G Sec VaR and Bond price-sensitivity measure.

 

 

Banks stare at Huge MTM Losses as Yields Rise.

Banks are staring at significant mark-to-market losses in the April-June 2022 quarter as some approached the Reserve Bank of India, seeking a one-off relaxation following rises in bond yields.

This is common for a bank to call such a loss a notional whenever the benchmark yield moves up.

Mid-to-large government banks are each expected to report anything between ?350 crores and more than ?1,000 crores in treasury losses.

During the three months, the benchmark bond yields surged as much as 75 basis points to a high of 7.60% on June 13. Price fall when yields rise. The benchmark bond yielded 7.46% Wednesday.

“Banks with IFR are better placed to cushion against marked-to-market losses,” a banker said. Further, “It depends on individual banks as to how they have provided for.” Banks with better financials have the money to hold losses as they do not sell securities. They report MTM losses in their books for quarterly earnings. However, some banks booked losses from their “Available for Sale” (AFS) or “Held for Trading” (HFT) books.

Three major Asset Owners are banks, Insurance Companies and Pension Fund. The Fund House is Mutual Funds. Such a loss is common for all fixed income security investors. Banks report MTM losses periodically. The mutual fund reflects such a loss in daily NAV, and the insurance company does report quarterly, but appreciation and depreciation are not incorporated.

To some extent, the bond market is not as liquid as the equity market. The price discovery for non-traded bond valuation is highly questionable.

Banks use the FIMMDA Base yield curve for the value of non-traded bonds and 15 days of the cumulative bond traded data for a traded bond.

It is always challenging that value non-traded bonds using BASE Yield for residual tenure and SPREAD for outstanding credit rating. The accuracy is commonly compromised and undervalued or overvalued standard practice. Casual regulatory supervision is the reason.  

The mutual fund uses the SLV valuation method provided by the Indian CRA, which is not publicly available for reference.

Bank valuation is more transparent.

The question is, How can banks Overcome such losses?

One, offset notional treasury losses in a rising rate cycle using IFR (Investment Fluctuation Reserves), the second, using G Sec VaR and sensitive analysis for the corporate bond to control comparatively/highly price-sensitive bond.

Sadly, banks do not prefer to use G Sec VaR for G Sec portfolios or price-sensitivity measures for the corporate bond portfolio to reduce portfolio losses.   

In 2015, Ex RBI Governor Mr Rajan introduced IFR, which has gone through revisions over the years.

IFR: The accounting treatment permits a reserve provision against MTM notional gains in the investment portfolio. This can be adjusted to offset losses arising from the investment book.

But much earlier, -1988 The market risk amendment of 1988, the Basel Accord in 1996, the advent of the New Basel Accord (Basel II) in 2004, and subsequent revisions in the accord have brought about a sea of changes in the risk management framework adopted at banks globally in recent years.

IFR is used for loss adjustment/postponement, but G Sec VaR is a tool to control such losses.  

VaR itself is a risk measure. A more significant VaR number would indicate greater risk in a portfolio. Thus, VaR can rank portfolios in order of risk.

In addition to what VaR offers, the VaR number helps determine the required regulatory capital for the bank’s exposure to risk.

Eventually, not only the banks but an increasing number of other financial institutions and firms are also aligning their risk management framework in a similar line.

Unfortunately, the VaR tool is not commonly/publicly available for use. Thus, the central bank does not insist on the bank’s use of VaR.

The tool called M Duration with the convexity is used for the bond-sensitive measure. Finding M Duration and Convexity for each bond in holding is time-consuming.  That is why neither the regulator nor the investor insisted on it. But portfolio losses are actual.

Mid-to-large government banks are each expected to report anything between ?350 crores and more than ?1,000 crores in treasury losses.

A decade-old service provider updebts.com not only help such institution to manage bond portfolio but also help them to reduce portfolio losses using G Sec VaR and Bond sensitivity measure advanced tools.