Reserve Bank of India makes banks' investment norms more stringent

Over 5% sale from held-to-maturity category will need prior approval

The Reserve Bank of India (RBI) has revised investment norms for commercial banks, making it more stringent as it created a new category namely – fair value through profit and loss (FVTPL).

The held for trading (HFT) will now be a separate investment subcategory within FVTPL.

From April 1, 2024, when these new norms come into effect, banks will classify their entire investment portfolio (except investments in their own subsidiaries, joint ventures and associates) under three categories -- held to maturity (HTM), available for sale (AFS), and fair value through profit and loss (FVTPL).

“The category of the investment will be decided by the bank before or at the time of acquisition, and this decision shall be properly documented,” the RBI said in a notification on Tuesday.

After transitioning to this framework, banks are not allowed to reclassify investments between categories (viz. HTM, AFS, and FVTPL) without the approval of the boards, as well as from the regulator.

The norms mandated that securities that are classified under the HFT sub-category within FVTPL should be fair valued on a daily basis, whereas other securities in FVTPL will be fair valued at least on a quarterly, if not on a more frequent basis.

Importantly, sale of investments from the HTM category in any financial year should not exceed 5 per cent of the opening carrying value of the HTM portfolio. Any sale beyond this threshold will require the RBI’s approval.

The RBI has also said banks should create an investment fluctuation reserve (IFR) until the amount of IFR is at least 2 per cent of the AFS and FVTPL (including HFT) portfolio, on a continuing basis, by transferring to the IFR an amount not less than the lower of the net profit on sale of investments during the year or net profit for the year, less mandatory appropriations. IFR will be eligible for inclusion in Tier II capital to address the systemic impact of sharp increase in yields in government securities, the new norms said.

Banks were advised to create an IFR with effect from 2018-19, to reach a level of 2 per cent of their AFS and HFT portfolio within a period of three years where feasible, to build up adequate reserves to protect against increase in yields in future.

The RBI has dispensed with the requirement to keep an investment reserve account (IRA).

In the Discussion paper in 2022, the RBI had said specific reserves, such as IRA and IFR, might not be required. This was in the backdrop of maintaining regulatory capital, coupled with a proposed capital charge for market risk in Basel III. However, the RBI’s prudent approach had prescribed for IFR, experience of RBI having to provide special dispensations on occasions when the interest rate cycle has turned upwards.

The regulator said these directions were expected to enhance the quality of banks’ financial reporting, improve disclosures and provide a fillip to the corporate bond market, while strengthening the overall risk management framework of banks.

Regarding investments in subsidiaries, associates and joint ventures, the new norms mandates that such investments should be held at acquisition cost.

“Any discount or premium on the acquisition of debt securities of subsidiaries, associates and joint ventures shall be amortised over the remaining life of the instrument,” the RBI said.

THE MOVE 
 

Banks to classify investment portfolio (except investments in their own subsidiaries, joint ventures, and associates) under three categories — held to maturity, available for sale, and fair value through profit and loss
 

Banks won’t be allowed to reclassify investments between categories once transition is completed
 

Sale of investments from HTM category in any financial year to not exceed 5% of the opening carrying value of HTM portfolio