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Banks to incur losses after RBI lowered bond prices

MUMBAI: The Reserve Bank of India has ordered Fixed Income a..

MUMBAI: The Reserve Bank of India has ordered Fixed Income and Money Market Dealers Association, which sets prices of bonds for official purposes, to lower the prices of select securities, dashing hopes of banks looking to reduce losses in their bond portfolio.

In the October-December quarter, bond valuations fell as the government breached fiscal deficit target, leading to losses for banks — mostly state-owned lenders — in their bond portfolio.

Now, trades in some illiquid papers had suddenly intensified in the last hour on December 29, the last full trading day of 2017, three people with knowledge of the matter told ET.

"This raised regulatory doubts," one of them said. "RBI ordered to take the level recorded at 4.05 pm that day instead of the usual 5 pm closing level," the person said.

A trader at a bond house said that while some smart traders have shifted to the benchmark paper from illiquid bonds, some banks tried to take advantage of the illiquid bonds risking their portfolios a bit. "The bet backfired," the person said.

FIMMDA confirmed revision of valuation prices in a running ticker on its website. "As per RBI instruction valuation prices (SLR and non-SLR) for month and quarter ending December 29, 2017 are revised and uploaded on our website on 31st December," it said. "All RBI regulated entities are advised to comply with the same."

During October-December, the benchmark bond yield surged about 87 basis points, pulling prices down. Bond yields and prices move in opposite directions.

"RBI seems to have done the right thing as bank risk management has a greater role to play in any market crisis," said one of the sources cited earlier.

A government paper (carrying 6.79% coupon) maturing in 2029 was yielding about 10 basis points less than the benchmark bond maturing in 2027.

"Ideally, when you see some potential of rate rises, you should cut average duration of your bond portfolios," said a head of treasury from a large bank. "Some banks constrained with red-tapism could not do so which, in turn, have resulted in mark-to-market losses," the person said.

Earlier in this month, ET had reported that a group of state-owned banks approached the central bank seeking exemption from recognising mark-to-market losses on their government bond portfolios in the December quarter.

They requested the regulator to allow them to spread these losses over two quarters (ending December and March).

The RBI had in 2013 permitted banks to spread their losses over a period instead of in the same quarter. At that time, the rupee was at a record low while bond yields had shot up about 100 basis points within a short span.

"If RBI keeps giving such exemptions it will set a precedence diluting the role of risk management in public sector banks, which are already battling so many other things," said another dealer from a bank.

Benchmark bond yields spurted almost 100 basis points in 2017.

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