Banks

India I Equities
Sector Update

16 September 2009

India Banks Sensex: 16454

Relaxing investment norms? What if? Nifty: 4892

„ Relaxing ‘held-to-maturity’ limit. According to press reports,

the RBI is weighing whether to raise the limit of G-Sec
Sujan Hajra
investments that can be ‘held-to-maturity’ (HTM). Currently, +9122 6626 6720
banks hold 31% of net demand and time liabilities (NDTL) in G- sujanhajra@rathi.com
Secs, whereas only 25% can be held to maturity. In this note, we
analyze the impact such a decision would have on listed banks. Clyton Fernandes
+9122 6626 6744
clytonfernandes@rathi.com
„ Raising the HTM limit may almost be a fait accompli. The
banking system’s current G-Sec holding is 31% of NDTL, Kaitav Shah
implying that at least 6ppt has to be classified as available for sale +9122 6626 6545
kaitavshah@rathi.com
(AFS) and hence has to be marked to market. Given the
government’s large market borrowing program and expectations
of upward bias in bond yields, we expect raising the HTM limit
would induce banks to subscribe to G-Sec.

„ Consequences of an HTM limit revision. A likely relaxation of

the HTM limit would raise two issues: (1) the extent to which the
limit would be raised, and (2) whether banks would be allowed to
shift from AFS to HTM and vice-versa once again this fiscal. We
expect the RBI to allow at least 30% of NDTL to be classified as
HTM. Also, we expect the RBI to allow banks to shift between
AFS and HTM mid-year, as a one-time dispensation.

„ Government-owned banks to gain. The recent under-

performance by government-owned banks (PSUs) was due to the
rising risk of MTM losses if G-Sec yields moved beyond 7.5%.
Relaxing the HTM limit is likely to be a big relief for banks,
particularly for PSUs, as they have a high proportion of AFS and
of longer duration. Banks Mcap weightage vs Gsec yields

„ SBI, BOB and BOI likely to benefit the most. We expect the
HTM limit to be raised from 25% to 30% of NTDL. If this (%) (%)
happens and if G-Sec yields rise to 8%, large-cap PSU banks could 30.0 11.0

see a 7% increase in FY10e net profit. We expect SBI, BOB and 26.0
9.0
BOI to be the largest beneficiaries. 22.0
7.0
18.0
„ Near term benefits, but long-term outlook subdued. Long-
14.0 5.0
term, we remain negative on PSU banks due to our expectations
Jan-04
Aug-04
Apr-05
Dec-05
Aug-06
Apr-07
Dec-07
Aug-08
Apr-09

of weak credit offtake and consequently low margins, higher credit

costs and increasing bond yields. Bank's share of BSE Mcap 10 yr Gsec yield(RHS)

Source: Anand Rathi Research

Anand Rathi Financial Services, its affiliates and subsidiaries, do and seek to do business with companies covered in its research reports. Thus, investors should be
aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making
their investment decision. Disclosures and analyst certifications are located in Appendix 1.

Anand Rathi Research India Equities

16 September 2009 India Banks – Relaxing investment norms? What if?

Relaxing investment norms? What if?

Potential relaxation of banks’ investment norms. According to a press
report (Business Standard, 11 Sep ’09), the RBI may be weighing whether to
relax the limit to which banks can keep their investments in G-Secs and
other approved securities in the “held-to-maturity” (HTM) category.
Under current norms, banks are allowed to keep up to 25% of their net
demand and time liabilities (NDTL) in HTM. Banks do not need to mark-
to-market (MTM) their HTM portfolio and thereby do not need to
provide for any investment depreciation. Investments kept in “available-
for-sale” (AFS) category face MTM requirements at least once in every
quarter.
Sharp increase in banks’ G-Sec holding. The G-Sec holding of banks
has increased from 26.2% in Oct ’08 to 31.1% in Aug ’09 (see Fig 1). In
absolute terms, banks’ investments in G-Sec have increased by ~Rs4trn
(US$80bn). During the same period, the yield on the benchmark (10-year
residual maturity) G-Sec has ranged from 5% to 7.5%. While softening
yields provided banks with treasury profits and / or write-back of
investment depreciation provisions, hardening yields will lead to the
opposite, resulting in lower profitability or draw-down from reserves, if
current earnings are insufficient.

Fig 1 – Banks’ G-Sec holding (% of NDTL)

45
43
(Banks' g-sec (SLR) holding,% of
net demand and time liabilities)

41
39
37
35
33
31
29
27
25
Apr-00
Sep-00
Mar-01
Sep-01
Mar-02
Sep-02
Mar-03
Sep-03
Mar-04
Sep-04
Mar-05
Sep-05
Mar-06
Aug-06
Feb-07
Aug-07
Feb-08
Aug-08
Feb-09
Aug-09

Net SLR Gross SLR

Source: Anand Rathi Research.

Banks’ participation in the government borrowing program crucial.

Banks have been the main funding source for the government’s market
borrowing (see Fig 2). In the current year, there has been a sharp rise in
the Union government’s borrowing – in net terms, from Rs2.6trn in FY09
to Rs4trn in FY10 (budget). In addition, borrowings by state governments
are also likely to increase sharply to Rs1.5-2trn. Participation from banks is
crucial to support the government’s borrowing plan.

Anand Rathi Research 3

16 September 2009 India Banks – Relaxing investment norms? What if?

Fig 2 – Banks’ share in government borrowing

225
200

(Banks' share in govt. borrowing,%)

175
150
125
100
75
50
25
0

Apr-02

Jan-03
Jun-03
Aug-02

Nov-03

Jul-05
Apr-04
Sep-04
Feb-05

Dec-05
May-06
Oct-06
Mar-07
Aug-07
Dec-07
May-08
Oct-08
Mar-09
Source: Anand Rathi Research.

Raising the HTM limit may almost be a fait accompli. The current
G-Sec holding for the banking system at 31% is well over (1) the
regulatory SLR requirement of 24% of NDTL and (2) the maximum
permissible limit for G-Sec under HTM (25% of NDTL). This means that
for banks, at least 6% of their NDTL has to be classified as AFS, as the
HTM limit has been exhausted. With the large government borrowing
program, the bias for G-Sec yields is upwards. Hence, banks now run the
risk of MTM losses on their AFS G-Sec holdings. Hence, the upward
revision in the HTM limit may be a fait accompli if banks have to be
induced to participate in the large market borrowing program of the
government.
Other regulatory changes also seem to be on the anvil. The potential
relaxation of the HTM limit by the RBI brings to the fore two related
issues. First, to what extent the limit would be raised. Second, whether
there would be a one-time dispensation to shift banks’ G-Sec portfolio
from AFS to HTM and vice-versa.
Relaxation of the HTM limit may be substantial. The total borrowing
plan of the Union and state governments during 2HFY10 is likely to be in
excess of Rs2.5trn (US$50bn). Considering banks subscribe to 75% of this
debt issue (the long-term average is 88%, see Fig.2), this amounts to ~4%
of banks’ NDTL. Therefore, at this level, banks SLR holding would be in
excess of 35% of NDTL. In view of this, we feel that the RBI would allow
at least 30% of NDTL to be classified as HTM. In fact, the RBI might
give boards of individual banks the discretion to decide the level of NDTL
they want to maintain as HTM, depending on their investment strategy.
Permission to shift between AFS and HTM. Under current norms,
banks can switch G-Sec between HTM and AFS, once a year, preferably at
the start of the financial year. RBI’s Master Circular No. DPOD BP.
BC.15 / 21.04.141/2007-08 – Prudential norms for classification,
valuation and operation of investment portfolio by banks, July 2007 states
that: “Banks may shift investments to/from Held to Maturity category
with the approval of the Board of Directors once a year. Such shifting will
normally be allowed at the beginning of the accounting year. No further
shifting to/ from this category will be allowed during the remaining part
of that accounting year.”

Anand Rathi Research 4

16 September 2009 India Banks – Relaxing investment norms? What if?

To limit MTM losses on G-Sec investments, banks might like to shift

some of their existing AFS investments to HTM, if or when the HTM
limit is extended. But doing so during the current financial year would
require a one-time dispensation by the RBI, as most banks have already
shifted between AFS and HTM in 1QFY10 (see Fig 3). If the RBI does
not provide this dispensation, then banks would tend to sell off their
existing AFS G-Sec and buy G-Sec directly into HTM. This simultaneous
purchase and sale of a large amount of G-Sec is likely to make yields
volatile, unlikely to be palatable to the RBI and the government.
Therefore, we expect RBI to also allow banks to shift between AFS and
HTM mid-year, as a one-time dispensation.

Fig 3 – AFS / HTM share of total investments

FY09 1QFY10
AFS % HTM % AFS % HTM %
BOB 25.1 74.5 20.2 79.5
BOI 21.1 78.9 28.1 71.5
Canara Bank 27.5 71.8 35.1 64.3
Union Bank 22.9 77.1 30.8 69.2
PNB 12.0 88.0 10.4 76.6
IDBI 25.9 71.7 15.1 83.4
Corporation Bank 37.3 62.2 27.3 71.9
Dena Bank 20.0 79.7 13.7 86.3
Source: Company

PSU Banks likely to be major gainers from possible regulatory

changes. The recent under-performance by government-owned banks
(PSUs) was due to the rising risk of MTM losses if G-Sec yields moved
beyond 7.5%. Relaxing the HTM limit is likely to be a big relief for banks,
particularly for PSUs, as they have a high proportion of AFS and of longer
duration. However, on the flip side, PSU banks are unlikely to derive gains
from any G-Sec rally, as they would not be allowed to further shift
investments from HTM to AFS.
Expected treasury losses. If the 10 year benchmark G-Sec yields rise to
~8%, MTM losses are likely to be ~9% of FY10 PBT for BOI and Canara
Bank, ~11% of FY10 PBT for Union Bank and BOB and ~15% for SBI.
For PNB, MTM losses are likely to be much lower, ~2% of FY10 PBT.

Fig 4 – Impact of rising bond yields: MTM losses

MTM losses
Yield on
% of FY10 PBT
AFS1QFY10 AFS duration investments @7.5% @8%
@8% G-Sec
FY09
% of inv book years % Rsm Rsm %
BOB 20.2 3.0 6.9 1,994 3,576 11.3
BOI 28.1 3.2 7.1 1,648 3,936 8.6
Canara Bank 35.1 2.8 7.6 (688) 2,180 9.2
Union Bank 30.8 2.7 7.4 566 2,742 10.8
PNB 10.4 2.4 7.5 - 821 1.7
SBI* 27.4 2.1 6.7 12,558 20,310 14.8
Assumptions: AFS comprises wholly of 10yr G-Sec * As of March31st, 2009
Source: Company, Anand Rathi Research

Anand Rathi Research 5

16 September 2009 India Banks – Relaxing investment norms? What if?

Fig 5 – Impact of rising bond yields if HTM limit is relaxed to 30%

Treasury losses Decrease in G-Sec provisioning Increase in net profit
@7.5% @8% @7.5% @8% @7.5% @8%
Rsm Rsm Rsm Rsm % %
BOB 170 305 1,824 3,271 5.8 10.3
BOI 428 1,023 1,220 2,913 2.7 6.4
Canara Bank (358) 1,133 (331) 1,047 (1.4) 4.4
Union Bank 298 1,444 268 1,298 1.1 5.1
PNB - (543) - 1,365 - 2.8
SBI* 5,243 8,479 7,316 11,832 5.3 8.6
* As of March31st, 2009 Source: Company, Anand Rathi Research.

SBI, BOB and BOI are likely to benefit the most. We have assumed
the revision in HTM from 25% of NTDL to 30% of NTDL. Assuming
this happens and if G-Sec yields rise to 8%, large-cap PSU banks’ could
see a 7% increase in FY10e PAT. We expect SBI, BOB and BOI to be the
biggest beneficiaries.
Near term benefits, but long-term outlook subdued. Long-term, we
remain negative on PSU banks due to our expectations of weak credit
offtake and consequently low margins, higher credit costs and increasing
bond yields.

Anand Rathi Research 6

Appendix 1
Analyst Certification
The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the
compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research
analyst(s) in this report.

The research analysts, strategists, or research associates principally responsible for the preparation of Anand Rathi Research have received compensation
based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment
banking revenues.
Anand Rathi Ratings Definitions
Analysts’ ratings and the corresponding expected returns take into account our definitions of Large Caps (>US$1bn) and Mid/Small Caps (<US$1bn) as
described in the Ratings Table below.

Ratings Guide
Buy Hold Sell
Large Caps (>US$1bn) >20% 5-20% <5%
Mid/Small Caps (<US$1bn) >30% 10-30% <10%

Anand Rathi Research Ratings Distribution (as of 1 Sep 09)

Buy Hold Sell
Anand Rathi Research stock coverage (89) 45% 12% 43%
% who are investment banking clients 7% 0% 0%

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