RBI issues guidelines on treatment of banks' illiquid assets

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The Reserve Bank today issued draft guidelines on prudent valuation of banks' long-term assets which are illiquid in nature.

"The prudent valuation adjustment for illiquid positions has assumed greater importance in the wake of the recent financial crisis," RBI said in the draft supplementary guidance.

"This guidance seeks to provide indicative guidelines to banks to define illiquid positions and subsequent valuation adjustments through Tier I capital," it said.

The guidance also contains certain additional valuation adjustment to be made to the derivatives portfolio, it said.

These guidelines require banks to make specified valuation adjustments for various risks or costs in their portfolios including derivatives, which are subject to 'mark to market' requirement and also for illiquidity of these positions.

The guidelines on which comments are invited till October 19, permit banks to follow any recognised model or method for computing the amount of valuation adjustment.

RBI said that illiquid positions are generally disposed of at much lower price than the value reflected by banks in the books of accounts as per applicable accounting standards.

These concerns have become more pronounced after the financial crisis.

The recent market events such as large capital inflows or outflows, global financial crisis, large increases in government borrowings, frauds involving many active market participants in particular market segments leading to erosion of confidence in the financial markets, etc. Could render the prices quoted a few days back or even the same day unreliable for fair valuation, it said.

Banks need to take into account such events while valuing their positions, it said.

Liquidation of large concentrated positions may result in adverse movement in the price the moment the off-loading starts, particularly when the market is not deep, it said.

Banks need to make a downward adjustment to the fair value of such positions reflected in the books of the banks, to reflect this uncertainty, it added.