Banks' heavy investments into G- secs since the note-ban may turn out to be a bad call as they await a treasury shock in the current quarter following the 45 -50 bps spike in bond yields.
The bond yields gained after the Reserve Bank surprised the market with a status quo and more so with its negative stance on inflation, in the February 8 policy review.
Since then after the sub-6.3 per cent levels, the yields have rallied 45-50 basis points.
While banks have bought G-secs at yields of 6.2-6.4 per cent, the yields are currently trading at 6.9 per cent, says Deustche Bank in a report today.
Banks have collected around Rs 10 trillion in deposits during the note ban period and expect almost 40 per cent of that fresh deposits to remain with them.
On top of this treasury loses are weak core income growth, the report said, thus it expects lower earnings in Q4.
"We see near-term impact on banks' earnings as slow loan growth is likely to result in lower NIMs, while treasury gains a key source of earnings are also at risk after a 45- 50 bps spike in bond yields post the RBI policy.
"Also, investment yields for most banks have now come down to nearly 7 per cent and it is very likely that incremental bond gains will be limited. Therefore, we cut earnings estimate to 3-8 per cent for most banks. While all banks will be affected, PSU banks and Axis Bank, ICICI Bank are at higher risks," Deustche said in the report.
Banks have been heavily relying on treasury of late, even as banks have used it to make high provisions. Post- demonetisation, the rush of deposits was used to buy G-secs which may also be out of money now. Unlike the past, higher bond yields are not associated with better growth and improving NIMs. Even asset resolutions remain slow.
Banks used the negative loan growth and deposits surge during the note ban months to buy SLR investments in 3Q.
Deposit growth in 3Q was 3-10 per cent driving growth in the investment book to 10-30 per cent on a quarterly basis, while system loan growth at 5 per cent remains extremely weak.
Over the past few quarters, treasury gains have been a key earnings driver for most banks, given their struggle with low growth, declining NIMs/fees and higher credit cost.
"For state-run banks, treasury gains have been 70-650 per cent of pre-tax profit over the last few quarters. In fiscal 2017, banks are likely to book about 1.5-2.5 per cent of investment book as gains following a strong fiscal 2016, benefiting from lower rates.
Even for fiscal 2018, it sees only 0.7-1 per cent of investment book as gains. But with bond yields now moving up, this may be at risk. State-run banks, especially smaller banks, are more exposed", the report said.
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