Banking Sector Well Prepared To Withstand Reverses From Hardening Yields: RBI Paper

The banking sector is "well prepared" in the current phase of hardening yields, said a paper by RBI officials published on Thursday.

The timely creation of the 'investment fluctuation reserve' has helped the lenders as it provides adequate buffers to withstand trading losses, the paper published in the RBI Bulletin for October said.

In the paper which does not represent the institutional views of the RBI, authors Radheshyam Verma and Rakesh Kumar noted that hardening of G-sec (government securities) yield is a market risk that banks confront in an environment of rising inflation and monetary policy normalisation process.

It said there may be some disproportionate impact of the reversal of the monetary policy stance on bank profitability, and added that bigger banks are in a better position to withstand changing policy environment courtesy the advantage of scale.

"Overall, the banking sector appears to be well prepared in the current phase of hardening of yields as the timely creation of investment fluctuation reserve (IFR) provides adequate buffers to withstand trading losses," the paper said.

The empirical analysis suggests that the short-term yield and slope have a differentiated impact on trading income (negative) and net interest margin (positive), the paper said.

For larger banks, the impact of short-term yield on trading income was found to be smaller, it said, adding the net interest margin was found to be a bit more responsive to the short-term rate in the case of larger banks.

With the systemic impact of interest rates on financial markets, the MTM (mark-to-market) losses have been a major source of concern for both banks and regulators, it said.

"Going forward, strengthening of risk management practices and internal controls by banks remains of paramount importance," it said.