Banks will have to do their own cost to benefit analysis to put corporate bonds in HTM, says ICICI Bank

Bonds are classified broadly into three groups, one is held-to-maturity (HTM) bonds. Bonds classified as HTM will have to be held till they mature, banks cannot sell them in between. Second is available-for-sale (AFS), these bonds may be sold by banks after a couple of years to book profit. Third held-for-trading (HFT) these are bonds in which banks trade very quickly within 90 days or so.

Last week the Reserve Bank of India (RBI) announced big changes about how banks should value the bond investments on their books. First, current rules HTM bonds are - you can hold only up to 23 percent of a bank deposits in HTM. Under the new rules, no limits, you can hold any amount of bonds under HTM. Second one currently corporate bonds are not allowed under held-to-maturity category. New rules - corporate bonds can be kept as HTM category. Third, under current rules profit and loss on AFS bonds have to be adjusted in the profit and loss (P&L) in that quarter when they are sold. Under new rules, banks have to create an AFS reserve in the balance sheet by moving capital there. So sales will not affect that quarter’s P&L.

All AFS profit and loss have to be adjusted now only in the capital account, not in the P&L.

Fourth important on HFT - currently, the mark-to-market losses go to the P&L, but profits don't go to the P&L, profits you cannot take. Under new rules, profits can also be taken to the P&L.

A: You've explained the changes pretty well. The ability of banks now to put corporate bonds in HTM is one of the most significant changes. There are others as well that we can possibly discuss. But as far as corporate bonds are concerned, I think the way banks are going to respond to this new guideline will be – I think each one bank will have to look at its own kind of balance sheet and the way they have been operating and then decide on what is the best way of going forward. And the reason I'm saying it is that while the fact that I can put a corporate bond in the HTM is really very positive, because I can actually get the higher yield coming from corporate bond, but I don't need to be worrying about the mark-to-market (MTM) risk. But also bear in mind that the minute a corporate bond goes from the trading book to the HTM book, the banks will also lose the benefit of the PSL not being there for a corporate bond.

So to that extent, I think the way banks will react is each bank will have to do its own cost benefit analysis, in terms of what the focus of the Treasury is and what the situation of the balance sheet is. And banks, like PSU banks and nationalized banks possibly, I suspect, do not have PSL as a big issue - might be more aggressive in putting corporate bonds in the HTM, while private sector banks would typically will have PSL issues in terms of how they satisfy the requirement, they might do this cost benefit analysis and say that once you put it in the HTM does the cost of doing PSL outweigh the benefit of putting the corporate bond in the HTM.

A: So, in terms of the larger guidelines, I would rather than speak for the banking system in general and I would of course, make a differentiation whenever I think it is justified, but it's a big positive for the financial ecosystem in general, because most of the changes - by the way it's a 90 page document and there are a lot of small changes as well, other than the big changes.

But most of the changes actually increase the flexibility for the banks, and also results in increasing transparency and disclosure. And basically one of the things that you mentioned is the most important thing, which adds to flexibility is the removal of the HTM limit, which actually can help in capping an upside in yields when there is an adverse event. Bear in mind that HTM was a very important tool that RBI sometimes has been using as a tactical tool, whenever there is an event risk or a big event that is not going well and yields are shooting up, they come and increase HTM. So what it will do is, depending upon the steepness of the curve, if the curve is flat, then banks don't get an incentive to go into the longer end of the segment or go into any spread paper. But if there is steepness in the curve, then the banks do get the benefit of going into the longer end of the curve, because they can pick up the extra yield, which comes out of these investments.

Also, one important aspect was that post FY26, banks will have to disclose the book value and the fair value of the entire book. This is something that is not happening right now. So pretty much anybody poring over the balance sheet of P&L would not really know whether the bank's HTM book is performing better than any other bank’s HTM book. Now what that will do is a very large gap should be between the book value and the MTM value of the HTM book is not generally considered good for various stakeholders. And since this is going to be disclosed post 26, I think it will dissuade banks from cherry picking from HTM book for booking profits. And in the long run, this is good both from an analysis perspective that they have more information and also from a market perspective that you don't get artificial supply coming in from the HTM book.

One more small thing is, while of course there are a lot of positives associated with these relaxations, let me just point out a couple of negatives. It is that there is now less flexibility to sell bonds from the HTM. Earlier the current guidelines actually allow a one-time transfer from the AFS book to the HTM book unlimited in the month of April, typically, which then allows the bank to sell it later. And hence, banks could have - some banks were doing it, were able to pick up the best bonds, transfer it and then sell it and book profits. Now going forward, one time transfer post guideline coming into benefit into operation is not going to be allowed. And similarly, there was a five percent limit for sale from HTM, that is still there going forward. But then there is a need for disclosure even if you sell within the 5 percent limit. And so some banks might decide not to do even that 5 percent selling because there has to be a lot of disclosure.

A: These changes are synchronizing the rules with what is there in the international market and hence, there were certain points which are actually impeding the development of bonds and derivative markets. And I think some of the things which are coming in this will actually help in easing out those restrictions.

So first of all, impact on the corporate bond market will be a good positive because of the HTM thing. But there again, I fear that it might be over for primary issuances rather than secondary market because if banks are going to put bonds in HTM and it's not going to come out again, that's good for primary issuances, but not necessarily good for secondary market. But where the bond market will take a fillip is the thing that you're referring to about this change in the symmetric accounting of bond and derivative P&L where both the unrealized profits and losses of both bonds and derivatives get recognized. Now, this will now encourage banks to do more bond trades, where the pricing of the underlying cash market and the derivative were very closely linked to each other, but banks were not able to do beyond a particular point because if there was loss in the bonds, it flows through, and a gain in the derivative, it anyway flows through. But if it is a gain in bond and a loss in derivative, only the loss would have flown through unless you actually sold the underlying bond. So those kinds of changes actually are going to be very positive. So, when a bank does such kind of bond derivative deals, it doesn't need to really bother about selling the bond in order to recognize the gain. It just flows through automatically.

A: I think there are two or three things from a fundamental perspective for the rupee, I would pretty much say that, though the recent numbers coming out is not giving a big upside to the rupee, I would say broadly that it is in line with the yearly projections that we have, like we have an estimate of $55 billion CAD. So nothing that has come out in the first five months of data makes us to believe that that is not the case.

And also from a valuation perspective - what you have to take into account is that the rupee because of the inflation, actually flipping around, three months ago, US inflation was very high and Indian inflation was on the lower side. But now India's inflation even though it's coming down, it's on the higher side, and US inflation is on the lower side. So on a Real Effective Exchange Rate (REER) basis, Indian rupee has got overvalued. So from that perspective, it actually looks a little dicey.

From an international perspective, because when you speak of INR, you have to look at what is happening to the dollar and what's happening to China. And when you look at US, the dollar is benefiting of the US exceptionism, where I think every other economy is not doing well, and the dollar is doing much better. And from a China perspective, China has been - everybody knows that now the growth is weak. So it's weakening. So I think the key thing to answer your question on INR is what is RBI going to do when there is a depreciating pressure? I think maybe they will let it gradually depreciate rather than do anything much.