The government, in the Union Budget 2026, proposed a record gross market borrowing of ₹17.2 lakh crore for the next fiscal year, which came in higher than market expectations. The announcement also sent the yield on India’s 10-year G-Sec to a one-year high on 2 February.
Though yields have cooled off in the subsequent sessions, they remain at an eleven-month high of 6.7%, even after cumulative rate cuts of 125 basis points in the repo rate.
While the higher yields could put pressure on banks’ treasury portfolios, especially in state-owned banks that maintain large portfolios of government securities, analysts have said the impact could be limited, noting that stronger core credit growth and improving margins can offset treasury swings over the full year.
They also pointed out that PSU banks are structurally better placed today to handle bond yield volatility than in earlier cycles, largely because balance sheets and treasury positioning have strengthened over the past few years.
Anil Rego, Founder and Fund Manager at Right Horizons PMS, decodes the near-term impact on treasury income, margins, and profitability.
Edited excerpts:
The government’s FY27 gross borrowing has come in higher than market expectations, keeping bond yields elevated. How meaningful could the near-term mark-to-market impact be on PSU banks’ treasury books, especially for banks with higher G-sec exposure?
The higher-than-expected FY27 gross borrowing program is likely to keep government bond yields firm in the near term, which in turn raises the risk of MTM pressure on banks’ treasury portfolios.
With yields projected to grind higher over the course of the year amid elevated borrowing needs and a reduced probability of rate cuts, valuation losses on held-for-trading and available-for-sale books could become more visible, especially for institutions carrying a larger proportion of G-secs outside the HTM bucket.
For PSU banks in particular, the impact will be uneven. Those that had earlier built sizeable HTM cushions may be relatively insulated, as securities in this category are not subject to daily MTM. However, banks that increased AFS exposure during the softer yield phase could see quarterly treasury volatility rise if the 10-year yield trends toward higher levels over FY27.
That said, the stress is more likely to be earnings-timing related rather than structural: stronger core credit growth and improving margins can offset treasury swings over the full year, but reported profits in individual quarters may appear more volatile if bond yields remain elevated.
With bond yields firming up, do you see any spillover impact on PSU banks’ net interest margins or overall profitability in the near term, or is the impact largely limited to treasury income?
Firming bond yields are more likely to affect PSU banks through treasury performance rather than causing a sharp, immediate hit to core NIMs. Rising yields typically translate into mark-to-market pressure on the available-for-sale and trading portfolios, creating volatility in treasury income. This becomes more relevant in an environment where yields are expected to drift higher alongside elevated government borrowing and a reduced likelihood of policy rate cuts.
However, the transmission to NIMs is slower and more nuanced. On the asset side, a large share of PSU bank loan books is linked to floating benchmarks, which allows lending rates to reprice over time.
On the liability side, deposit costs also adjust with a lag, but competitive pressures in mobilizing term deposits may keep funding costs somewhat sticky. As a result, while sustained high yields can gradually compress margins if deposit repricing outpaces loan repricing, the near-term impact on NIMs is usually limited.
Overall profitability in the short run is therefore more vulnerable to treasury swings than to core banking spreads, with operating performance and credit growth playing a bigger role in cushioning earnings volatility.
PSU banking stocks have corrected sharply following the spike in bond yields. From a valuation perspective, do you see this correction as largely sentiment-driven, or do earnings risks justify the recent sell-off?
The recent correction in PSU banking stocks appears to be driven more by sentiment around rising yi bondelds than by a moderation in underlying earnings. The spike in yields has heightened concerns about mark-to-market pressures on treasury portfolios and the possibility of softer bond gains, which tend to weigh disproportionately on PSU banks given their relatively higher exposure to government securities.
With yields expected to remain firm amid elevated government borrowing, the near-term treasury volatility is a genuine risk and has understandably unsettled investors.
That said, the earnings impact is likely to be more about quarterly volatility than a structural impairment of profitability. Core operating trends for PSU banks, including credit growth, improving asset quality, and stronger provision buffers built over recent years, provide a cushion against treasury-led fluctuations.
NIMs may face gradual pressure if funding costs stay elevated, but the adjustment is typically slower and more manageable than the market reaction suggests. In that context, the sharp price correction seems to reflect a sentiment reset tied to rates rather than a broad-based downgrade to the sector’s medium-term earnings trajectory, though near-term reported profits could remain uneven if bond yields stay high.
Are PSU banks better positioned today to absorb volatility in bond yields compared to previous cycles, given improvements in capital adequacy, HTM buffers, and treasury risk management?
PSU banks are structurally better placed today to handle bond yield volatility than in earlier cycles, largely because balance sheets and treasury positioning have strengthened over the past few years. Capital adequacy levels across most large public-sector lenders are materially higher than in the previous rate upcycles, giving them a thicker buffer to absorb mark-to-market swings without materially constraining lending or growth plans.
In addition, many PSU banks have consciously built larger HTM portfolios, which shield a meaningful portion of their government bond holdings from daily valuation changes, thereby reducing earnings volatility from rising yields.
The nature of the current yield environment also matters. With government borrowing expected to remain elevated and the probability of policy rate cuts having diminished, bond yields are seen staying firm, which keeps treasury risk in focus.
However, compared with earlier periods when treasury books were used more aggressively to boost profits, banks today follow tighter duration management and more conservative classification between HTM and available-for-sale buckets. As a result, while near-term treasury income can still be volatile, especially for banks with higher AFS exposure, the risk of systemic stress or large capital erosion from bond moves appears significantly lower than in past cycles.
Looking beyond the near-term volatility, how should investors assess PSU banks in an environment of higher government borrowing? Does credit growth and operating performance still provide enough cushion over FY27?
Beyond the immediate volatility from higher bond yields, the broader investment case for PSU banks still hinges more on core operating trends than on treasury movements. Elevated government borrowing is likely to keep yields firm and reduce the scope for bond-driven gains, but that primarily affects treasury income rather than the fundamental earnings engine of these banks. With the rate outlook tilting toward a prolonged pause and yields expected to stay elevated, treasury contributions may remain subdued and occasionally volatile through FY27.
Credit growth and operating performance to be key cushions
However, credit growth and operating performance continue to be the key cushions. PSU banks have been seeing healthier loan growth across retail, MSME, and corporate segments, supported by stronger balance sheets and lower legacy stress. Asset quality has improved meaningfully over the past few years, reducing provisioning drag and allowing a greater share of operating profit to flow through to the bottom line.
Even if net interest margins face some gradual pressure from higher deposit costs, the impact is typically spread over time rather than abrupt. In that context, while higher borrowing and firm yields may cap treasury upside, steady credit expansion, better recoveries, and disciplined cost control can still support overall profitability through FY27, making the earnings story more resilient than bond-market moves alone might suggest.
Disclaimer: : This story is for educational purposes only. The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.
