MUMBAI, Nov 4: The year 1997-98 financial year provides the best opportunity to move to a 100 per cent marked-to-market system for banks, says the latest Debt Markets Update of I-Sec.

The average decline of 200 basis points over the yield curve specified by the RBI on 31st March 1997, should result in large gains for banks on their `current' portfolio which will give them enough buffer to mark the entire `permanent' portfolio to market, it argued.

According to the report, this will be a big leap forward in the reform process and will further strengthen the banking sector for the inevitable move towards Capital Account Convertibility.

However, the flip side is that with 100 per cent marked-to-market,the volatility of earnings for banks will increase sharply and some banks which hold disproportionately large amounts of low coupon long/maturity securities will be adversely hit, it said.

In order to move to 100 per cent marked-to-market, banks will need to value their entire stock of government securities (Rs 1,87,000 crore) at market price. This will be a sharp increase of about Rs 96,000 crore compared to the market to market stock of the previous year, the update said.

However, out of this amount Rs 28,000 crore is the investment made by banks in the current financial year which is on the whole trading at a significant premium to par value. Hence, a total of Rs 68,000 crore (96,000-28,000) of securities from the permanent account will need to be valued at market.

It can be safely assumed that the sureties forming the permanent portfolio of banks would be low coupon and/or long maturity ones, rest forming the permanent portfolio (Rs 91,000 crore).

The dated securities (other than zeros and those issued this year) with a coupon of 11 per cent or less and/or a residual maturity of greater 10 years constitute over 30 per cent of the total outstanding government stock, the study said.

The net position for the banking sector after 100 per cent marked-to-market would be positive if the revaluation gains on Rs 91,000 crore securities already marked to market on 31st March 1997 is greater than the loss incurred on shifting Rs 68,000 crore of stock from the permanent to the current category. it said The paper expects the yields given by RBI for 31st March 1998 are likely to be at least 225 basis points lower across maturities than those specified last year.

The average price value of a basis point (PVBP) for Rs 91,000 crore of current portfolio (which is assumed to be formed of bonds with a coupon of 12 per cent or more and a residual maturity less than 10 years) is estimated at-3.5.

An yield drop of 225 basis points, then, would translate into price appreciation of roughly Rs 7.87 on par value of Rs 7,160 crore on a Rs 91,000 crore portfolio, it said.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.