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Bond Rally and Bank Credit |
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13 Jan 2009 15:00 IST by WealthMonk Advisor
Government securities saw a huge run up over the last few weeks. In a little over 4 months the yields on the benchmark 10 year government bond has fallen (yields and prices are inversely related) from 9.5% levels to less than 5%. In the process, bond holders have made huge trading profits. Government bonds are actively traded securities with banks being the most significant participants in this market. It was far easier for banks to deploy funds raised by accepting deposits, into government bonds rather than actively lend. In an economy that is slowing down, the aversion to lend money goes up as banks fear defaults from borrowers for a host of reasons. However it is important to deploy money somewhere so that banks are able to generate income over and above what it pays to depositors and covers it’s own costs. Government securities offered a great option for banks. They saw the opportunity in government securities and deployed more than what they are required to since they have an easy option to get investment returns.
With the yields falling (and bond prices going up) to 5% levels, the potential of gilts to offer significant trading gains is no longer there. While there would always be investment and trading options, the juice is pretty much gone. So RBI action to reduce repo and reverse repo would finally start taking effect since banks will be forced to look for avenues to make more than what they pay depositors. This should fuel credit flow back into the economy.
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Posted in: Economy
, Indian Economy
Tags : Banks
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