Markets

Will state bonds yield losses for banks?

MUMBAI: The central banks latest norms on the treatment of mark-to-market treasury losses came as a welcome surprise to Indian lenders, but they still face prospects of substantial value erosion on their investments in state-government bonds after Mint Street sought a change in valuation methods.

With a new set of rules now deployed to compute the value of the bond holdings, lenders may be staring at an estimated loss of about Rs 5,000-6,000 crore. The new guidelines take effect within the next two weeks.

“State bond yields may rise, triggered by the new mark-to-market guidelines,” said Ajay Manglunia, executive vice president, head, fixed income – Edelweiss Financial services. “Banks, which have sizable holdings of those state bonds, would have to take a hit for mark-to-market losses.”

On Thursday, the 10-year state bond yields rose about five basis points to 8.45%.

State bonds are known as State Development Loans (SDLs) in market parlance.

More than a decade ago the Fixed Income and Money Market Derivatives Association (FIMMDA) had derived the process of state bond valuation amid low trading in the instruments for pricing guidance, which is now set to be scrapped after the central banks latest direction.

State government securities are currently valued applying the Yield to Maturity (YTM) method, with a uniform mark-up of 25 basis points above the yield of the Central Government securities (G-Secs) of equivalent maturity. This means if an investor buys state bonds at 8.40%, these are valued at 8.25% if the benchmark G-Sec yields 8%.

The central bank moved the goal posts Wednesday in its bi-monthly policy. It has now said that the securities issued by each state government be valued based on observed prices.

Total outstanding state bonds would be about 24 lakh crore, of which banks could own Rs 8-9 lakh crore, dealers said.

Going by this calculation, the removal of 25 basis points spread over the government bond yields may result in an estimated mark-to-market loss of about Rs 5,000-6,000 crore, adjusted for residual maturities and categories of book keeping.

“The spreads on state development loans could move up as there will be no valuation gains arising from buying these securities now,” said Shailendra Jhingan, Shailendra Jhingan, CEO, ICICI Securities Primary Dealers. “There would also be differential pricing for different states based their fiscal metrics, which would be a welcome change.”

The spread or gap between the benchmark bond yield and state bonds is now at about 50-55 bps, which may expand to 75-85 basis points.

“This (RBI move) will reduce incentives for commercial banks to invest in SDL as it will exert pressure on state and corporate bond yields,” said Soumyajit Niyogi, associate director, India Ratings and Research.

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