RBI proposes new norms for classification of banks’ investment portfolio

• Reserve Bank of India (RBI) on Friday proposed new norms for the classification and valuation of the investment portfolio of banks, with a view to align them with the global prudential framework and accounting standards.
• According to the proposed norms, the investment portfolio of banks will be divided into three categories held-to-maturity (HTM), available for sale (AFS), and fair value through profit and loss account (FVTPL).
• The extant instructions pertaining to the prudential norms on the classification and valuation of the investment portfolio are largely based on the Report of Informal Group on Valuation of Banks’ Investment Portfolio, which was submitted in 1999.
• The recommendations of this informal group culminated in the issue of prudential guidelines on the investment portfolio in October 2002, which forms the basis of the current norms.
• The new norms propose to bridge the gap between the existing guidelines and global standards and practices with regards to classification, valuation and operations of the investment portfolio of commercial banks.

Existing Investment portfolio of Banks

• The investment portfolio of banks at present are classified under tree categories: held to maturity (HTM), held for trading (HFT) and available for sale (AFS).
• HTM securities are acquired by banks with the intention to hold them till maturity.
• Securities acquired by banks with the intention to trade by taking advantage of the short-term price or interest rate movements are classified under HFT.
• Instruments that do not fall in these two categories are classified under AFS.
• In a discussion paper, the RBI said FVTPL will now accompany the HTM and AFS categories.
• HFT will be a sub-category within FVTPL.

New proposals

• RBI proposed to allow banks to hold corporate bonds, or even equity shares of subsidiaries, associates and joint ventures, in the held-to-maturity category (HTM) of their investment books.
• Investments in the HTM category are not required to be valued at the current market price, and hence, banks do not have to incur a mark-to-market loss if the market declines to the current prices of the instruments.
• Earlier, only government and state government securities, and certain securities by infrastructure companies were allowed in the HTM category.
• Also, banks were not allowed to keep more than 25 per cent of their total investments in this category.
• In a draft discussion paper on prudential norms on investment by banks, the RBI proposed removing the ceiling on investments in HTM as a percentage of total investments and also the ceiling on SLR securities that can be held there.
• Feedback on the draft can be given till February 15.
• According to experts, this will allow banks to buy more bonds for both government and corporates, thereby increasing the investor base for these securities.
• However, according to the draft discussion paper, “the controls for sale from HTM shall be tightened to ensure that the basic principles and tenets for the classification of securities as HTM and valuation of them at cost are not invalidated.”
• FVTPL will be the residual category where all investments that are not eligible to be included in HTM or AFS will be classified.
• This category may include investments such as securitization receipts (SRs), mutual funds, alternative investment funds, equity shares, derivatives (including those made for hedging) with no contractually specified periodic cash flows that are only payments of principal and interest on principal outstanding can be kept.
• In either of these categories, while valuing assets initially, if the security cannot be assessed due to lack of market quotes, losses will have to be recognized immediately, while gains should be deferred.
• Securities held in HTM will have to be carried at cost and will not require marking to market after initial recognition with any discount or premium on acquisition being amortized over the life of the instrument.
• However, these assets have to be assessed quarterly to account for any permanent diminution in value and the impairment, if any, must be debited to the Profit and Loss Account as per RBI.