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The government may face fresh problems for its mammoth borrowing programme, with several major banks, especially public sector players, expressing difficulty in buying more long-tenure bonds during the auctions owing to growing mark-to-market risks to their balance sheet.
One indication of this was the fact that many large bond buyers stayed away from the Rs 12,000 crore (Rs 120 billion) auction conducted on August 7 when Reserve Bank of India rejected all bids.
Treasury executives at some of the largest bond buyers said their bank had little headroom to buy government securities and hold these in the held-to-maturity (HTM) category.
Banks can keep securities in the HTM category only up to 25 per cent of net demand and time deposits. These securities remain in their portfolio till maturity, so banks do not have to follow mark- to-market accounting and make provisions if the value of the security drops below its face value.
When banks buy a government bond, they classify them into three categories - trading, available for sale (AFS) or HTM. If a security in the trading portfolio is not traded for 90 days it has to be shifted to AFS.
But the RBI expects banks to shift securities from AFS to HTM, or vice versa, at the start of the year and that too with prior permission of the bank's board or the investment or the asset-liability committees.
With HTM capacity virtually exhausted, any bonds banks buy now have to be classified as available for sale, for which mark-to-market provisions would be required. Fearing a mark-to-market hit, banks have become reluctant to put the securities in this category since yields are projected to rise.
Bond prices and yields have an inverse relationship. So, when bond yields harden, there is price erosion for which banks have to set aside funds and take a knock on their profits.
Many of the treasury heads at the public sector players confirmed that they stayed away from the August 7 auction and at least one of them has also written to the central bank, pointing to its inability to make large purchases.
Bankers said one option for the RBI was to raise the ceiling on HTM classification from the present level of 25 per cent of the net demand and time liabilities. "Even if it is 27 or 28 per cent, we will be able to come back to the auctions," said a bank executive.
The government and RBI have taken several steps to ensure that the Centre's gross market borrowing, which has jumped from the second half of the last financial year, to fund the stimulus packages, did not upset the financial sector and loan flow. During the current financial year, the Centre has budgeted to borrow a record Rs 451,000 crore (Rs 4,510 billion), of which Rs 299,000 crore (RS 2,990 billion) is to be borrowed by the end of September.
With lower demand for credit, banks have stepped up investment in government securities, which rose to Rs 163,000 crore (Rs 1,630 billion) during April-July 2009 against Rs 31,259 crore (Rs 312.59 billion) in corresponding period last year.
A treasury executive with private sector bank said that while banks had the option not to participate in bond auctions, the public sector players had practically no choice but "to pick up" bonds to support the borrowing programme.
"A higher level of the investment portfolio is exposed to ups and downs in interest rates, making the balance sheet volatile for no fault of ours," said a public sector bank executive.
