Capitalmind
Capitalmind
Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
Fixed Income

RBI – Banks Selling “Hold To Maturity” Securities

RBI’s latest notification:

In terms of our Master Circular No. DBOD.BP.BC.18/21.04.141/2010-11 dated July 1, 2010 on ‘Prudential Norms for Classification, Valuation and Operation of Investment Portfolio by Banks’, securities acquired by banks with the intention to hold them up to maturity may be classified under Held to Maturity (HTM) category. Banks are, however, allowed to shift investments to/from HTM with the approval of the Board of Directors once a year. Such shifting is normally allowed at the beginning of the accounting year and no further shifting to/from HTM is allowed during the remaining part of that accounting year.

2. In this connection, it has been observed that many banks are resorting to sale of securities held under HTM category, that too frequently, to take advantage of favourable market conditions and to book profits. It needs to be reiterated that securities under HTM category are intended to be held till maturity and accordingly are not required to be marked to market.

3. In view of above, it has been decided that if the value of sales and transfers of securities to/from HTM category exceeds 5 per cent of the book value of investments held in HTM category at the beginning of the year, bank should disclose the market value of the investments held in the HTM category and indicate the excess of book value over market value for which provision is not made. This disclosure is required to be made in ‘Notes to Accounts’ in banks’ audited Annual Financial Statements.

Funda – banks buy stuff and can say listen I won’t mark these to market because I will hold them to maturity. Why? If you buy a 6% bond at Rs. 100 when interest rates are 6%, but soon interest rates spike to 12% then your bond will probably trade for Rs. 50 in the market (to provide a 12% yield). You have basically “lost” Rs. 50.

Note: The calculations are slightly more complex, so the price won’t exactly halve; the above example is simplified for clarity.

But you can say that boss, I lost nothing – my hundred rupees will come back because I’m not selling right now. That is, to an extent, true – a bond price will not matter if you hold till the end, because you’ll get your money back. (Caveat: the bond seller should not default). Here’s a demo – imagine the 7.46% bond expiring in 2017, at different yields today:

image

In 2008, From a price of Rs. 110 at 6%, if the yield were to rise to 9% the price would drop to 90. At 12% , the price would have been 74.42; but you notice that as the years pass by the difference in prices due to the yield changes gets smaller and smaller, and by 2017, it disappears completely – the price converges to 100.

Technically if you hold to maturity (HTM) there should be no need to “mark-to-market” – each bond can be said to be worth Rs. 100 (face value).

Banks move securities to HTM to take advantage of a rising yield market – where in a trading bond portfolio they would have to mark the bonds to market, and the market prices fall as yields rise. A HTM portfolio doesn’t need to be marked, so banks would move bonds from a trading portfolio to HTM – yet, when interest rates softened, even temporarily, they would sell the bonds from the HTM portfolio. What RBI has said is – you can’t trade bonds and still “hold to maturity”, so if you sell too much of the HTM portfolio, you have to report it separately.

divider

Subscribe to Capital Mind:

To subscribe to new posts by email, once a day, delivered to your Inbox:

[wysija_form id=”1″]

Also, do check out Capital Mind Premium , where we provide high
quality analysis on macro, fixed income and stocks. Also see our
portfolio which has given stellar returns in our year, trade by trade
as we progress. Take a 30-day trial:

[wysija_form id=”2″]