But the other fixed income instruments of banks don’t have such leeway of delayed payment, or a recall option. The market has started taking a cautious view on these instruments.
While the market doesn’t really expect the banks to default, it is a risk nevertheless. In some cases, primary market deals are not taking place as investors are asking for deep discounts to face value, whereas, banks are refusing to give so citing the government guarantee. The wide bid and ask spread, therefore, is stalling fresh issuance of public sector bonds.
Shameek Ray, head of debt capital market, ICICI Securities Primary Dealership, said it is getting difficult for banks to raise money from the primary market.
“Wholesale investors may have differing views on pricing based on liquidity, rate outlook and credit perceptions and may require a higher yield than what sellers in secondary markets may be offering and, hence, there have been few trades in recent times,” Ray said.
What is compounding the issue for some of the smaller banks under PCA is that investors have started shedding the bonds as the ratings get downgraded.
“The usual investors in bank tier-II bonds (subordinate debt) have been buy and hold investors like provident funds. But these funds have rating restrictions of not investing below AA and, hence, are no longer able to invest in the tier-II bonds of state-owned banks where the rating is now lower than AA,” said Ray.
Many of these banks have a rating of AA- now, lower than the minimum investment grade allowed under regulations.
Trades are limited by the low floating stock in market as there have been few tier-II issues in recent times, even when rates were far lower for banks to raise such instruments. Besides, regulatory guidelines give greater weightage to tier-1 capital (core equity and related bonds such as AT1), preventing investors to avoid taking much exposure on the subordinated debt instruments.
A persistent OMO purchase drive by the RBI could change the situation drastically. By providing the liquidity, the RBI can drive down elevated bond yields, which will help bank treasuries recover some of their losses. The 10-year bond yields are nearing 8 per cent now, from about 6.5 per cent seven months ago. As yields rise, bond prices fall.
Indeed, Macquarie expects the central bank “may need to conduct OMO purchase of Rs 800-1,000 billion in FY19, which will help to keep the liquidity condition near neutral levels”.