The Hindu Business Line : Rate hike: Banks’ bond portfolios may see loss

The latest round of rate increases by the RBI (repo rate by 50 basis points and cash reserve ratio by 25 basis points), are set to take both the rates to 9 per cent.

This may mean further increases in cost of funds and possible losses on the bond portfolios for banks.

Though the market had already priced in a 25 basis point hike in the repo rate, the double whammy did not go well with the market and most bank stocks hit the lower circuit.

The RBI has made it clear that inflation is its highest priority and has sent the strong message that this can only be achieved through management of liquidity and aggregate demand.

The policy is forward-looking and the CRR hike is pre-emptive.

It is expected to suck out Rs 9,000 crore from the banking system, once it takes effect on August 30. The RBI seems to have taken the stance that the earlier CRR hike on July 19 may not have a significant impact on the credit growth; this might be the reason for another rate hike.

In the review, the RBI seems to have taken the view that inflation (at 11.89 per cent) and crude oil prices (at about $125 a barrel), apart from deposit growth (21.7 per cent), credit growth (25.7 per cent) and broad money supply (20.5 per cent) are still way above tolerance levels.

The recent set of hikes may peg up the cost of funds for banks, which have already been borrowing an average Rs 30,000 crore daily through the repo window.

The call rates are already at 7.5-9 per cent, indicative of tight liquidity. This hike might force banks to review their lending rates.

Outlook

Bank profitability in the coming quarters may be under pressure.

The higher yield on bonds will dent the banks’ earnings especially banks with larger bond portfolios. An increase in the prime lending rate may slow advances growth and could also contributed to lower asset quality.

If the banks do not increase lending rates, they might have to take a hit on net interest margins.

The recent increase in the deposit rates is already reducing access to low-cost current account and savings account (CASA) deposits. In this scenario, banks with a higher CASA will be better placed to tackle rising cost of funds.

The review statement also asks banks to exercise greater caution on lending, in terms of credit quality, citing a high credit deposit ratio and possible asset-liability mismatch.

The RBI may consider doing supervisory review to check the portfolio of banks and their source of the funds.

The RBI may discontinue the Market Stabilisation Scheme for the time being and has also ceased the special market operation window for oil bonds, but there is no clarity on fertiliser bonds.

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