Domestic banks will now be less impacted by the fall in prices of government securities (G-Secs), thanks to the recent RBI norms on investment classification.
Banks can now exceed the present 25 per cent limit of total investments under the 'held to maturity' (HTM) category. This means that banks can transfer between 60 to 70 per cent of their G-secs to the HTM category, thus minimising the mark to market hit on their earnings. Even if the prices of G-Secs come down due to rising interest rates, banks' earnings will not be affected as was feared earlier.
The negative impact arising from 'mark to market' on banks' earnings will be 50 per cent less than earlier, says Merrill Lynch India. It is estimated that banks' earning will be impacted by less than 10 per cent from the fall in G-sec value as against earlier estimates of 15 to 25 per cent in FY07 arising from the mark to market hit.
Banks' earnings through FY05-06 are likely to remain unscathed even if their 'unrealised gains cushion' is fully eroded by then, analysts said. According to Merrill Lynch, banks like the Oriental Bank of Commerce (OBC), the State Bank of India (SBI), Punjab National Bank (PNB) and Corporation Bank are likely to be the least affected among government banks.
Private banks like ICICI Bank and HDFC Bank are also among the least impacted owing to the low duration of their portfolios and lower proportion of G-secs compared to some of the larger banks. These private banks are well positioned in a rising rate environment and also benefit from the changed investment norms. Even banks' tier I capital levels may actually improve against earlier estimates. This is because banks would now be required to have a smaller investment fluctuation reserve (IFR) as it is based only on 'non-HTM' securities. It may actually help ease some of the capital requirements over the next 12 to 18 months.
Most analysts see PSU banks poised for a rally with falling bond yields and inflation, compounded by the comfort on earnings from the change in the investment norms.