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RBI (Classification, Valuation and Operation of Investment Portfolio of Commercial Banks) Directions, 2023

The Reserve Bank of India had issued a Discussion Paper (DP) on January 14, 2022 proposing revisions to the current norms for the classification, valuation, and operation of investment portfolios of commercial banks. After considering the feedback received on the DP, the Reserve Bank of India (Classification, Valuation and Operation of Investment Portfolio of Commercial Banks) Directions, 2023 has been issued.

Revised norms

  1. The revised Directions include principle-based classification of investment portfolio, tightening of regulations around transfers to/from held to maturity (HTM) category and sales out of HTM, inclusion of non-SLR securities in HTM subject to fulfilment of certain conditions and symmetric recognition of gains and losses.
  2. These Directions are expected to enhance the quality of banks’ financial reporting, improve disclosures (disclosures of fair value of investments in HTM category, fair value hierarchy, sales out of HTM, etc.), provide a fillip to the corporate bond market, facilitate the use of derivatives for hedging, and strengthen the overall risk management framework of banks.
  3. While the revised Directions align the accounting norms for banks’ investment portfolios with global financial reporting standards, important prudential safeguards such as investment fluctuation reserve (IFR), due diligence/limits with respect to non-SLR investments, internal control systems, reviews and reporting etc. have been retained and prudential concerns on reliability of valuation have been addressed.
  4. The revised Directions shall apply to all commercial banks (excluding Regional Rural Banks) from the financial year commencing on April 1, 2024.

Categorisation of Investments

The RBI’s new directives require banks to classify their investment portfolios into three main categories:
  1. Held to Maturity (HTM): Under this existing category, banks should hold securities with the intention of keeping them until maturity. These securities should provide regular principal and interest payments.
  2. Available for Sale (AFS): Securities categorised as AFS are those acquired with the objective of collecting contractual cash flows while also having the option to sell them.
  3. Fair Value through Profit and Loss (FVTPL): This is a new category introduced by RBI and includes securities that do not qualify for HTM or AFS. Securities in this category are valued at fair market value, and any gains or losses are directly reflected in the bank’s profit and loss account.
It’s important to note that the HTM category does not include certain securities, such as those with convertible features or loss absorbency features. Preference shares and equity shares are also excluded from HTM classification.

Initial Recognition 

Under the new RBI guidelines, all investments must be measured at fair value upon initial recognition. The presumption is that the acquisition cost is the fair value unless specific circumstances suggest otherwise. For example, if transactions involve related parties, occur under duress, or take place outside the principal market for that class of securities, the presumption may be tested. Government securities acquired through auctions, switch operations, and open market operations conducted by the RBI will be recognised at the price at which they are allotted.

Subsequent Measurement

The treatment of securities varies depending on their categorisation:
  1. Held to Maturity (HTM): Securities in the HTM category will be carried at cost and will not be marked to market after initial recognition. Any discounts or premiums on these securities will be amortised over the remaining life of the instrument.
  2. Available for Sale (AFS): AFS securities will be fair-valued at least quarterly. Amortisation of discounts or premiums on debt securities in this category will be applied over the remaining life of the instrument.
  3. Fair Value through Profit and Loss (FVTPL): Securities in the FVTPL category will be fair-valued, and any gains or losses from this valuation will be directly credited or debited to the profit and loss account.

Investments in Subsidiaries, Associates, and Joint Ventures

Investments in subsidiaries, associates, and joint ventures will be held separately from other investment categories. These investments will be initially recognised at their acquisition cost. If the investee entity later becomes a subsidiary, associate, or joint venture, the carrying value will be adjusted accordingly.

Impairment Evaluation

 Banks are required to regularly assess the impairment of investments in subsidiaries, associates, and joint ventures. Various indicators, such as defaults in debt repayments, credit rating downgrades, and significant declines in fair value, will trigger the need for impairment evaluation. In such cases, banks must obtain an independent valuation and make provisions for impairment accordingly.

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