We often hear RBI mulling either to increase or reduce HTM %. Lets understand how it impacts liquidity…
Banks garner money and lend to the needy earning the arbitrage. We know as SLR banks have to keep some percentage of funds in G-sec, SDLs and gold. Apart from that banks also invest in securities/subsidiaries which they assume will perform well. In all, banks invest huge chunk of their money in different set of instruments and subsidiaries.
Investment of banks is classified in to three categories
- Held to maturity(HTM)
- Available for Sale(AFS)
- Held for trading(HFT)
While investing banks clarifies it as either of above three. Securities acquired by the banks with the intention to hold them till maturity will be classified under Held to Maturity. The securities acquired by the banks with the intention to trade by taking advantage of the short-term price/ interest rate movements etc. will be classified under Held for Trading. The securities which do not fall within the above two categories will be classified under Available for Sale.
Securities bought under HFT should be traded in 90days else it then falls under AFS category.
Let’s understand with an example
- ABC banks has total investment of Rs.100. below is the breakup (as per balance sheet)
- Govt. Securities – 40rs
- Other Approved securities – 10rs
- Shares – 20rs
- Debentures & Bonds – 20rs
- Subsidies/JVs – 10 (this comes under HTM by default)
- Others – 0
Banks do not present HTM, AFS and HFT classification in annual reports. Let’s assume below is the classification.
- HTM – 25rs
- AFS – 60rs
- HFT – 15rs
RBI has issued guidelines for banks not to exceed HTM above 25% for their investment. But why would banks love to hold till maturity. It is because HTM portfolio are not marked to market so temporary losses due to inching up rates (which will drive prices down) will have to be adjusted in balance sheet thereby dampening the numbers. Now, The moment RBI reduces HTM from 25% to 23%, banks have to take 2% of that securities in AFS which then has to be marked to market. Hence banks at appropriate time dump the G-sec in the market (specially falling rate market) to book profit and avoid showing losses/depreciation on account of Mark to market. This improves G-sec supply and hence liquidity in the market (Note : At the same time long term G-sec rates recedes to some extent on account of increased supply in the market).
Appreciate your inputs.
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