Bond cover-up

A large part of Indian banks’ non-performing asset (NPA) woes can be traced to the fact that when their lending decisions go awry, they sweep them under the carpet to present a palatable financial picture to the public. This window-dressing is now set to extend to their treasury operations too. The RBI has this week allowed banks to defer the recognition of large mark-to-market losses on their bond portfolios made in the quarters ending December and March, by spreading them over four quarters. Given that banks are estimated to have provided for losses of ₹15,500 crore for the December quarter alone, this will help them write back provisions and pad up their reported profits over the next few quarters. This is the diametric opposite of conservative accounting practice, as banks liberally used treasury windfalls in FY17 to shore up their profits by nearly ₹60,000 crore. Analysts believe that RBI’s relaxation is intended to cushion banks from the likely surge in NPA provisions over the next few months.

There may be pragmatic considerations driving the RBI’s decision. Liberal splotches of red ink on P&Ls may have spooked depositors and aggravated public sector banks’ capital adequacy problems. Banks have stayed away from government bond auctions of late and the RBI was probably under pressure to cajole them back too. The regulator has also tried to counter-act the impact of this leeway by asking banks to disclose their deferred losses and requiring them to create an Investment Fluctuation Reserve, to handle future spikes. But the move still is a negative for investors and markets. While analysts may be able to strip out the treasury component to get to the true and fair picture of bank profits, lay investors and depositors are likely to be misled by the banks’ reported numbers. It is also unfair that other bond market participants such as insurers, pension funds and debt mutual funds — which have retail investors — will have to bear market losses on bonds while banks go scot-free. There’s also a moral hazard to letting banks escape the consequences of their poor treasury calls time and again.

It is not as if the RBI is unaware of this. Just this January, in a speech at an industry event, Deputy Governor Viral Acharya hauled up banks for taking a “Heads I win, tails the regulator dispenses” approach to managing treasuries. He recounted multiple instances in the past where banks had pocketed hefty profits from falling rates, while lobbying the regulator for accounting leeway when staring at losses. But that the RBI has had to give in to the banking lobby yet again, after talking tough, hints at the inherent conflicts it faces between its regulatory role, and that as the manager of Government debt. One hopes that the regulator will keep pressuring banks to upgrade their risk management and treasury skills through tools such as interest rate futures, swaps and options.

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