Softening of yields due to surplus liquidity is likely to help Indian banks book ₹38,200 crore of treasury gains (gains made by trading in financial markets) in FY17, according to India Ratings.

This would be significantly higher than the profit made by banks in total (profits from lending plus trading plus fees) at ₹23,600 crore last fiscal, the report said, adding that public sector banks had reported losses worth ₹17,700 crore last fiscal.

A surge in deposits, due to demonetisation, will increase demand for government and high-rated corporate bonds, and is likely to put downward pressure on yields given the current tepid credit-demand scenario.

Banks which hold about ₹29 lakh crore of government bonds (as on November 11, 2016) are poised to benefit from the softening of yields

The development would enable banks, which are facing weak profitability, pressure on asset quality and weakness in lending business, to strengthen their capital adequacy ratios, besides providing a likely opportunity for better-placed banks to improve their provision coverage ratios (money set aside to cover bad loans), which until recently was witnessing a downtrend.

The gains would also enable public sector banks to contribute towards their Basel-III capital requirements reducing the need to raise capital from outside. Banks have already raised capital through domestic additional Tier 1 (AT1) issuances worth ₹15,400 crore this year; this route would receive additional impetus due to reduction in yields.

India Ratings observed that a few mid-sized public sector banks saw their investment portflios rise as they could deploy incremental deposits in recent quarters.

Banks would also gain about 100-150 basis points on bonds issued by States under the Ujwal Discom Assurance Yojana (UDAY), India Ratings said.

UDAY bonds (bonds with maturity periods of 4-15 years issued at 8.1 to 8.75 per cent are now trading at about 7.25 per cent) have been converted into bonds from standard restructured loans given to state electricity distribution companies (discoms). In FY16, the value of loans converted to state government bonds under UDAY was about ₹75,000 crore.

The current value of the portfolio is about ₹1 lakh crore, a significant part of which continues to be a part of banks’ investment portfolio, the report said.

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