Banks Favour Premium Corporate & State Bonds In HTM Portfolio

Urban co-operative banks have seen an improvement in their credit profile and financial stability, supported by regulatory backing and a series of reforms, particularly in governance, amidst the economic recovery post-pandemic. Embracing new investment norms effective from 1 April, these banks are now favouring instruments with higher premiums over government securities for their held-till-maturity (HTM) portfolios. They are strategically increasing their holdings of corporate bonds and state government securities to enhance yields on their portfolios, as noted by market participants.

With loans repriced and higher lending rates for fresh loans, there has been an enhancement in net interest margins from a low of 1.89 per cent in FY20. VRC Reddy, the head of treasury at Karur Vysya Bank, emphasised the preference for instruments offering good spreads without compromising on credit risk, particularly those placed in HTM portfolios under the new norms. The yield spread between AAA-rated corporate bonds and the benchmark 10-year government bond has narrowed by 5 basis points (bps) in April, reaching 41 bps on Tuesday.

Under the revised investment norms, commercial banks can now include non-SLR bonds in their investment portfolio, except for those with an original maturity of less than one year. However, this restriction does not apply to investments in commercial papers, certificates of deposits, and non-convertible debentures (NCDs) with an original maturity of up to one year, as per Reserve Bank of India (RBI) guidelines. The new norms also require banks to permanently categorize bonds as "held-to-maturity," with only 5 per cent of the portfolio eligible for withdrawal throughout the year, subject to approval from both the bank's board and the RBI.

The preference for higher premiums on state government securities over central government securities remains significant for banks, contributing to their investment decisions. Post the transition to the new framework, banks are no longer permitted to reclassify investments among categories without approval from their boards and regulators. Additionally, the norms mandate daily fair valuation for securities classified under the held-for-trading (HFT) sub-category within FVTPL, while other securities in FVTPL must be fair valued at least on a quarterly basis.