“Significant impact on the profitability of the Indian banking system”

There could be a significant impact on the profitability of the Indian banking system, as inflation data for May and June 2021 exceeded the Reserve Bank of India (RBI) target corridor, in turn putting pressure on the curve. long-term returns, according to India. Assessments and Research (Ind-Ra).

Retail price inflation remained above the upper 6 percent threshold set by the Monetary Policy Committee for the second consecutive month in June, at 6.26 percent from 6.30 percent in May.

A 100 basis point (bp) upward shift in the yield curve could impact the operating profit before provisioning (PPOP) of public sector banks (PSB) by 8% and that of private banks of 3.2%, Ankit Jain, senior analyst, Ind-Ra, said in a note.

The impact on the entire banking system could be 5.8 percent. A basis point is equal to one hundredth of a percentage point.

Ind-Ra estimated that the 100bp shift in the yield curve would have an impact of 28bp on the common equity tier 1 of PSBs and that of private banks by 13bp; while for the whole banking system, the impact could be 22 basis points year-on-year (year-on-year).

The memo says this was taken on an after-tax basis, ignoring the ability of banks to reclassify their trading book and likely partial compensation for lower retirement costs.

Three cycles of yield curve expansion

By analyzing past interest rate cycles, Ind-Ra observed that there had been three cycles of expansion of the yield curve from FY05, showing a strong inverse correlation between Treasury revenues. and the movement of interest rates.

In addition, the sensitivity observed for PSBs was much higher than that of private banks.

Ind-Ra said that during the first cycle, the contribution of treasury revenues to PPPP was reduced to 3.4% in FY07 from 21.3% in FY05, while it was reduced to 3.2% in FY12, from 15.3% in FY10 in cycle two and 5.6 percent in FY12 19 versus 22.5 percent in fiscal year 18 in third cycle.

In addition, the sensitivity was similar for private banks; however, the volatility of PPPP and PAT (profit after tax) was limited due to a lower trading book share than PSBs through FY14 and stronger operating profit buffers.

Nonetheless, private banks were also affected during the FY18-FY19 cycle in which treasury revenues fell to 3.3% from 9.7% PPPP and 9.3% from 25.8% PAT. .

Muted direct debit

With demand for credit remaining subdued since fiscal 2017, banks have maintained a balance between holding a higher statutory liquidity ratio (SLR) and interest rate risk, also taking risks when granting loans in a declining interest rate environment, the note said.

After the first wave of covid, the RBI further extended the exemption to allow banks to hold more than 25 percent of their total investments in the held-for-trading category, provided they hold until at 22 percent in the form of SLR (statutory liquidity ratio) securities, he added.

While the holding limit for SLR securities had already been increased to 22% from 19.5% previously, the RBI at its February meeting of the Monetary Policy Committee extended the window for such holdings until March 2023 and a gradual reduction thereafter by December 2023..

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