Banking sector appears well prepared in the current phase of hardening of yields: RBI Bulletin

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The banking sector appears to be well prepared in the current phase of hardening of yields as the timely creation of investment fluctuation reserve (IFR) provides adequate buffers to withstand trading losses, per an article in RBI’s latest monthly bulletin.

The investment fluctuation reserve (IFR) is created by transferring the gains realised on sale of investments.

It enables banks to maintain an adequate reserve to protect against increase in yields on their balance sheet in the future.

In the wake of the guidelines and with falling yields and resultant higher trading profits resulting in higher transfer of funds to IFR, the IFR has reached 2.2 per cent of HFT (held for trading) and AFS (available for sale) portfolio by end-March 2022 at the system level,said RBI officials Radheshyam Verma^ and Rakesh Kumar in the article “Impact of G-Sec Yield Movements on Bank Profitability in India.”

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Rise in G-sec yields

However, with sharp rise in G-Sec (Government Security) yields and fall in bond prices in Q1 (April-June) :2022-23, banks recorded treasury losses in their trading book to the tune of 4.9 per cent of their operating profit.

However, at the system level, SCBs (scheduled commercial banks) managed to maintain their IFR above 2 per cent which reached 2.7 per cent by March 2023.

As compared to PSBs (public sector banks), PVBs (private sector banks) were more proactive in provisioning towards IFR, the authors said.

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PVBs crossed 2.0 per cent of their HFT and AFS portfolio in September 2021, while PSBs reached IFR of 2 per cent in March 2022. Despite the hardening of G-Sec yields, PSBs and PVBs were able to manage IFR above 2 per cent.

“Going forward, strengthening of risk management practices and internal controls by banks remains of paramount importance. Deepening of interest rate derivatives market also assumes significance in mitigating the adverse movements in interest rates on bank portfolios by encouraging the participation of banks for hedging and neutralising large changes in yields,” the RBI officials said.