Bond bonanza to help Indian banks battle world's worst bad loan ratio

The windfall treasury profits come as a relief for lenders staring at a potential surge in bad loan provisions due to a slowing economy and a cash squeeze in the nation's shadow banking system.

One of Asia's best bond rallies is bolstering Indian banks' efforts to accelerate clean-up of the world's worst bad-loan pile.

The benchmark 10-year sovereign bond yield dropped about 50 basis points in July, extending the past year's decline to more than 130 basis points. Each basis point fall in the yield adds Rs 3.5 billion ($50 million) to banks' treasury gains, boosting their ability to writedown bad loans, estimates by ICRA Ltd show.

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The windfall treasury profits come as a relief for lenders staring at a potential surge in bad loan provisions due to a slowing economy and a cash squeeze in the nation's shadow banking system. India's proposal last month to issue the country's first overseas bond and bets on deep cuts in policy rates are adding fresh legs to the bond rally.

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This may not be the first time a bond bonanza helped India clean up bad debt in its financial system. Two decades back, when the soured-debt ratio at banks was hovering close to 15 per cent, yields on government securities fell sharply, generating mark-to-market gains that came handy in cleaning out the bad debt pile, Romesh Sobti, chief executive officer at IndusInd Bank, said in a recent interview.

"While this time around the drop in the sovereign bond yields is not as dramatic, the quantum of bond holding is way higher," Sobti said. "Gains will be handsome enough to enable banks to start cleaning up the books faster."

Credit markets are already cognizant of this bond boon. The average cost of credit-default swaps insuring the bonds of five Indian lenders against nonpayment for five-years has dropped 35 basis points last month, according to data provider CMAI. This has been the sharpest drop in about five years.

Adding further to the optimism is the government's plan to infuse Rs 700 billion into state-run banks in the year to March 31 to strengthen their balance sheets and kick-start the nation's economic expansion. The pace of economic growth slowed for an eighth consecutive month year-on-year in June, according to Bloomberg Economics.

"Public-sector banks as a sector can emerge from the red behind lower provisions and potentially better trading-related gains," said Ismael Pili, co-head for Asian bank research at CreditSights Singapore. "