Bond Yield Surge Above 7% Puts PSU Bank Treasury Gains at Risk

Public sector Banks are facing a fresh earnings risk as rising government bond yields threaten treasury income and the value of their investment portfolios. India’s benchmark 10-year government bond yield ended September at around 7.15 per cent, sharply higher than approximately 6.72 per cent at June-end. At the same time, drought conditions in Maharashtra and Karnataka have revived concerns around potential farm-loan relief.

While agricultural loan waivers can affect credit discipline and cash flows, the more immediate financial pressure for banks could come from the sharp correction in government bonds, particularly for lenders that benefited significantly from treasury gains in recent quarters.

Bond prices and yields move in opposite directions. As yields rise, existing bonds carrying lower coupons lose value. Banks holding sizeable government-security portfolios can therefore face mark-to-market pressure and weaker gains from bond sales.

India’s 10-year government bond yield was around 7.15 per cent on September 30, compared with roughly 6.72 per cent at June-end, representing an increase of more than 40 basis points during Q2FY27.

Global conditions have also become less supportive. The U.S. 10-year Treasury yield climbed above 5 per cent during September amid elevated inflation concerns and uncertainty over the future path of interest rates. Consequently, the India-U.S. 10-year yield spread narrowed to around 195 basis points from about 272 basis points in March 2026.

Foreign portfolio investors withdrew a net Rs 10,602 Cr from Indian government bonds under the Fully Accessible Route during September, marking the highest outflow in six months.

State Bank of India provides an example of how treasury income can influence bank profitability. The bank reported treasury gains of about Rs 4,319 Cr in Q1FY27, when bond-market conditions were relatively supportive, making treasury income a meaningful contributor to quarterly profitability.

The changed yield environment during July-September means Q2FY27 could look different. A rise in yields can reduce realised gains from bond sales and create valuation pressure across securities held in portfolios where mark-to-market rules apply.

The issue is particularly relevant for PSU banks because treasury operations have historically formed a larger and more volatile component of earnings than for some large private-sector lenders. At the same time, banks remain major buyers of high-quality debt.

SBI recently purchased nearly Rs 5,000 Cr, or around 40 per cent, of Reliance Industries’ Rs 13,000 Cr 10-year bond issue carrying a 7.90 per cent coupon.

The second risk comes from the agriculture sector. Maharashtra has declared drought in 265 of 358 talukas, or about 75 per cent of the state, after deficient rainfall during the 2026 kharif season. Karnataka has also faced a severe rainfall deficit and announced immediate support for drought-affected farmers.

PSU banks generally have higher agricultural exposure than large private-sector lenders. In FY26, agricultural loans accounted for roughly 10 per cent of SBI’s domestic loan book, compared with around 4 per cent for HDFC Bank.

However, a government-funded waiver does not automatically translate into an equivalent loss for banks. Under the nationwide 2008 Agricultural Debt Waiver and Debt Relief Scheme, the government ultimately reimbursed lending institutions more than Rs 52,400 Cr.

Similarly, Uttar Pradesh’s 2017 farm relief programme involved assistance of more than Rs 36,000 Cr.

The two risks affect banks differently. Farm waivers can weaken repayment behaviour, delay recoveries and increase uncertainty around agricultural credit, but government reimbursement can limit the direct earnings impact.

Rising bond yields, however, can affect investment portfolios more immediately. With domestic yields above 7 per cent, U.S. yields above 5 per cent and foreign investors reducing exposure to Indian government debt, treasury performance is emerging as an important variable for PSU banks heading into Q2FY27 results.

For investors, movements in the 10-year gilt yield, treasury gains, mark-to-market impact and agricultural asset quality will therefore be important numbers to monitor in the coming quarters.

Disclaimer: The article is for informational purposes only and not investment advice.