Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Bank G-Sec fears: How real? - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Jun 11, 2004

    Bank G-Sec fears: How real?

    There has been a persistent fear among the investment fraternity of a possible erosion of the value of investment portfolio of banks if there is a rise in interest rates. These fears have been compounded due to the fact that public sector banks, which are bound by regulatory requirements to maintain G-Sec investment portfolios, have in the last 2-3 years increased their exposure to this segment.

    According to the Indian Banks' Association (IBA), Government Securities (G-Sec) holding of Indian banks stands at around 35%-40% of aggregate deposits (summation of demand deposits and time deposits), as compared to only 4.6% in banks of US, a negligible 0.3% in banks of UK and around 6.9% in banks of the Euro zone. However, one needs to keep in mind the fact that Indian banks have to hold a minimum of 25% of their deposits in the form of G-Secs. This requirement is called the SLR.

    In this article, we will discuss the complexity of this problem and the remedial measures that need to be taken to mitigate the impact of any adverse change in interest rates in the future. The table below indicates the duration of the G-Sec portfolios of the banking sector. The sector has been classified on the basis of foreign banks, private sector banks and public sector banks. The table indicates that the duration is the highest for the public sector banks and this means that they have a high sensitivity to any change in interest rates. Consequently, they are likely to witness higher erosion in the value of G-Sec portfolio compared to foreign and private sector banks if the interest rates rise.

    Category G-Sec portfolio* (Rs bn) Duration (years)
    Foreign banks 324 2.2
    Private sector banks 852 3.1
    Public sector banks 4,468 4.7
    Total 5,644 4.3

    * 2001-02 data
    Source: IBA and RBI

    The IBA has indicated that an interest rate shock (where rates rise significantly in a short span) would erode more than 25% of the networth of foreign banks. Among private sector banks, this proportion was around 54%, and among nationalized banks, it was as high as 89%. These figures indicate the susceptibility of various segments of the banking sector to adverse changes in interest rates. The RBI has already instituted a mechanism in place to protect banks against any adverse shocks due to interest rate changes. The Investment Fluctuation Reserve is such a mechanism that mandates banks to keep a reserve that will protect them against an interest rate shock in the future. The limit for this reserve has been kept at 5% of the investment portfolio. While most banks have already created these reserves, they are still some time away before the statutory limit is reached.

    Apart from this measure, there are other instruments that could help banks mitigate interest rate risk in the future. Interest rate swaps and interest rate futures are such instruments that are essentially derivative products which can help the sector hedge its G-Sec portfolio against interest rate shocks. Floating rate G-Secs are another instrument that can be used to mitigate the risk. However, the proportion of floating rate G-Secs to total G-Sec portfolio only stands at 3% currently. A conscious increase in the same by the Reserve Bank of India (RBI) may go a long way in insulating the banking sector from the interest rate risk.

    While the Indian banking sector has managed to take advantage of the falling interest rate regime, it remains to be seen how they manage a rising rate scenario. In particular, public sector banks will be under scrutiny due to their relatively higher risk in this regard. We would like to maintain that a rapid rise in interest rates will be very adverse for the sector. However, a measured rise may be well handled (which seems more likely at the current juncture). Investors need to focus on banks, which have lower dependence on profit from sale of investments as far as their other income is concerned. Since other income forms a large part of profit before tax for the sector, this aspect is of importance. Performance in the core business of lending will be a key determinant of valuations from here on.



    Equitymaster requests your view! Post a comment on "Bank G-Sec fears: How real?". Click here!


    More Views on News

    IDFC Bank: Strong Trading Income Shields Credit Slowdown (Quarterly Results Update - Detailed)

    Aug 10, 2017

    IDFC Bank is taking steps to address contracting NIMs and successfully transition in to a retail bank.

    ICICI Bank: Loan Slippages Trending Downwards (Quarterly Results Update - Detailed)

    Aug 10, 2017

    Asset quality will be the key thing to watch out for going forward.

    Axis Bank: Outside Watchlist Slippages a Big Worry (Quarterly Results Update - Detailed)

    Jul 31, 2017

    Almost 74% of the watchlist as provided by the bank of Rs 226 billion in FY16 has turned into non-performing assets.

    Should You Take SBI Chief's Advice and Load up on SBI Shares? (The 5 Minute Wrapup)

    Jul 6, 2017

    Does the stock score on the value versus price equation?

    AU Small Finance Bank Ltd. (IPO)

    Jun 27, 2017

    Should one subscribe to the IPO of AU Small Finance Bank Ltd?

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms


    Aug 18, 2017 03:37 PM