility of losses was less to fund the credit growth.

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