Bond yield rise squeezes banks' Q2 treasury gains

Rising bond yields took a toll on banks’ treasury earnings in the September quarter, leaving them with losses on their investment portfolios and fewer opportunities to book profits from bond sales. The hit was felt across public and private sector lenders, with the average treasury income falling 62% from a year earlier.

With yields remaining elevated, banks face the prospect of another weak quarter and the challenge of making up the lost income from other sources.

Indian banks’ treasury incomes came under pressure in the three months ended September as a rise in government bond yields led to mark-to-market (MTM) losses on their investment portfolios.

Among public sector banks, State Bank of India (SBI) reported a treasury income of ₹6,011 crore in the September quarter, down around 20% from ₹7,470 crore a year ago.

Management said losses arising from mark-to-market valuations and foreign exchange movements were close to ₹1,300 crore during the quarter, as against ₹2,900 crore a year ago, a decline of more than half.

“Other income was offset by the treasury not having enough gains or a bit of losses on the MTM side,” the bank’s management said during the September earnings conference on Tuesday. During the quarter, SBI’s other interest income fell by 19% on year to ₹2,741 crore.

Its public sector peer Punjab National Bank’s treasury income fell 57% year-on-year to ₹753 crore. Had it not been for the rise in yields, the bank’s treasury profit would have been more than ₹1,700 crores, said managing director Ashok Chandra during the bank’s earnings call.

“So, because of that MTM loss, the profit from the treasury is subdued now,” he said, adding that the bank is focusing on other activities such as exchange income and trading income. He expects treasury income to be around ₹700-800 crores during the December quarter.

Canara Bank reported a 69% decline in treasury income to ₹499 crore while Union Bank of India’s treasury income fell 35% to ₹701 crore.

However, Bank of Baroda bucked the trend, reporting a treasury income of ₹4,093 crore, nearly four times the ₹1,086 crore reported in the year-ago quarter. Its investor presentation showed trading gains from sale of investments rose to ₹1,824 crore from ₹654 crore, while gains from revaluation of investments rose to ₹1,907 crore from ₹178 crore.

Among private sector lenders, HDFC Bank’s treasury income fell by 67% to ₹780 crore, while ICICI Bank slipped to a loss of ₹230 crore as against a profit of ₹220 crore a year ago. Yes Bank’s treasury income remained largely flat at ₹156 crore as against ₹151 crore.

The aggregate treasury income of scheduled commercial banks fell 62% year-on-year, with the impact more prominent for the private sector at 66% while public sector banks saw a 59% decline as higher bond yields led to MTM losses and left banks fewer opportunities to sell bonds at a profit, CareEdge Ratings said in a report on 27 October.

Why the decline

Bankers attributed the weakness largely to the rise in government bond yields, affecting valuations of banks’ fixed-income portfolios. The yield on the benchmark 10-year paper, for instance, rose around 40 basis points (bps) through the quarter to end at 7.19% on 30 September. Expectations of a repo rate hike, surging crude prices amid the geopolitical uncertainties and higher US treasury yields led to this rise during the quarter.

Currently, the yield on the 10-year government bond is around 7.12%.

Bond yields and prices move in opposite directions. When yields rise, the market value of existing bonds falls, exposing banks to mark-to-market losses on their investment portfolios, even if the securities have not actually been sold.

If there are gains in the held-to-maturity (HTM) book, banks have the opportunity to book profits at least once a year under various conditions. “So, for those who’ve been able to do that, it’s good portfolio management. But those who have missed out need to make it up from other sources,” said Rajeev Pawar, treasury head at Ujjivan Small Finance Bank.

However, this year, there are challenges in increasing income from other sources as well because of recent restrictions on the forex exchange market.

In October, the central bank tightened rules governing rupee derivatives, introduced additional risk-mitigation requirements and restricted certain positions without underlying exposures. The measures, aimed at curbing speculative dollar demand and supporting the rupee, have also created operational uncertainty and affected liquidity in parts of the forex market.

“So then, the only scope for banks is to try and generate interest income from investing into high yielding corporate bonds and money market assets. However, this has an element of MTM swings.” Pawar said.

The limited avenues for generating alternative income have added to the pressure on banks’ treasury operations, with the decline in earnings extending across both public and private sector lenders, according to CareEdge Ratings.

“Treasury income fell to 0.09% of total assets from 0.11% in Q1FY27 and 0.26% a year ago… With yields still high after the repo rate hike, treasury income is likely to stay weak in Q3FY27,” the report said.

Last month, the Reserve Bank of India’s rate-setting panel increased the repo rate by 25 bps to 5.50% for the first time in nearly four years.

Current quarter prospects

Market participants had earlier expected treasury income of banks to remain weak in the third quarter as well. SBI has guided for a similar treasury income in the December quarter, but expects profits to improve in the March quarter as yields may soften.

US yields have already seen some softening following the outcome of the US midterm elections, correction in oil prices and expectations of an early resolution to the US-Iran war. The 10-year US Treasury closed at 4.89% on Wednesday, down 6 bps.

“It is still too early to make a definitive assessment of Q3 treasury profitability. However, the sharp bond rally this week has improved the outlook considerably. Q3 treasury performance is shaping up on a more promising note, with the bond rally providing a much-needed tailwind after a relatively subdued Q2,” V.R.C. Reddy, treasury head at Karur Vysya Bank, said estimating the yield on the 10-year government bond to move in the range of 7.05-7.10% in the near-term.