Face the inevitable the spike in bond yields

Face the inevitable the spike in bond yields

The sharp rise in bond yields has hit banks with losses on treasury operations dominated by sovereign bond holdings. Rating agency ICRA believes the fall in bond prices on expectation of the Central government breaching its fiscal deficit target has led to banks suffering a loss on paper of over Rs.15,500 crore in the quarter that ended in December. The yield on Indian 10-year benchmark government bonds has risen steeply, from about 6.5% at the end of August to 7.56% on January 16. Even the yield on newly issued 10-year bonds that would mature in 2028 has inched up 27 basis points since January 5. Bankers have pleaded that the Reserve Bank of India allow them to stagger the reporting of these losses over several quarters. In seeking leeway, they have pointed to the huge burden imposed on their balance sheets by non-performing assets clogging the banking system. After all, India’s banks, flush with cash since demonetisation, are the largest (and captive) holders of government bonds, thanks to a regime that requires them to maintain a high proportion of assets in them. That deposits have grown while credit offtake has not, makes matters worse. But seeking regulatory forbearance is not the solution. This argument may not find much traction with the banking regulator, going by Deputy Governor Viral Acharya’s remarks on Monday.

Any kind of accounting chicanery that makes the books look rosy will come at the cost of the accuracy with which banks reflect their financial health. Banks, which are supposed to be good at assessing not just creditors’ credibility but also the broader trends in the economy and the financial markets, cannot feign surprise at a rise and fall in bond yields. As Mr. Acharya has pointed out, banks understand the impact of interest rate movements and the risks of bond investments, and they perhaps choose to ignore this thanks to a “heads I win, tails the regulator dispenses” mindset. Just as banks need to be held accountable for their lending decisions and their advances, treasury operations and bond investments also need accountability and risk management systems. After all, there are trained professionals handling their large bond market operations who know of the principles of asset allocation and the hedging of risks. Banks should simply step up their game and address the reasons for their investment losses instead of resorting to measures aimed at hiding their problems. Any temporary measure, such as the request to stagger the recognition of bond losses, will only worsen it. Moreover, irrespective of the accounting standards banks are asked to follow, the markets can easily call this bluff and bid down their share prices.