COMMERCIAL BANKING/BANK MANAGEMENT QUESTION BANK

Answers to Question No. 1 to 10 may be given in 50 to 100 words. Each

question from No. 1 to 10 carries 2 marks.

Q 1. How would economic transactions between suppliers of funds and

ultimate users of funds occur in a world without FIs ? Explain with the
help of a diagram.

Q 2. Give three major reasons that suppliers of funds would not like to
directly purchase securities issued by ultimate users of funds ?

Q 3. Explain, with the help of a diagram, the financial intermediation

process/role performed by an FI ?

Q 4. What are the various kinds of financial intermediation roles

performed by an FI ?

Q 5. How can an FI reduce/overcome those problems faced by primary

savers/suppliers of funds in direct transfer of funds to ultimate users of
funds ? (4 marks)

Q 6. What is meant by Maturity intermediation ?

Q 7. What is meant by Denomination intermediation ?

Q 8. What are the core/primary activities of a Commercial Bank ?

Q 9. What are the differences between the Balance Sheets of a

Depository Institution like a Commercial Bank and a Non-financial Firm
like a Manufacturing Company ?

Q 10. It is said that Commercial Banks are highly leveraged entities.

Comment.

Q 11. Mention the different items that appear in a Bank’s Balance Sheet
in India.
 Q 12. Q 11. Mention the different items that appear in a Bank’s Income
Statement (Profit & Loss Account) in India.

Q 13. Classify the following accounts into one of the following

categories : (a) assets (b) liabilities (c) equity (d) revenue (e) expense (f)
Off-Balance Sheet (OBS) activity.

(1) Retail Deposits (2) Paid-up-capital (3) Loan Commitments (4) Consumer
loans (5) Interest on Investment securities (6) Interest on Savings Bank
Deposits (7) Current Deposits (8) Letter of Credit (9) Retained earnings
(10) Provision on NPA Loans

Q 14. Define Net Interest Income (NII) and Net Interest Margin (NIM).

Q 15. Define Operating Profit and Net Profit/Net Income in a Bank’s

Income Statement.

Q 16. It is said that Bank’s Profitability Management boils down to two

components : Spread Management ( or Management of NIM) and Burden or
Overhead Management. Comment on the statement by explaining terms like
Spread, NIM and Burden and the strategies to improve profitability of a
Bank.

Q 17. It’s often said that Banks must rely less on Net Interest Income/
Core Income and more on the Non-Interest Income/Other Income. Comment
on the statement defining the terms like Core Income and explaining (a) the
various sources of Non-interest Income and (b) the sources and strategies
to control the Non-interest expenses.

Q 18. What is meant by an Off-Balance Sheet (OBS) activity ? What are

some of the forces responsible for them ?

Q 19. How does one distinguish between an off-balance sheet asset and an
off-balance sheet liability ?

Q 20. What are the main off-balance sheet activities undertaken by

commercial banks ?
Q 21. Banks typically differentiate between interest and non-interest
income and expense. What are the primary components of each ? Define Net
Interest Income (NIM) and burden. What does a bank’s efficiency ratio
measure ?

Q 22. A bank’s efficiency ratio (ER) is defined as the ratio of Non-interest

expense to the total of Net interest income and Non-interest income.
Should the efficiency ratio be low or high for increasing bank’s
profitability ?

Q 23. Arrange the following items into an income statement. Label each
item, place it in the appropriate category and determine the bank’s bottom-
line net income.

a. Interest paid on Term deposits Rs.100,000/-

b. Interest paid on Certificate of deposits Rs.101,000/-
c. Interest received on GOI Securities Rs.44,500/-
d. Fees received on selling of insurance and mutual funds Rs.23,000/-
e. Dividends paid to Shareholders of Rs.0.50 per share for 5,000 shares
f. Provision for loan losses/NPA provision Rs.18,000/-
g. Interest and discount on loans Rs.1,89,700/-
h. Interest paid on SB accounts Rs.33,500/-
i. Interest received on Corporate/PSU bonds Rs.60,000/-
j. Employees salary and benefits Rs.1,45,000/-
k. Purchase of a new Computer system Rs.50,000/- (Depreciation for the
current year Rs.10,000/-)
l. Service charge/commission receipts from customer accounts
Rs.41,000/-
m. Occupancy expenses for the bank building Rs.22,000/-
n. Taxes of 34% of taxable income are paid
o. Safe Deposit Locker rent receipt Rs.15,000/-

Q 24. M/s XYZ Bank Ltd. has the following Balance Sheet & Income
Statement.

(Figures are in Rs. Crores)

Balance Sheet
 Liabilities & Equity Assets Assets
Demand Deposits 47,000 Cash & Bal. with RBI 9,000
Term Deposits 89,000 Bal. with Banks/Money
at call & short notice 42,000
Debentures 19,000 Investment securities 23,000
Total Liabilities 155,000
Paid up Equity Capital 12,000 Loans & advances 90,000
Share Premium 4,000 Fixed assets 15,000
Retained Earnings 12,000 Other assets 4,000
Total Liabilities & Equity 183,000 Total assets 183,000

Income Statement

Interest & discount on Loans 9,000

Interest on Investment securities 4,000
Interest on Money Market 6,000
Securities
Interest on deposits in banks 1,000
Total Interest Income 20,000
Interest on Deposits 9,000
Interest on debentures 2,000
Total Interest Expense 11,000
Net Interest Income 9,000
Non-interest/Other Income 2,000
Non-interest/Other Expense 1,000
Operating Profit 10,000
Provision for loan losses/NPA 2,000
Provision
Profit before tax 8,000
Tax paid 3,000
Net Income/Net Profit 5,000
(Profit after tax)

For XYZ Bank, calculate :

a. ROE
b. ROA
c. EM (Equity Multiplier)
d. ER (Efficiency Ratio)
e. AU
f. PM

Q 25. What is the difference between firm-specific credit risk and

systematic credit risk ? How can a Bank alleviate firm specific credit risk ?

Q 26. What is the process of asset transformation performed by a Bank ?

Why does this process often lead to the creation of interest rate risk ?
What is interest rate risk ?
Q 27. What is refinancing risk ? How is refinancing risk part of interest
rate risk ? If an FI funds long-term assets with short-term liabilities, what
will be the impact on earnings of an increase in the rate of interest ? A
decrease in the rate of interest ?

Q 28. What is reinvestment risk ? How is reinvestment risk part of interest

rate risk ? If an FI funds short-term assets with long-term liabilities, what
will be the impact on earnings of a decrease in the rate of interest ? An
increase in the rate of interest ?

Give Answer to Question Nos. 1 to 30 in a couple of words. Each

question carries 1 mark.
Q 1. What is the process of pooling small amounts of savings from
individuals to be given as loans known as------ ?

Q 2. What is the process of borrowing of relatively short-term funds

from savers, who often cannot commit their funds over long periods, and
making long-term loans to borrowers who require a long-term commitment
to funds known as ?

Q 3. What is the limit/amount of deposit insurance available to a single

individual depositor per bank ?

Q 4. All scheduled commercial banks are required to deposit a certain

percentage of their Net Demand and Time Liabilities in the form of cash
with RBI. What is the name of this and the current rate ?

Q 5. Expand SWIFT ?

Q 6. Expand RTGS ?

Q 7. Name two non-fund based credit facilities commonly provided by a

commercial bank ?

Q 8. Name the right of a banker to combine/adjust two accounts of a

customer, one with a credit balance and the other with a debit balance ?

Q 9. Name the right of the Banker to retain possession of the goods &
securities owned by the debtor (borrower) until the debt due from the
latter is paid ?

Q 10. Name the bill finance facility under which Buyer’s Bank discounts
the bill for the account of the Buyer and remit the amount to the
Drawer/Seller of the Bill and Buyer’s Bank recovers the amount paid on
the bill along with interest and other charges, if any from the Buyer (his
Customer) on the due date of the bill. This is a working capital facility to
the buyer as an alternative to the Cash Credit facility against stocks.
Q 11. What is the name of a bill which is payable after a specified
period of time ?

Q 12. Name a credit facility which is a substitute of a Term loan and

also a non-fund based credit facility ?

Q 13. In countries like USA and Japan, issue of bank guarantee is

prohibited, instead the banks there issue a specific type of Letter of
Credit for this purpose. Name this Letter of Credit ?

Q 14. Write the expression for Working Capital Gap (WCG) ?

Q 15. Write the expression for Tangible Net Worth (TNW) ?

Q 16. Current ratio is 1, find out the Net Working Capital (NWC) ?

Q 17. THIS IS A SIMPLE METHOD OF WORKING CAPITAL ASSESSMENT WHERE THE

WORKING CAPITAL REQUIREMENT OF THE BUSINESS UNIT TO BE ASSESSED
AT 25% OF THE PROJECTED ANNUAL GROSS SALES FOR THE NEXT YEAR.
NAME THIS METHOD ?

Q 18. Define Margin of Safety (MoS) in relative form which is used as

tool in Term loan appraisal.

Q 19. In loan syndication, a borrower is liable to pay a charge which is

certain percentage on the undrawn/unutilized portion of the loan. Name
this charge ?

Q 20. In a loan transaction, very often borrower has got better

information than the banker. This situation is known as ------ ?

Q 21. After loan is availed by the borrower, very often borrower

indulges in irresponsible or problematic behavior which may lead to
negative outcome. This situation is known as ------------- ?

Q 22. Define Net NPA to Net Credit Ratio ?

Q 23. What is the NPA provision rate for Loss Loan Asset ?
Q 24. What is the maximum default period beyond which a loan account
will be classified as NPA in the books of the bank ?

Q 25. Name the new risk recognized in Basel II ?

Q 26. What is the minimum Capital adequacy ratio (CAR) for Banks in
India as per Basel II ?

Q 27. Sub-ordinated debt is a part of Tier I or Tier II capital ?

Q 28. BCBS defines one risk as “the risk of direct or indirect loss
resulting from inadequate or failed internal processes, people and
systems or from external events”. This risk is called as --------- ?

Q 29. When the asset of a bank is short funded (borrowing short,

lending long), this gives rise to a risk which is a particular form of
interest rate risk. Name this risk ------ ?

Q 30. Name the ratio used for assessing the repayment capacity of a
borrower in case of a Term Loan ?

Q 31. If a Bank funds long-term assets with short-term liabilities, what will be the
impact on earnings of an increase in the rate of interest ?

this
Q 32. When the asset of a bank is long funded (borrowing long, lending short),
gives rise to a risk which is a particular form of interest rate risk. Name
this risk ------ ?

Q 33. If a Bank funds short-term assets with long-term liabilities, what will be the
impact on earnings of a decrease in the rate of interest ?

Q 34. Who decides interest rate on Savings Bank account ?

Q 35. What is the current interest rate on Savings Bank account ?

Q 36. What is the interest rate payable on Current Deposit account ?

Q 37. Who decides interest rate on Term Deposit account ?

 Q 38. What is the full form of BPLR ?

Q 39. Who decides the BPLR of a Bank ?

Q 40. Define the Rate Sensitivity Gap (RSG) also known as Re-pricing
Gap or Funding Gap ?

Q 41. What are the three pillars of Basel II new capital accord ?

Q 42. What is the new risk introduced as per Basel II ?

Q 43. Define Capital Adequacy Ratio (CAR), also known as Capital to

risk-weighted asset ratio (CRAR).

Q 44. What are the two reasons for Which banks need liquidity ?

Q 45. What two methods do Banks/Financial Institutions use to manage

the liquidity needs ?

Q 46. Calculate the re-pricing gap and impact on net interest income
(NII) of a 1% increase in interest rates for the following position :
RSA = 100 crore, RSL = 50 crore

Q 47. Calculate the re-pricing gap and impact on net interest income
(NII) of a 1% increase in interest rates for the following position :
RSA = 50 crore, RSL = 150 crore

Question Nos. 1 to 6 carry 5 marks each.

Q 1. Mention the different items that appear in a Bank’s Income Statement (Profit & Loss
Account) in India. Show step by step calculation to derive Operating Profit and Net Profit after
tax (Net Income).

Question Nos. 7 to 9 carry 10 marks each.

Q 7. What are three pillars of Basel II new Capital accord ? What is the new risk introduced as per
Basel II ? Define Capital Adequacy Ratio, also known as Capital to risk-weighted asset ratio (CAR or
CRAR). What is the minimum Capital adequacy ratio requirement for Banks in India ?
Q 8. What is Credit Default Swap (CDS) ? Explain with the help of a diagram.

: : 2 : :

Q 9. M/s XYZ Bank Ltd. has the following Balance Sheet & Income Statement.
Balance Sheet (Figures are in Rs. Crores)
Liabilities & Equity Assets Assets
Demand Deposits 57,000 Cash & Bal. with RBI 19,000
Term Deposits 99,000 Bal. with Banks/Money
at call & short notice 52,000
Debentures 29,000 Investment securities 33,000
Total Liabilities 185,000
Paid up Equity Capital 22,000 Loans & advances 110,000
Share Premium 14,000 Fixed assets 15,000
Retained Earnings 12,000 Other assets 4,000
Total Liabilities & Equity 233,000 Total assets 233,000

* Average earning assets = 200,000

Income Statement

Interest & discount on Loans 19,000

Interest on Investment securities 5,000
Interest on Money Market Securities 6,000
Interest earned on deposits in banks 1,000
Total Interest Income 31,000
Interest paid on Deposits 10,000
Interest paid on debentures 3,000
Total Interest Expense 13,000
Non-interest/Other Income 4,000
Non-interest/Other Expense 6,000
Operating Profit 16,000
Provision for loan losses/NPA Provision 3,000
Profit before tax 13,000
Tax paid 3,000
Net Income/Net Profit 10,000
(Profit after tax)

For XYZ Bank, calculate :

a. NIM
b. ROE
c. ROA
d. EM (Equity Multiplier)
e. AU
 f. PM

Q 10. Explain the Letter of Credit (LC) Mechanism by means of a diagram.

-----------------End of Question Paper--------------

Q 4. Why banks need liquidity ? What two methods do Banks/Financial Institutions use to manage the
liquidity needs ?

Q 5. Calculate the re-pricing gap and impact on net interest income (NII) of a 1% increase in interest
rates for the following positions :
a. RSA = 100 crore, RSL = 50 crore
b. RSA = 50 crore, RSL = 150 crore
c. RSA = 75 crore, RSL = 70 crore
d. What conclusions can you draw about the re-pricing model from the above results ?

: : 2 : :

Question Nos. 9 & 10 carry 10 marks each.

Q 10. (a) As per the duration gap model of interest rate risk management, the change in the Market
Value of the Equity (MVE) of an FI is given as under :

∆ E = - DGAP x A x ,

(Where the symbols have usual meanings as under

Change in E = - Adjusted duration gap x Asset size x Interest rate shock)

Derive the above formula and explain the effect of the above three factors on the market value of
the FI’s equity due to interest rate volatility.

(b) If the market values of assets and liabilities are Rs.2,400/- Crore and Rs.2,100/- Crore
respectively, compute the change in the market values of equity given the following information :

Duration of Assets 5 years

Duration of Assets 4 years

Interest rate 11%

Change in Interest rate + 1%

-------------------END-------------------------

Question Nos. 1 to 6 carry 2 marks each.

Q 7. The following information relates to the assets of a bank :

Nature of Asset Amount (Rs. in Crore)

Standard Asset 5,600
Sub-Standard Asset :
Secured Exposure 2,150
Unsecured Exposure 1,000
Doubtful Asset :
up to 1 year 1,200
1 – 3 years 480
above 3 years 220
Loss Asset 150

Additional information :
(i) Standard asset carries a provision of 0.40%
(ii) The proportion of security available for the doubtful assets is 65%, 40% and 25%
for the three categories respectively.

Calculate the provisioning requirement of the bank based on the above information.

: : 2 : :

Question Nos. 7 to 15 carry 3 marks each.

 Q 9. Classify the following accounts into one of the following categories : (a) assets (b)
liabilities (c) equity (d) revenue (e) expense (f) Off-Balance Sheet (OBS) activity.

(1) Retail Deposits (2) Paid-up-capital (3) Loan Commitments (4) Consumer loans (5)
Interest on Investment securities (6) Interest on Savings Bank Deposits (7) Current
Deposits (8) Letter of Credit (9) Retained earnings (10) Provision on NPA Loans

Question Nos. 16 to 18 carry 5 marks each.

Q 16. What is refinancing risk ? How is refinancing risk part of interest rate risk ? If an FI
funds long-term assets with short-term liabilities, what will be the impact on earnings of an
increase in the rate of interest ? A decrease in the rate of interest ?

Q 17. What is reinvestment risk ? How is reinvestment risk part of interest rate risk ? If
an FI funds short-term assets with long-term liabilities, what will be the impact on earnings
of a decrease in the rate of interest ? An increase in the rate of interest ?

Q 18. Arrange the following items into an income statement. Label each item, place it in the
appropriate category as per the Bank’s Income Statement (P & L A/c) format and determine
the bank’s bottom-line net income.
p. Interest paid on Term deposits Rs.100,000/-
q. Interest paid on Certificate of deposits Rs.101,000/-
r. Interest received on GOI Securities Rs.44,500/-
s. Fees received on selling of insurance and mutual funds Rs.23,000/-
t. Dividends paid to Shareholders of Rs.0.50 per share for 5,000 shares
u. Provision for loan losses/NPA provision Rs.18,000/-
v. Interest and discount on loans Rs.1,89,700/-
w. Interest paid on SB accounts Rs.33,500/-
x. Interest received on Corporate/PSU bonds Rs.60,000/-
y. Employees salary and benefits Rs.1,45,000/-
z. Purchase of a new Computer system Rs.50,000/- (Depreciation for the current year
Rs.10,000/-)
aa. Service charge/commission receipts from customer accounts Rs.41,000/-
bb. Occupancy expenses for the bank building Rs.22,000/-
cc. Taxes of 34% of taxable income are paid
dd. Safe Deposit Locker rent receipt Rs.15,000/-
Q 8. ABC bank has 11.75% as its average cost of funds. If the transaction
cost involved for credit accommodation is 0.5% and if the bank plans to
maintain a 3% margin on the same, compute the contractual rate for the
loan which is adjusted for loan defaults and losses. Following additional
information for the problem : Principal loan amount – Rs.1,500/- crore,
Probability of repayment – 0.9, Recovery rate for the principal and interest
component – 0.95.

Case Study 1

Read the case let carefully and answer the following questions. Each
Answer should be specific/to the point and not to exceed 4 to 5 lines.

Axis Bank has to control cost of funds improve bottomline

(ET dtd.12.01.09)

Q 10. Define Net Interest Income (NII), Net Interest Margin (NIM) and
Burden or Overhead.

Q 11. What do you mean by CASA deposits ? Why is it so important for a

bank ?

Q 12. Comment on the statement “Falling interest rates affect lending

rates rather than the borrowing or deposit rates”.

Q 13. What are the sources of other income for a bank ? Why it’s so
important for the bank in the present environment ?

Q 14. What are the sources of other income for a bank ? Why it’s so
important for the bank in the present environment ?

Q 15. Comment on the statement “The amount provided under the head of
provisions and contingencies fell by 34% Y-o-Y due to reversals of provisions
on corporate and government bonds, amounting to Rs.147 crore boosting its
profit growth. In fact, this is the most crucial aspect of the results, where
the profit growth is more on account of drop in provisions than the growth in
net interest income (NII).”
Q 16. “Going forward, the cost of deposits is expected to come down that
would ease the pressure on NIM”. Explain this statement.

AXIS Bank reported a 63.2% growth in net profit for the quarter ended
December 2008 on growing business and a sharp drop in provisions and
contingencies. Bank’s business as measured by the sum of deposits and
advances grew by 54.5% year-on-year (Y-o-Y). This was in line with the trend
seen in the first half of the financial year 2009. Net interest margin (NIM)
fell by close by close to 79 basis points (bps) to 3-12% for the December
quarter, as term deposits posted a growth of 75%, while CASA deposits
grew by just 29%. Term deposits attract higher interest than CASA
deposits. The bank also reduced interest rates after the RBI’s rate cuts.
Falling interest rates affect lending rates rather than the borrowing or
deposit rates. Therefore, it was expected that bank’s NIM could be
affected, though the change was substantial and it is extremely crucial for
Axis Bank to control its rising cost of deposits. Other income rose by 50%
Y-o-Y on strong momentum in fee income which grew by 56.7% and trading
gains.

The amount provided under the head of provisions and contingencies fell by
34% Y-o-Y due to reversals of provisions on corporate and government
bonds, amounting to Rs.147 crore boosting its profit growth. In fact, this is
the most crucial aspect of the results, where the profit growth is more on
account of drop in provisions than the growth in net interest income (NII),
which stood at a mere 24.4% against 70.8% during the six months ended
September 2008. The positive aspect of the third quarter result is that the
bank is still posting a very high growth on its loan book. The performance at
the operating level is satisfactory. The key concern is high cost of deposits.
The bank has to control its cost of funds, as it may affect its bottomline
growth in coming quarters. Going forward, the cost of deposits is expected
to come down that would ease the pressure on NIM. And if this happens, the
bank would continue to post high growth rates in profit as seen in the first
nine months of the financial year 2009.

Case Study 2

Read the case let carefully and answer the following questions. Each
Answer should be specific/to the point and not to exceed 4 to 5 lines.

Arcil to float USD600-m fund to invest in NPAs

(ET dtd.19.01.09)

Q 10. What do you mean by asset quality/credit quality ? How the asset
quality of a bank is measured ?

Q 13. Why the banks have voiced concerns over the impact on their asset
quality in the present situations ?

Q 13. What is the difference between firm-specific credit risk and

systematic credit risk ? How can a Bank alleviate firm specific credit risk ?

Q 14. Define loan sales. What is the difference between loans sold with recourse and without
recourse from the prospective of both sellers and buyers ?

ARCIL, the country’s first asset reconstruction company, is looking to float a

USD600-million fund for investing in distressed bank assets, said managing
director & CEO of the Company S Khasnobis. Arcil has proposed to
contribute 20% of the fund and the balance would be raised from
International and Domestic investors. The company will float the product in
next three months and the funds would be raised in phases on the basis of
requirement. “The fund will be used for cash purchases of NPAs from
banks”, Mr. Khasnobis said here on Saturday on the sidelines of the 4th
international convention of the Association of National Exchange Members
of India. With the latest proposal to float a fund, which would be used to
finance its cash purchases, Arcil is certainly positioning itself for a better
business prospect next fiscal.

Given the economic downturn, every top banker has voiced concerns over the
impact on their asset quality. They expect NPAs to rise from the current
levels. This is an opportunity for Arcil to grow its business. Arcil buys bad
loans from banks and expedite recovery of the amounts locked in NPAs.
Sectors like exports, textiles, gems and jewellery, logistics have faced
severe stress following the slowdown and these sectors are likely to
contribute most in the rise of NPAs. As job cuts have also become a regular
affair now, banks may also face rise in NPAs in their housing loans. Arcil has
recently started purchasing distressed assets, especially bad home loan
assets. However, its main focus continues to be buying the distressed
corporate loans from banks.

Case Study 3

Read the case let carefully and answer the following questions. Each
Answer should be specific/to the point and not to exceed 4 to 5 lines.

Treasury loss : Rs.1,500 Crore

PSU Banks to take a major hit due to rising yields
(ET dtd.28.06.08)

Q 11. What do you mean by mark-to-market (MTM) ?

Q 10. Mention the three categories of investment securities held by banks
based on the objectives of investments.

Q 13. Out of this which categories of investments are subjected to Mark-

to-market (MTM) accounting ? And what is the frequency of MTM for such
categories ?

Q 6. Whatare objectives of an investment portfolio of a bank ?

Q 13. “Banks run into losses on their bond portfolios, when bond yields rise
sharply. Thus, in the current circumstances, banks with a larger share of
portfolios in the AFS category (non-HTM bucket), and that too, bonds with a
longer duration, will be most affected.”

The first quarter of 2008-09 could see banks declare losses up to Rs.1,500
Crore on treasury operations. Nationalised banks are more likely to bear the
brunt of rising yields compared to their private sector peers since a few
large PSU banks have perked as much as 50-60% of their bond portfolios in
the available-for-sale (AFS) category. As against this, private sector majors
such as ICICI Bank, HDFC Bank and Axis Bank have perked only 15-20% of
their bond portfolios in the AFS bucket. As per RBI guidelines, banks have
to mark-to-market (MTM) a portion of their G-sec book (i.e., 26-30% of
assets owing to high SLR), which is in the non-held-to-maturity (HTM)
category. Thus, in the current circumstances, banks with a larger share of
portfolios in the AFS category (non-HTM bucket), and that too, bonds with a
longer duration, will be most affected. In addition, banks have also to mark-
to-market all their non-G-sec investments (like corporate bonds) every
quarter.

According to a recent report published by Merrill Lynch, for every 10-basis

points rise in yields, banks could incur a loss of up to Rs.250 Crore. It may be
recalled that the yield on the benchmark paper, the 8.24% bond maturing in
2018 (residual maturity of 10 years), has moved up from 7.90% in March
2008 to over 8.85% in June 2008. Banks run into losses on their bond
portfolios, when bond yields rise sharply. Bond prices fall when yields rise
and banks have to mark-to-market the holdings in the AFS category based
on the yield prevailing on the last day of the quarter. Recently, the RBI
hiked repo rate – rate at which banks borrow from RBI – and the CRR by 50
bps each. This has caused yields to move up drastically in the past week of
this quarter. Given the PSU banks have large SLR requirements, most banks
would have huge stocks of the benchmark bond, which alone has witnessed a
fall of more than 400 paise rise in barely three months time. SBI, the
largest PSU player, seems to be the worst hit, given the significant exposure
to varied class of securities. The bank has parked up to 80% of its bond
holdings in the HTM category, but faces the risk of incurring a loss of more
than Rs.350 Crore this quarter.