India’s central bank is considering reducing the proportion of lenders’ bond holdings that is shielded from market fluctuations as it seeks to boost trading in government securities.
Banks can hold as much as 25 percent of their deposits to maturity without valuing them at the latest market prices. Lenders have to invest at least 23 percent of their deposits in securities issued by the finance ministry and other approved notes under the so-called Statutory Liquidity Ratio.
The hold-to-maturity norms protect banks from losses and encourage them to buy government debt. Yields on India’s 10-year government bonds fell 52 basis points last year, according to data compiled by Bloomberg. The biggest drop in yields in four years may make it easier for the central bank to change the rules, according to Reserve Bank of India Deputy Governor Harun Rashid Khan.
“We are trying to phase out” the accounting rule of holding debt to maturity, Khan said in an interview in Colombo on Feb. 2 . “This may be right time to do it as bond market has rallied and many of them are in the money.”
India’s 10-year bond yield declined 14 basis points last month, the most since June, to 7.91 percent, according to data compiled by Bloomberg, as the central bank cut interest rates for the first time in nine months.
“We will take market participants into confidence and draw up a plan that is quite non-disruptive,” said Khan.
The rule may spur activity as investors “book profit,” said Arvind Sampath, treasury head at Fullerton India Credit Co., owned by a unit of Singapore’s state-owned Temasek Holdings Pte. “The usage of hedging products, primarily interest rate futures and swaps will also increase.”
Need to Hedge
While foreign banks mostly value their investments at prevailing prices due to global accounting rules, state-owned banks make most of the relaxation provided under the hold-to- maturity category to keep losses from reflecting in their balance sheets, which also discourages any need to hedge, according to Harihar Krishnamoorthy, treasurer at FirstRand Ltd. (FSR) in Mumbai.
State-owned banks, which manage 74 percent of bank assets in India, account for less than 2 percent of of the interest rate swaps market, central bank data show. Private sector banks, which manage about 19 percent of total assets, account for 18 percent of swaps outstanding, and foreign banks, which manage about 7 percent, account for 80 percent.
Apart from held-to-maturity, Indian lenders also hold debt in the held-for-trading category, where the assets have to be valued at current prices at least every month. Such securities must be sold within three months after they were bought.
Investments in the so-called available-for-sale grouping need to be valued every quarter. There is no compulsion to sell the securities marked under this category.
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