After a profitable first quarter in treasuries, banks’ trading operations in the second quarter will be hit as the next few months may be challenging, as the domestic money market may pay the price of tight liquidity for stability in the currency.
The yields of government securities (G-secs) increased on Monday after RBI sought to curb rupee volatility by tightening liquidity and reduce speculative positions in the currency. These measures may well continue for some time. This is considering the global uncertainties surrounding monetary tightening in the US and in particular India’s vulnerability from its elevated current account deficit.
The Reserve Bank of India on Monday announced measures to tighten liquidity by limiting the daily borrowing under the Liquidity Adjustment Facility (LAF) window to Rs 75,000 crore. Banks with wide funding gaps will also be impacted by rising funding costs as short-term money has become costlier.
G Secs lower
Banks’ trading income will be sharply hit with the 100 basis points (bps) jump in the bond yields on Tuesday. The widely traded 8.33 per cent G-Sec, maturing in 2026, ended sharply weaker at Rs 101.25 from Rs 105.40, while yields hardened to 8.17 per cent from Monday’s close of 7.66 per cent.
Banks may, therefore, need to re-appraise the size and duration of their trading portfolios, both of which had grown fairly aggressively in FY13 in anticipation of an easing monetary policy, India Ratings said.
The agency said, it concerns remain about the large funding gaps that persist in the banking system, which increases banks’ vulnerability during such periods of liquidity shock. Banks with large mismatches in their asset-liability positions are now particularly exposed to a hit on their net interest margin, as the cost of short-term deposits increases. This further emphasises the need for a re-balancing of banks’ asset-liability positions by issuing long-term liabilities to reduce the system’s refinancing risks, especially when liquidity is tightened at short notice.
The near-term impact of tight liquidity on domestic growth would therefore likely be negative. However, the long-term benefits that are likely to accrue from a stable currency and a better control on inflation could help improve the asset quality outlook for banks. These benefits could also provide an improved environment for corporate India to plan long-term investments.