MUMBAI: With the Reserve Bank of India (RBI) planning to implement draft guidelines pertaining to the liquidity coverage ratio (LCR) from April, banks have started shuffling their investment portfolios among different investment categories.
Keeping draft LCR guidelines in mind, banks are planning to expand their availability for sale (AFS) book by keeping government securities with a maturity below five years in the said category, said market participants.
As per the investment norms, banks have three investment categories: held to maturity, available for sale, and fair value through profit and loss.
New LCR norms have pushed banks to buy short-term government bonds, as these guidelines would require banks to make more investments in high-quality liquid assets. Hence, keeping in AFS will give banks a room to sell short-term securities whenever there is a situation of stress.
“We have expanded our AFS books, and we are planning to continue doing so. Since our LCR stands at 105%, we plan to increase it to 110%. So, keeping that in mind, we need to invest more in short-term G-secs. And since it is a rate cut cycle, we would prefer it to keep in AFS,” said Nidhu Saxena, MD, Bank of Maharashtra, in a post-result conference call.
According to the bank’s quarterly results till now, most banks’ LCR is well above the threshold of 100%, hence putting them in a safe place. Large private banks such as HDFC and Kotak Mahindra Bank have LCRs of 128% and 140%, respectively. HDFC saw a 500 basis point rise in their LCR percentage on a quarterly basis. Meanwhile, Kotak Mahindra Bank has maintained the ratio well above the threshold.
In bond market parlance, AFS is referred to as a trading book, which means banks can take out their investments as and when required, unlike HTM and fair value.
Earlier in July, the Reserve Bank of India (RBI) released new draft guidelines on the LCR, which are expected to increase credit costs for banks, pressure margins, and drive demand for short-term government securities. These guidelines aim to tighten the Basel III Framework on Liquidity Standards.
Market participants said that keeping g-secs in AFS will serve them twin benefits. In addition to meeting requirements for the LCR norms, traders can reap benefits by booking gains in short-term securities, as these bonds are usually preferred in rate-cut cycles. With rising expectations that the RBI is likely to cut the policy rate at least by March, this has prompted traders to increase their bets on the shorter end of the curve.
So to reap the benefits of rate cuts, banks find it profitable to hold a higher percentage of G-Secs under AFS because if they keep it in other heads, they can no longer shuffle their investments, translating into a loss of Treasury income.
However, in order to avoid any mismatches in asset-liability due to heavy reliance on short-term bonds to meet the new LCR requirements, banks have strategically planned to move long-term government bonds into the held-to-maturity category (HTM).
The new LCR norms, if implemented as they are, and the cut in the policy rate may lead to a sharp decline in yields on short-term government securities. “Owing to this, most of the incremental buildup by the banks is kept in the AFS category, which is purely a trading call. The market has a discounted rate cut and spike in demand for short-term g-secs; hence, to reap early benefits, AFS is the best choice,” said a banking official at a large state-owned bank.
Source: The Financial Express
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