Windfall gains on bond portfolios

Mumbai: After five consecutive years of posting losses, public sector banks (PSBs) reported net profits in the fiscal 2020-21, supported by windfall gains on their bond portfolio, rating agency Icra Ratings said in a report.

Apart from trading gains, the return to profitability was supported by lower credit provisions on their legacy non-performing assets (NPAs), after the high provisions made during the last few years, it said. "The onset of Covid-19 resulted in windfall gains for public banks with trading profits on their bond portfolios rising sharply after the steep cut in policy rates by the Reserve Bank of India (RBI) in March 2020," the agency said in the report. The repo rate and the reverse repo rate were cumulatively cut by 115 basis points (bps) and 155 bps, respectively, during March 2020 and May 2020 to 4 per cent and 3.35 per cent, respectively, by May 2020. In FY21, PSBs reported a net profit of Rs 32,848 crore as against loss of Rs 38,907 crore in 2019-20, the agency's Vice President (Financial Sector Ratings) Anil Gupta said.

According to the agency's estimates, public sector banks booked profits of Rs 31,600 crore due to gains on bond portfolio compared to overall profit before tax (PBT) of Rs 45,900 crore in FY2021, the report said "with a year-on-year (YoY) deposit growth of 11.4 per cent and muted credit growth of 5.5 per cent in FY2021, the liquidity in the banking system remained abundant at Rs 5-7 lakh crore in FY2021." With the rate cuts and abundant liquidity, the daily average for the benchmark 10-year government securities declined from 6.42 per cent in Q4 FY2020 to 6 per cent in Q1 FY2021, 5.93 per cent in Q2 FY2021 and 5.90 per cent in Q3 FY2021 before rising to 6.06 per cent in Q4 FY2021. The significant volatility in bond yields also provided banks with ample trading opportunities, the report said. "As the banks booked gains on their bond holdings, their fresh investments are closer to the market rates, thereby aligning the yield on their bond portfolios closer to the market rates. The yield on the investment book for the public banks declined to 6.18 per cent in Q4 FY2021 from 6.79 per cent in Q4 FY2020," Gupta said. The agency further said notwithstanding the profits reported by the public banks in FY2021, the profits before tax (PBT) of other public banks (excluding State Bank of India – SBI) were lower than their trading gains, reflecting the challenges posed by Covid-19 on the asset quality and profitability. On an aggregate basis, the 11 public banks (excluding SBI) reported a trading gains of Rs 25,500 crore as against profit before tax of Rs 18,400 crore, it said. Like public banks, private banks saw an improvement in their trading profits to Rs 18,400 crore in FY2021 (Rs 14,700 crore in FY2020), which was 21 per cent of their PBT in FY2021 (28 per cent in FY2020).

According to Gupta, while banks make windfall profits amid the declining yield scenario, they could face challenges in their bond portfolios in a rising interest rate regime. "While the RBI is unlikely to be in a rush to hike interest rates in the near term, banks would need to be mindful as treasury profits would be relatively muted in FY2022," he said.