Most Indians have watched the iconic James Bond movies or at least heard of them, where the super hero always wins no matter what the odds. However, here we are dealing with a different type of bond.
Bonds are essentially loans given by investors to borrowers such as governments, corporations or public institutions. In India, government bonds are issued through auctions conducted by the Reserve Bank of India (RBI). Commercial banks, insurance companies, mutual funds and large institutional investors buy these bonds. After the initial issue, bonds can be traded like shares in the secondary debt market.
Where Is the Problem?
Bonds offer fixed interest payments, which is called the coupon rate and the repayment of the face value (principal amount) after maturity. Let's take an example: The Government of India issues a 10-year bond with a face value of ₹100 and a 6% coupon rate. That means it pays ₹6 every year for 10 years to every investor, without any uncertainty.
Now suppose the Government issues fresh bonds to raise capital to meet its financial obligations. The new bonds, let's say, offer a 6.5% coupon rate. Your legacy bond still pays you ₹6, which is less attractive to investors. Therefore, if you try to sell your old bond, no one will pay the full ₹100 for it. They will wish to buy it at a discount — maybe ₹92 — so that the effective return (yield) matches the new 6.5% level.
Bond prices and yields enjoy an inverse relationship:
- When yields rise → bond prices fall.
- When yields fall → bond prices rise.
Banks hold a large amount of government bonds in their treasury portfolios, because they are considered safe investments, which offer regular returns, backed by sovereign guarantee. But when bond yields rise, as it is happening now, banks have to book mark-to-market losses in their treasury book, which reduces their treasury income or profits.
A bank's treasury operations are all about managing its own investments, and risks. It is essentially how the bank handles its own funds, not customers' deposits or loans. Treasury generates incomes for banks through interests, trading gains and forex operations. Therefore, elevated bond yields squeeze the treasury income of banks. This is exactly what the quarter 2 (Q2) performance of most banks in India is reflecting.
Major Indian banks reported a significant decrease in their treasury gains during the July-September quarter (Q2) due to hardening bond yields and lack of open-market operations by the Central Bank. The 10-year benchmark government bond yield rose to 6.64% in late August from a June low of 6.12%. HDFC Bank saw a 76% decline in treasury income to Rs 2,400 crore, ICICI Bank experienced over 67% reduction to Rs 220 crore, and Bank of India reported an 8.5% decrease to Rs 5,840 crore.
You may ask, interest rates are falling, how can bond yields harden in such a benign policy environment when inflation is at historic low? That is because, the yield on a long-term government bond depends not just on the current repo rate, but on expectations of future inflation, concerns on India's economic growth for the remaining quarters of FY 2025-26, especially in the face of US government's arbitrary tariff impositions on India's exports, volatility in the global crude oil market, and so on. There are also concerns that the stellar performance of India's economy in Q1 (Real GDP growth of 7.8%) FY 2025-26 is not reflecting the reality on ground across sectors.
The Silver Lining
The instability in bond yields may not continue for long with the RBI expected to step in and Indo-US trade talks reaching finalisation after a long hiatus, which will strengthen confidence of global investors in India's sovereign bonds.
