RBI impounds NDTL from banks as statutory obligation, currently at 18% for SLR and 3% on CRR, with special dispensation of holding SLR securities upto 19.5% in HTM category. While option to hold entire SLR book in HTM insulating from mark to market risk is not prudent practice (for determining book value), pushing Banks to buy more with option to park in HTM defies logic of financial intermediation. Now, post Covid-19 when market borrowing by the Government has shot up to over ₹12 Trillion to fund widening fiscal deficit, RBI hikes HTM limit for SLR securities to 22% with caveat that it applies for purchases of bonds issued on or after 1st September 2020.
RBI agenda of late is 2-fold – first, to ensure that Government’s borrowing schedule goes without market disruption at lowest cost possible and second, to ensure that credit flow to non-state borrowers is smooth at affordable rates. There’s debate on the priority of RBI, whether the Government or private borrowers, which will keep it aside for now. Having said this, RBI tried its best to direct credit flows to non-state borrowers (through provision of extremely lower cost liquidity providing better margin to cover credit cost) but couldn’t meet with success if seen from the quantum of reverse flow into Reverse Repo counter. Given the risk-aversion below AAA/AA borrowers, RBI has now chosen to divert the excess liquidity to the Government, thus helped to arrest run away spike on longer (5-15 years) tenor Gilt yields. It makes sense when new 10Y Gilt fell from issue coupon of 5.77% and 2nd issue devolved at 5.96% with spike to 6.20% – all within a month of issue in August, which is one of the worst disruption in the market. It’s an achievement of sort for RBI to establish stability at 5.90-5.95% when momentum was strong into 6.25-6.50%. It’s good to give the benefit of achievement to RBI and avoid getting deep into logic and conflict between intent & action.
What about Banks? Foremost, 10Y yield push back from 6.20-6.25% to 5.85-5.95% is big relief on AFS/HFT portfolios from huge mark to market loss that would have hit them hard on P&L of Q2/FY21. Secondly, does it makes sense for Banks to acquire longer tenor bonds at sub 6% yield when average cost of NDTL is around 6% for most banks at much shorter weighted average duration. This means that without spread benefit, Banks open up ALM risk when probability of hardening interest rate is high. So, it could end up as negative-sum game for Banks to buy Gilts to be issued since 1st September at 5.85-6%. Is RBI presuming that credit pick up is not going to happen in the medium term to push banks into this position? Does it provide comfort beyond OMOs ensuring that liquidity overhang position is there to stay to keep replacement cost remain sub 6%? If replacement cost between outgoing & incoming cost goes high, then would be big regret for Banks for obliging to RBI & the Government for buying against backstop market risk dispensation!
What’s the utility & usefulness of HTM category? Is it used for the purpose of intent to park matched maturity assets for liabilities. For example, if there is fixed rate term deposit of 10 years, Banks can buy 18% of the deposit in HTM category to achieve matched maturity ALM. When deposits are not marked to market, it makes sense to avoid m2m on statutory obligation and good for spread preservation through the life span of the deposit. The catch here is that while depositors have the flexibility for premature closure without penalty, the same dispensation is not available if the underlying (cover) SLR is at loss. So, bottom-line is that HTM category ends up as parking lot for “out of the money” securities (at lower YTM to market) when there’s option to take out “in the money” securities once in a year or for participation in the OMO to book profits categorised as “profit on sale of investments” and most call as trading profit from Treasury without mention of NII sacrifice for residual period. While it’s not fair to release financial results without disclosure of m2m position of HTM book, it’s not the time to deal with this now, but good to flag this as an agenda for investors, depositors and other stakeholders on the liability side of the balance sheet.
RBI Governor is “walking the talk” decisively ensuring that Government is not put to any kind of discomfort when the going gets tough, and of course to ensure orderly market conditions to ensure price stability to extent possible. It’s another subject on What Next whether 10Y could be made sustainable at 5.85-6%.
Moses Harding
