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Foreign banks prefer short-dated securities: RBI

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‘Such investments help them in overnight call market operations’

D. Sampath Kumar
Radhika Menon

Mumbai, July 23 More than half the foreign banks’ portfolio of investments in government securities is locked into short-dated securities (securities that mature in less than a year), says an RBI study published in the latest edition of its monthly bulletin.

In contrast, State Bank India and other public sector banks keep less than 10 per cent in such securities. In fact, SBI has actually reduced its exposure in 2005-06 (the latest year for which such data is available) to 9 per cent from 13 per cent in 2003-04.

Strategy

Foreign banks attribute their preference for short-dated government securities to their perception that interest rates more often than not, go up than come down. The fact that they also borrow funds in the short end of the market makes the case for their investment strategy, all the more compelling.

“For foreign banks, the treasury operations and funding take place mainly through the overnight call market. So, we prefer investing in one or two-year Treasury bills,” said a senior treasury official at a foreign bank.

“With surplus liquidity and call rates plunging to lows of 0.25 per cent, it makes more sense investing in a 2-year paper which offers a yield of 7.5 per cent rather than in a 10-year security which has a yield of 8 per cent,” added the official.

Sometimes such investments are also dictated by the policies of their overseas principal. In the case of one French bank, the global parent asks them not to invest in securities where the maturity is beyond five years.

Public sector banks

Although public sector banks suffer depreciation in their portfolios when yields harden, they choose to invest in longer dated securities because they reap benefits when there is a fall in interest rates.

But traders in the money market say that a fall in prices across longer dated securities is more drastic in comparison to securities at the shorter end.

“Short-term securities help foreign banks against adverse movements in interest rates. Besides, unlike public sector banks, foreign banks maintain separate banking (for statutory liquidity ratio requirement) and trading books,” said a bond dealer at a private bank.

Bond dealers say that even if there is a downturn in interest rates, on the whole, foreign banks stand to gain. The reason - periods when there are losses from hardening yields are much longer than when there are gains from easing interest rates.

But public sector bank officials scoff at any suggestion that they are missing out on an investment trick here. “Our portfolio is very large at Rs 38,000 crore. Foreign banks on the other hand have a smaller portfolio and it is easier to manoeuvre within that,” said the treasury head of a public sector bank. He has a point. It is not easy looking for Rs 20,000 crore in short-dated securities if the bank has to mimic the investment strategy of smaller foreign banks.

(This article was published in the Business Line print edition dated July 24, 2007)
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