Master Circular - Prudential norms for classification, valuation and operation of investment portfolio by banks - ఆర్బిఐ - Reserve Bank of India
Master Circular - Prudential norms for classification, valuation and operation of investment portfolio by banks
RBI/2011-12/65 July 1, 2011 All Commercial Banks Dear Sir, Master Circular – Prudential norms for classification, Please refer to the Master Circular No. DBOD. BP. BC.18 / 21.04.141/ 2010-11 dated July 1, 2010, containing consolidated instructions/guidelines issued to banks till June 30, 2010, on matters relating to prudential norms for classification, valuation and operation of investment portfolio by banks. The above Master Circular has since been suitably updated by incorporating instructions/guidelines issued between July 1, 2010 and June 30, 2011, and furnished in the Annex. This updated version has also been placed on the RBI web-site (http://www.rbi.org.in). 2. An Appendix containing a list of circulars referred for the purpose of the current Master circular is furnished at the end of the Annex. Yours faithfully, (Deepak Singhal) Encl: As above Annex MASTER CIRCULAR – PRUDENTIAL NORMS FOR CLASSIFICATION, Table of Contents
MASTER CIRCULAR – PRUDENTIAL NORMS FOR CLASSIFICATION, VALUATION AND 1. Introduction 1.1 nvestment Policy (a) Banks may sell a government security already contracted for purchase, provided:
For purchase of securities from RBI through Open Market Operations (OMO), no sale transactions should be contracted prior to receiving the confirmation of the deal/advice of allotment from the RBI . Banks successful in the auction of primary issue of government may enter into contracts for sale of the allotted securities in accordance with the terms and conditions as per Annex I-C. (c) The settlement of all outright secondary market transactions in Government Securities will be done on a standardized T+1 basis effective May 24, 2005. (e) The brokerage on the deal payable to the broker, if any, (if the deal was put through with the help of a broker) should be clearly indicated on the notes/ memoranda put up to the top management seeking approval for putting through the transaction and a separate account of brokerage paid, broker-wise, should be maintained. (f) For issue of BRs, the banks should adopt the format prescribed by the Indian Banks' Association (IBA) and strictly follow the guidelines prescribed by them in this regard. The banks, subject to the above, could issue BRs covering their own sale transactions only and should not issue BRs on behalf of their constituents, including brokers. (i) Banks desirous of making investment in equity shares/ debentures should observe the following guidelines: ii) With the approval of respective Boards, banks should clearly lay down the broad investment objectives to be followed while undertaking transactions in securities on their own investment account and on behalf of clients, clearly define the authority to put through deals, procedure to be followed for obtaining the sanction of the appropriate authority, procedure to be followed while putting through deals, various prudential exposure limits and the reporting system. While laying down such investment policy guidelines, banks should strictly observe Reserve Bank's detailed instructions on the following aspects: a. STRIPS Paragraph 1.1.1) iii) The aforesaid instructions will be applicable mutatis mutandis, to the subsidiaries and mutual funds established by banks, except where they are contrary to or inconsistent with, specific regulations of Securities and Exchange Board of India (SEBI) and RBI governing their operations. 1.1.1 STRIPS 1.1.2 Ready Forward Contracts in Government Securities. (b) Ready forward contracts in the above-mentioned securities may be entered into by: (a) Any scheduled bank (b) Any primary dealer authorised by the RBI, (c) Any non-banking financial company registered with the RBI, other than Government companies as defined in Section 617 of the Companies Act, 1956, (d) Any mutual fund registered with the SEBI, (e) Any housing finance company registered with the National Housing Bank, (f) Any insurance company registered with the Insurance Regulatory and Development Authority, (g) Any non-scheduled Urban Co-operative bank, (h) Any listed company, having a gilt account with a scheduled commercial bank, subject to the following conditions: (i) Any unlisted company which has been issued special securities by the Government of India and having gilt account with a scheduled commercial bank; subject to the following conditions in addition to the conditions stipulated for listed company: (c) All persons or entities specified at (ii) above can enter into ready forward transactions among themselves subject to the following restrictions: (d) All ready forward contracts shall be reported on the Negotiated Dealing System (NDS). In respect of ready forward contracts involving gilt account holders, the custodian (i.e., the CSGL account holder) with whom the gilt accounts are maintained will be responsible for reporting the deals on the NDS on behalf of the constituents (i.e. the gilt account holders). (e) All ready forward contracts shall be settled through the SGL Account / CSGL Account maintained with the RBI, Mumbai, with the Clearing Corporation of India Ltd. (CCIL) acting as the central counter party for all such ready forward transactions. (f) The custodians should put in place an effective system of internal control and concurrent audit to ensure that: (h) No sale transaction shall be put through, in the first leg of a ready forward transaction by CSGL constituent entities without actually holding the securities in the portfolio. (i) Securities purchased under the ready forward contracts shall not be sold during the period of the contract except by entities permitted to undertake short selling, (j) Double ready forward deals in any security are strictly prohibited. 1.1.3 Transactions through SGL account a) The amount of the SGL form (cost of purchase paid by the purchaser of the security) would be debited immediately to the current account of the selling bank with the RBI. b) In the event of an overdraft arising in the current account following such a debit, penal interest would be charged by the RBI, on the amount of the overdraft, at a rate of 3 percentage points above the SBI Discount and Finance House of India's (SBIDFHI) call money lending rate on the day in question. However, if the SBIDFHI's closing call money rate is lower than the prime lending rate of banks, as stipulated in the RBI's interest rate directive in force, the applicable penal rate to be charged will be 3 percentage points, above the prime lending rate of the bank concerned, and c) SGL bouncing’ shall mean failure of settlement of a Government securities transaction on account of insufficiency of funds in the current account of the buyer or insufficiency of securities in the SGL / CSGL account of the seller, maintained with the Reserve Bank of India. In the event of bouncing of SGL transfer forms and the failure of the account holder concerned to offer satisfactory explanation for such bouncing, the account holder shall be liable to pay penalties as under: (i) Graded monetary penalties subject to a maximum penalty of Rs.5 lakhs per instance;
(ii) On the tenth default in a financial year, the eligible entities will be debarred from using the SGL A/c for undertaking short sales in Government securities even to the extent permissible under circular IDMD.No /11.01.01(B) / 2006-07 dated January 31, 2007 as amended from time to time, during the remaining portion of the financial year. In the next financial year, upon being satisfied that the a/c holder in question has effected improvements in its internal control systems, RBI may grant specific approval for undertaking short sales by using the SGL A/c facility. (iii) The monetary penalty may be paid by the account holder concerned by way of a cheque or through electronic mode for the amount favouring the Reserve Bank of India, within five working days of receipt of intimation of order imposing penalty from RBI. The defaulting member shall make appropriate disclosure, on the number of instances of default as well as the quantum of penalty paid to the Reserve Bank during the financial year, under the “Notes to Account” in its balance sheet. The Reserve Bank reserves the right to take any action including temporary or permanent debarment of the SGL account holder, in accordance with the powers conferred under the Government Securities Act, 2006 as it may deem fit, for violation of the terms and conditions of the opening and maintenance of SGL/ CSGL accounts or breach of the operational guidelines issued from time to time. 1.1.4 Use of Bank Receipt (BR) a) No BR should be issued under any circumstances in respect of transactions in c) No BR should be issued on the basis of a BR (of another bank) held by the bank and no transaction should take place on the basis of a mere exchange of BRs held by the bank. d) BRs could be issued covering transactions relating to banks' own Investments Accounts only, and no BR should be issued by banks covering transactions relating to either the Accounts of Portfolio Management Scheme (PMS) Clients or Other Constituents' Accounts, including brokers. e) No BR should remain outstanding for more than 15 days. f) A BR should be redeemed only by actual delivery of scrips and not by cancellation of the transaction/set off against another transaction. If a BR is not redeemed by delivery of scrips within the validity period of 15 days, the BR should be deemed as dishonoured and the bank which has issued the BR should refer the case to the RBI, explaining the reasons for which the scrips could not be delivered within the stipulated period and the proposed manner of settlement of the transaction. g) BRs should be issued on semi-security paper, in the standard format (prescribed by IBA), serially numbered and signed by two authorised officials of the bank, whose signatures are recorded with other banks. As in the case of SGL forms, there should be a control system in place to account for each BR form. h) Separate registers of BRs issued and BRs received should be maintained and arrangements should be put in place to ensure that these are systematically followed up and liquidated within the stipulated time limit. i) The banks should also have a proper system for the custody of unused B.R. Forms and their utilisation. The existence and operations of these controls at the concerned offices/ departments of the bank should be reviewed, among others, by the statutory auditors and a certificate to this effect may be forwarded every year to the Regional Office of Department of Banking Supervision (DBS), RBI, under whose jurisdiction the Head Office of the bank is located. j) Any violation of the instructions relating to BRs would invite penal action, which could include raising of reserve requirements, withdrawals of refinance facility from the RBI and denial of access to money markets. The RBI may also levy such other penalty as it may deem fit in accordance with the provisions of the Banking Regulation Act, 1949. 1.1.5 Retailing of Government Securities 1.1.6 Internal Control System (a) There should be a clear functional separation of (i) trading, (ii) settlement, monitoring and control and (iii) accounting. Similarly, there should be a functional separation of trading and back office functions relating to banks' own Investment Accounts, Portfolio Management Scheme (PMS) Clients’ Accounts and other Constituents (including brokers') accounts. The Portfolio Management service may be provided to clients, subject to strictly following the guidelines in regard thereto (covered in paragraph 1.3.3). Further, PMS Clients Accounts should be subjected to a separate audit by external auditors. (b) For every transaction entered into, the trading desk should prepare a deal slip which should contain data relating to nature of the deal, name of the counter-party, whether it is a direct deal or through a broker, and if through a broker, name of the broker, details of security, amount, price, contract date and time. The deal slips should be serially numbered and controlled separately to ensure that each deal slip has been properly accounted for. Once the deal is concluded, the dealer should immediately pass on the deal slip to the back office for recording and processing. For each deal there must be a system of issue of confirmation to the counterparty. The timely receipt of requisite written confirmation from the counterparty, which must include all essential details of the contract, should be monitored by the back office. (c) With respect to transactions matched on the NDS-OM module, since CCIL is the central counterparty to all deals, exposure of any counterparty for a trade is only to CCIL and not to the entity with whom a deal matches. Besides, details of all deals on NDS-OM are available to the counterparties as and when required by way of reports on NDS-OM itself. In view of the above, the need for counterparty confirmation of deals matched on NDS-OM does not arise. The deals in Government security transactions in OTC market that are mandated to be settled through CCIL by reporting on the NDS, are not required to be confirmed physically as OTC deals depend on electronic confirmation by the back offices of both the counterparties on NDS system like the NDS-OM deals. However, all government securities transactions, other than those mentioned above, will continue to be physically confirmed by the back offices of the counterparties, as hitherto (d) Once a deal has been concluded, there should not be any substitution of the counter party bank by another bank by the broker, through whom the deal has been entered into; likewise, the security sold/purchased in the deal should not be substituted by another security. (f) In the case of transaction relating to PMS Clients' Accounts (including brokers), all the relative records should give a clear indication that the transaction belongs to PMS Clients/ other constituents and does not belong to bank's own Investment Account and the bank is acting only in its fiduciary/ agency capacity. (g) (i) Records of SGL transfer forms issued/ received, should be maintained. (h) Banks should put in place a reporting system to report to the top management, on a weekly basis, the details of transactions in securities, details of bouncing of SGL transfer forms issued by other banks and BRs outstanding for more than one month and a review of investment transactions undertaken during the period. (i) Banks should not draw cheques on their account with the RBI for third party transactions, including inter-bank transactions. For such transactions, bankers' cheques/ pay orders should be issued. (j) In case of investment in shares, the surveillance and monitoring of investment should be done by the Audit Committee of the Board, which shall review in each of its meetings, the total exposure of the bank to capital market both fund based and non- fund based, in different forms as stated above and ensure that the guidelines issued by RBI are complied with and adequate risk management and internal control systems are in place; (k) The Audit Committee should keep the Board informed about the overall exposure to capital market, the compliance with the RBI and Board guidelines, adequacy of risk management and internal control systems; (l) In order to avoid any possible conflict of interest, it should be ensured that the stockbrokers as directors on the Boards of banks or in any other capacity, do not involve themselves in any manner with the Investment Committee or in the decisions in regard to making investments in shares, etc., or advances against shares. (m) The internal audit department should audit the transactions in securities on an ongoing basis, monitor the compliance with the laid down management policies and prescribed procedures and report the deficiencies directly to the management of the bank. (n) The banks' managements should ensure that there are adequate internal control and audit procedures for ensuring proper compliance of the instructions in regard to the conduct of the investment portfolio. The banks should institute a regular system of monitoring compliance with the prudential and other guidelines issued by the RBI. The banks should get compliance in key areas certified by their statutory auditors and furnish such audit certificate to the Regional Office of DBS, RBI under whose jurisdiction the HO of the bank falls. i) For engagement of brokers to deal in investment transactions, the banks should observe the following guidelines: [Certain clarifications on the instructions are furnished in the Annex II.] ii) Inter-bank securities transactions should be undertaken directly between banks and no bank should engage the services of any broker in such transactions. Exceptions: 1.1.8 Audit, review and reporting of investment transactions a) Banks should undertake a half-yearly review (as of 30 September and 31 March ) of their investment portfolio, which should, apart from other operational aspects of investment portfolio, clearly indicate amendments made to the Investment Policy and certify adherence to laid down internal investment policy and procedures and RBI guidelines, and put up the same before their respective Boards within a month, i.e by end-April and end-October. b) A copy of the review report put up to the Bank's Board, should be forwarded to the RBI (concerned Regional Office of DBS, RBI) by 15 May and 15 November respectively. 1.2 Non- SLR investments Banks have made significant investment in privately placed unrated bonds and, in certain cases, in bonds issued by corporates who are not their borrowers. While assessing such investment proposals on private placement basis, in the absence of standardised and mandated disclosures, including credit rating, banks may not be in a position to conduct proper due diligence to take an investment decision. Thus, there could be deficiencies in the appraisal of privately placed issues. The risk arising from inadequate disclosure in offer documents should be recognised and banks should prescribe minimum disclosure standards as a policy with Board approval. In this connection, RBI had constituted a Technical Group comprising officials drawn from treasury departments of a few banks and experts on corporate finance to study, inter alia, the methods of acquiring, by banks, of non-SLR investments in general and private placement route, in particular, and to suggest measures for regulating these investments. The Group had designed a format containing the minimum disclosure requirements as well as certain conditionalities regarding documentation and creation of charge for private placement issues, which may serve as a 'best practice model' for the banks. The details of the Group’s recommendations are given in the Annex III and banks should have a suitable format of disclosure requirements on the lines of the recommendations of the Technical Group with the approval of their Board. (iii) Internal assessment (iv) Some banks / FIs have not exercised due precaution by reference to the list of defaulters circulated / published by RBI while investing in bonds, debentures, etc., of companies. Banks may, therefore, exercise due caution, while taking any investment decision to subscribe to bonds, debentures, shares etc., and refer to the ‘Defaulters List’ to ensure that investments are not made in companies / entities who are defaulters to banks / FIs. Some of the companies may be undergoing adverse financial position, turning their accounts to sub-standard category due to recession in their industry segment, like textiles. Despite restructuring facility provided under RBI guidelines, the banks have been reported to be reluctant to extend further finance, though considered warranted on merits of the case. Banks may not refuse proposals for such investments in companies whose director’s name(s) find place in the ‘Defaulter Companies List’ circulated by RBI, at periodical intervals and particularly in respect of those loan accounts, which have been restructured under extant RBI guidelines, provided the proposal is viable and satisfies all parameters for such credit extension. Prudential guidelines on investment in Non-SLR securities 1.2.3 The guidelines on listing and rating pertaining to non-SLR securities vide paragraphs 1.2.7 to 1.2.16 are not applicable to banks’ investments in: 1.2..4 Definitions of a few terms used in these guidelines have been furnished in Annex IV with a view to ensure uniformity in approach while implementing the guidelines. Regulatory requirements 1.2.6 Banks should undertake usual due diligence in respect of investments in non- SLR securities. Present RBI regulations preclude banks from extending credit facilities for certain purposes. Banks should ensure that such activities are not financed by way of funds raised through the non- SLR securities. Listing and rating requirements 1.2.8 The Securities Exchange Board of India (SEBI) vide their circular dated September 30, 2003(amended vide circular dated May 11, 2009) have stipulated requirements that listed companies are required to comply with, for making issue of debt securities on a private placement basis and listed on a stock exchange. According to this circular, any listed company, making issue of debt securities on a private placement basis and listed on a stock exchange, has to make full disclosures (initial and continuing) in the manner prescribed in Schedule II of the Companies Act 1956, SEBI (Disclosure and Investor Protection) Guidelines, 2000 and the Listing Agreement with the exchanges. Furthermore, the debt securities shall carry a credit rating of not less than investment grade from a Credit Rating Agency registered with the SEBI. 1.2.9 Accordingly, while making fresh investments in non-SLR debt securities, banks should ensure that such investment are made only in listed debt securities of companies which comply with the requirements of the SEBI circular dated September 30, 2003(amended vide circular dated May 11, 2009), except to the extent indicated in paragraph 1.2.10 and 1.2.11 below. Fixing of prudential limits 1.2.10 Bank’s investment in unlisted non-SLR securities should not exceed 10 per cent of its total investment in non-SLR securities as on March 31, of the previous year, and such investment should comply with the disclosure requirements as prescribed by the SEBI for listed companies. Further, as there is a time lag between issuance and listing of securities, investment in non-SLR debt securities (both primary and secondary market) by banks where the security is proposed to be listed on the Exchange(s) may be considered as investment in listed security at the time of making investment. However, if such security is not listed within the period specified, the same will be reckoned for the 10 per cent limit specified for unlisted non-SLR securities. In case such investments included under unlisted non-SLR securities lead to a breach of the 10 per cent limit, the bank would not be allowed to make further investment in non-SLR securities (both primary and secondary market) as also in unrated bonds issued by companies engaged in infrastructure activities till such time bank’s investment in unlisted non- SLR securities comes within the limit of 10 per cent. 1.2.11 Bank’s investment in unlisted non-SLR securities may exceed the limit of 10 per cent, by an additional 10 per cent, provided the investment is on account of investment in Securitisation papers issued for infrastructure projects, and bonds/debentures issued by Securitisation Companies (SCs) and Reconstruction Companies (RCs) set up under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFEASI Act) and registered with RBI. In other words, investments exclusively in securities specified in this paragraph could be up to the maximum permitted limit of 20 per cent of non-SLR investment. 1.2.12 Investment in the following will not be reckoned as ‘unlisted non-SLR securities’ for computing compliance with the prudential limits prescribed in the above guidelines: (i) Security Receipts issued by SCs / RCs registered with RBI.(ii) Investment in Asset Backed Securities (ABS) and Mortgage Backed Securities (MBS), which are rated at or above the minimum investment grade. However, there will be close monitoring of exposures to ABS on a bank specific basis based on monthly reports to be submitted to RBI as per proforma being separately advised by the Department of Banking Supervision. (iii) Investments in unlisted convertible debentures. However, investments in these instruments would be treated as “Capital Market Exposure”. 1.2.13 The investments in RIDF / SIDBI/RHDF Deposits may not be reckoned as part of the numerator as well as denominator for computing compliance with the prudential limit of 10 per cent of its total non-SLR securities as on March 31, of the previous year. 1.2.14 With effect from January 1, 2005, only investment in units of such mutual fund schemes, which have an exposure to unlisted securities of less than 10 per cent of the corpus of the fund, will be treated on par with listed securities for the purpose of compliance with the prudential limits prescribed in the above guidelines. While computing the exposure to the unlisted securities for compliance with the norm of less than 10 percent of the corpus of the mutual fund scheme, Treasury Bills, Collateralised Borrowing and Lending Obligations (CBLO), Repo/Reverse Repo and Bank Fixed Deposits may not be included in the numerator. 1.2.15 For the purpose of the prudential limits prescribed in the guidelines, the denominator viz., 'non-SLR investments', would include investment under the following four categories in Schedule 8 to the balance sheet viz., 'shares', 'bonds & debentures', 'subsidiaries/joint ventures' and 'others'. 1.2.16 Banks whose investment in unlisted non-SLR securities are within the prudential limit of 10 per cent of its total non-SLR securities as on March 31, of the previous year may make fresh investment in such securities and up to the prudential limits. Role of Boards 1.2.18 Boards of banks should review the following aspects of non-SLR investment at least at quarterly intervals:
Disclosures 1.2.20 Banks should disclose the details of the issuer composition of non-SLR investments and the non-performing non-SLR investments in the ‘Notes on Accounts’ of the balance sheet, as indicated in Annex V. 1.2.21 Trading and Settlement in Corporate Debt Securities As per the SEBI guidelines, all trades with the exception of the spot transactions, in a listed debt security, shall be executed only on the trading platform of a stock exchange. In addition to complying with the SEBI guidelines, banks should ensure that all spot transactions in listed and unlisted debt securities are reported on the NDS and settled through the CCIL from a date to be notified by RBI. 1.2.22 Repo in Corporate Debt Securities 1.2.23 Limits on Banks' Exposure to Capital Markets A. Solo Basis B Consolidated Basis The aggregate exposure of a consolidated bank to capital markets (both fund based and non- fund based) should not exceed 40 per cent of its consolidated net worth as on March 31 of the previous year. Within this overall ceiling, the aggregate direct exposure by way of the consolidated bank’s investment in shares, convertible bonds / debentures, units of equity- oriented mutual funds and all exposures to Venture Capital Funds (VCFs) [both registered and unregistered] should not exceed 20 per cent of its consolidated net worth. 1.3 General 1.3.2 Transactions in securities - Custodial functions 1.3.3 Portfolio Management on behalf of clients ii) The following conditions are to be strictly observed by the banks operating PMS or similar scheme with the specific prior approval of RBI: iii) PMS clients' accounts should be subjected by banks to a separate audit by external auditors as covered in paragraph 1.1.5 (a). iv) Banks should note that violation of RBI instructions will be viewed seriously and will invite deterrent action against the banks, which will include raising of reserve requirements, withdrawal of facility of refinance from the RBI and denial of access to money markets, apart from prohibition from undertaking PMS activity. v) Further, the aforesaid instructions will apply, mutatis mutandis, to the subsidiaries of banks except where they are contrary to specific regulations of the RBI or SEBI, governing their operations. vi) Banks / merchant banking subsidiaries of banks operating PMS or similar scheme with the specific prior approval of the RBI are also required to comply with the guidelines contained in the SEBI (Portfolio Managers) Rules and Regulations, 1993 and those issued from time to time. 1.3.4 Investment Portfolio of bank - transactions in Government Securities i) The entire investment portfolio of the banks (including SLR securities and non-SLR securities) should be classified under three categories viz. ‘Held to Maturity’, • However, in the balance sheet, the investments will continue to be disclosed as per the existing six classifications: viz. a) Government securities, ii) Banks should decide the category of the investment at the time of acquisition thand the decision should be recorded on the investment proposals. 2.1 Held to Maturity ii) Banks are allowed to include investments included under HTM category upto 25 per cent of their total investments. The following investments are required to be classified under HTM but are not accounted for the purpose of ceiling of 25 per cent specified for this category: iii) Banks are, however, allowed since September 2, 2004 to exceed the limit of 25 percent of total investment under HTM category provided: iv) The non-SLR securities, held as part of HTM as on September 2, 2004 may remain in that category. No fresh non-SLR securities, are permitted to be included in HTM, except the following: v) To sum up, banks may hold the following securities under HTM: (b) Non-SLR securities included under HTM as on September 2, 2004. (c) Fresh re-capitalisation bonds received from the Government of India towards their re-capitalisation requirement and held in Investment portfolio. (d) Fresh investment in the equity of subsidiaries and joint ventures (e) RIDF/SIDBI/RHDF deposits. (f) Investment in long-term bonds (with a minimum residual maturity of seven years) issued by companies engaged in infrastructure activities. (vi) Profit on sale of investments in this category should be first taken to the Profit & Loss Account, and thereafter be appropriated to the ‘Capital Reserve Account’. It is clarified that the amount so appropriated would be net of taxes and amount required to be transferred to Statutory Reserves. Loss on sale will be recognised in the Profit & Loss Account. As regards, the ‘Special Reserves’ created by banks under Section 36(1) (viii) of Income Tax Act, 1961, only the net amount of such Reserves (net of tax payable) should be taken into account for the purpose of Tier-I capital. (vii) The debentures/ bonds must be treated in the nature of an advance when: Or
And And Since, no fresh non-SLR securities are permitted to be included in the HTM, these investments should not be held under HTM category and they should be subjected to mark- to-market discipline. They would be subjected to prudential norms for identification of non-performing investment and provisioning as applicable to investments. 2.2 Available for Sale & Held for Trading 2.3 Shifting among categories ii) If the value of sales and transfers of securities to/from HTM category exceeds 5 per cent of the book value of investments held in HTM category at the beginning of the year, banks should disclose the market value of the investments held in the HTM category and indicate the excess of book value over market value for which provision is not made. This disclosure is required to be made in ‘Notes to Accounts’ in banks’ audited Annual Financial Statements. However, the one-time transfer of securities to/from HTM category with the approval of Board of Directors permitted to be undertaken by banks at the beginning of the accounting year and sales to the Reserve Bank of India under pre-announced OMO auctions will be excluded from the 5 per cent cap. iii) Banks may shift investments from AFS to HFT with the approval of their Board of Directors/ ALCO/ Investment Committee. In case of exigencies, such shifting may be done with the approval of the Chief Executive of the bank/Head of the ALCO, but should be ratified by the Board of Directors/ ALCO. iv) Shifting of investments from HFT to AFS is generally not allowed. However, it will be permitted only under exceptional circumstances like not being able to sell the security within 90 days due to tight liquidity conditions, or extreme volatility, or market becoming unidirectional. Such transfer is permitted only with the approval of the Board of Directors/ ALCO/ Investment Committee. (v) Transfer of scrips from AFS / HFT category to HTM category should be made at the lower of book value or market value. In other words, in cases where the market value is higher than the book value at the time of transfer, the appreciation should be ignored and the security should be transferred at the book value. In cases where the market value is less than the book value, the provision against depreciation held against this security (including the additional provision, if any, required based on valuation done on the date of transfer) should be adjusted to reduce the book value to the market value and the security should be transferred at the market value. In the case of transfer of securities from HTM to AFS / HFT category, (a) If the security was originally placed under the HTM category at a discount, it may be transferred to AFS / HFT category at the acquisition price / book value. (It may be noted that as per existing instructions banks are not allowed to accrue the discount on the securities held under HTM category and, therefore, such securities would continue to be held at the acquisition cost till maturity). After transfer, these securities should be immediately re-valued and resultant depreciation, if any, may be provided. (b) If the security was originally placed in the HTM category at a premium, it may be transferred to the AFS / HFT category at the amortised cost. After transfer, these securities should be immediately re-valued and resultant depreciation, if any, may be provided. In the case of transfer of securities from AFS to HFT category or vice-versa, the securities need not be re-valued on the date of transfer and the provisions for the accumulated depreciation, if any, held may be transferred to the provisions for depreciation against the HFT securities and vice-versa. 3. Valuation ii) Banks should recognise any diminution, other than temporary, in the value of their investments in subsidiaries/ joint ventures, which are included under HTM and provide therefor. Such diminution should be determined and provided for each investment iii) The need to determine whether impairment has occurred is a continuous process and the need for such determination will arise in the following circumstances: (a) On the happening of an event which suggests that impairment has occurred. This would include: (i) the company has defaulted in repayment of its debt obligations. (b) When the company has incurred losses for a continuous period of three years and the net worth has consequently been reduced by 25% or more. (c) In the case of new company or a new project when the originally projected date of achieving the breakeven point has been extended i.e., the company or the project has not achieved break-even within the gestation period as originally envisaged. When the need to determine whether impairment has occurred arises in respect of a subsidiary, joint venture or a material investment, the bank should obtain a valuation of the investment by a reputed/qualified valuer and make provision for the impairment, if any. 3.2 Available for Sale 3.3 Held for Trading 3.4 Investment Fluctuation Reserve & Investment Reserve Account Investment Fluctuation Reserve (i) With a view to building up of adequate reserves to guard against any possible reversal of interest rate environment in future due to unexpected developments, banks were advised to build up Investment Fluctuation Reserve (IFR) of a minimum 5 per cent of the investment portfolio within a period of 5 years. (ii) To ensure smooth transition to Basel II norms, banks were advised in June 24, 2004 to maintain capital charge for market risk in a phased manner over a two year period, as under: (a) In respect of securities included in the HFT category, open gold position limit, open foreign exchange position limit, trading positions in derivatives and derivatives entered into for hedging trading book exposures by March 31, 2005, and (iii) With a view to encourage banks for early compliance with the guidelines for maintenance of capital charge for market risks, it was advised in April 2005 that banks which have maintained capital of at least 9 per cent of the risk weighted assets for both credit risk and market risks for both HFT (items as indicated at (a) above) and AFS category may treat the balance in excess of 5 per cent of securities included under HFT and AFS categories, in the IFR, as Tier I capital. Banks satisfying the above were allowed to transfer the amount in excess of the said 5 per cent in the IFR to Statutory Reserve. (iv) Banks were advised in October 2005 that, if they have maintained capital of at least 9 per cent of the risk weighted assets for both credit risk and market risks for both HFT (items as indicated at (a) above) and AFS category as on March 31, 2006, they would be permitted to treat the entire balance in the IFR as Tier I capital. For this purpose, banks may transfer the balance in the Investment Fluctuation Reserve ‘below the line’ in the Profit and Loss Appropriation Account to Statutory Reserve, General Reserve or balance of Profit & Loss Account. Investment Reserve Account (IRA) The provisions required to be created on account of depreciation in the AFS and HFT categories should be debited to the P&L Account and an equivalent amount (net of tax benefit, if any, and net of consequent reduction in the transfer to Statutory Reserve), may be transferred from the IRA to the P&L Account. Illustratively, banks may draw down from the IRA to the extent of provision made during the year towards depreciation in investment in AFS and HFT categories (net of taxes, if any, and net of transfer to Statutory Reserves as applicable to such excess provision). In other words, a bank which pays a tax of 30% and should appropriate 25% of the net profits to Statutory Reserves, can draw down Rs.52.50 from the IRA, if the provision made for depreciation in investments included in the AFS and HFT categories is Rs.100. (vii) The amounts debited to the P&L Account for provision should be debited under the head ‘Expenditure - Provisions & Contingencies’. The amount transferred from the IRA to the P&L Account, should be shown as ‘below the line’ item in the Profit and Loss Appropriation Account, after determining the profit for the year. Provision towards any erosion in the value of an asset is an item of charge on the profit and loss account, and hence should appear in that account before arriving at the profit for the accounting period. Adoption of the following would not only be adoption of a wrong accounting principle but would, also result in a wrong statement of the profit for the accounting period: (a) the provision is allowed to be adjusted directly against an item of Reserve without being shown in the profit and loss account, OR (b) a bank is allowed to draw down from the IRA before arriving at the profit for the accounting period (i.e., above the line), OR (c) a bank is allowed to make provisions for depreciation on investment as a below the line item, after arriving at the profit for the period, Hence none of the above options are permissible. (viii) In terms of our guidelines on payment of dividend by banks, dividends should be payable only out of current year's profit. The amount drawn down from the IRA will, therefore, not be available to a bank for payment of dividend among the shareholders. However, the balance in the IRA transferred ‘below the line’ in the Profit and Loss Appropriation Account to Statutory Reserve, General Reserve or balance of Profit & Loss Account would be eligible to be reckoned as Tier I capital. 3.5 Market value 3.6.1 Central Government Securities i) Banks should value the unquoted Central Government securities on the basis of the prices/ YTM rates put out by the PDAI/ FIMMDA at periodical intervals. ii) The 6.00 per cent Capital Indexed Bonds may be valued at “cost”, as defined in circular DBOD.No.BC.8/12.02.001/ 97-98 dated January 22, 1998 and BC.18/12.02.001/ 2000-2001 dated August 16, 2000. iii) Treasury Bills should be valued at carrying cost. 3.6.2 State Government Securities 3.6.3 Other ‘approved’ Securities Other approved securities will be valued applying the YTM method by marking it up by 25 basis points above the yields of the Central Government Securities of equivalent maturity put out by PDAI/ FIMMDA periodically. 3.7 Unquoted Non-SLR securities (a) The rate used for the YTM for rated debentures/ bonds should be at least 50 basis points above the rate applicable to a Government of India loan of equivalent maturity. NOTE: (c) Where the debenture/ bonds is quoted and there have been transactions within 15 days prior to the valuation date, the value adopted should not be higher than the rate at which the transaction is recorded on the stock exchange. 3.7.2 Zero coupon bonds (ZCBs) ZCBs should be shown in the books at carrying cost, i.e., acquisition cost plus discount accrued at the rate prevailing at the time of acquisition, which may be marked to market with reference to the market value. In the absence of market value, the ZCBs may be marked to market with reference to the present value of the ZCB. The present value of the ZCBs may be calculated by discounting the face value using the ‘Zero Coupon Yield Curve’, with appropriate mark up as per the zero coupon spreads put out by FIMMDA periodically. In case the bank is still carrying the ZCBs at acquisition cost, the discount accrued on the instrument should be notionally added to the book value of the scrip, before marking it to market. 3.7.3 Preference Shares The equity shares in the bank's portfolio should be marked to market preferably on a daily basis, but at least on a weekly basis. Equity shares for which current quotations are not available or where the shares are not quoted on the stock exchanges, should be valued at break-up value (without considering ‘revaluation reserves’, if any) which is to be ascertained from the company’s latest balance sheet (which should not be more than one year prior to the date of valuation). In case the latest balance sheet is not available the shares are to be valued at Re.1 per company. 3.7.5 Mutual Funds Units (MF Units) 3.7.6 Commercial Paper 3.7.7 Investments in Regional Rural Banks (RRBs) Investment in RRBs is to be valued at carrying cost (i.e. book value) on a consistent basis. 3.8. Investment in securities issued by SC/RC The above investment should be carried in the books of the bank / FI at the price as determined above until its sale or realisation, and on such sale or realisation, the loss or gain must be dealt with as under: (i) if the sale to SC /RC is at a price below the NBV, the shortfall should be debited to the profit and loss account of that year. (ii) If the sale is for a value higher than the NBV, the excess provision will not be reversed but will be utilised to meet the shortfall / loss on account of sale of other financial assets to SC / RC. All instruments received by banks / FIs from SC / RC as sale consideration for financial assets sold to them and also other instruments issued by SC / RC in which banks / FIs invest will be in the nature of non-SLR securities. Accordingly, the valuation, classification and other norms applicable to investment in non-SLR instruments prescribed by RBI from time to time would be applicable to bank’s / FI’s investment in debentures / bonds / security receipts / PTCs issued by SC / RC. However, if any of the above instruments issued by SC / RC is limited to the actual realisation of the financial assets assigned to the instruments in the concerned scheme the bank / FI shall reckon the Net Asset Value (NAV), obtained from SC / RC from time to time, for valuation of such investments. 3.9 Valuation and classification of banks’ investment in VCFs 3.9.1 The quoted equity shares / bonds/ units of VCFs in the bank's portfolio should be held under AFS and marked to market preferably on a daily basis, but at least on a weekly basis, in line with valuation norms for other equity shares as per existing instructions. 3.9.2 Banks’ investments in unquoted shares/bonds/units of VCFs made after August 23, 2006 (i.e issuance of guidelines on valuation, classification of investments in VCFs) will be classified under HTM for initial period of three years and will be valued at cost during this period. For the investments made before issuance of these guidelines, the classification would be done as per the existing norms. 3.9.3 For this purpose, the period of three years will be reckoned separately for each disbursement made by the bank to VCF as and when the committed capital is called up. However, to ensure conformity with the existing norms for transferring securities from HTM, transfer of all securities which have completed three years as mentioned above will be effected at the beginning of the next accounting year in one lot to coincide with the annual transfer of investments from HTM category. 3.9.4 After three years, the unquoted units/shares/bonds should be transferred to AFS category and valued as under: i) Units: In the case of investments in the form of units, the valuation will be done at the NAV shown by the VCF in its financial statements. Depreciation, if any, on the units based on NAV has to be provided at the time of shifting the investments to AFS category from HTM category as also on subsequent valuations which should be done at quarterly or more frequent intervals based on the financial statements received from the VCF. At least once in a year, the units should be valued based on the audited results. However, if the audited balance sheet/ financial statements showing NAV figures are not available continuously for more than 18 months as on the date of valuation, the investments are to be valued at Rupee 1.00 per VCF. ii) Equity: In the case of investments in the form of shares, the valuation can be done at the required frequency based on the break-up value (without considering ‘revaluation reserves’, if any) which is to be ascertained from the company’s (VCF’s) latest balance sheet (which should not be more than 18 months prior to the date of valuation)..Depreciation, if any on the shares has to be provided at the time of shifting the investments to AFS category as also on subsequent valuations which should be done at quarterly or more frequent intervals. If the latest balance sheet available is more than 18 months old, the shares are to be valued at Rupee. 1.00 per company. (iii) Bonds: The investment in the bonds of VCFs, if any, should be valued as per prudential norms for classification, valuation and operation of investment port- folio by banks issued by RBI from time to time. 3.9.5 Valuation norms on conversion of outstanding (a) Equity, debentures and other financial instruments acquired by way of conversion of outstanding principal and / or interest should be classified in the AFS category, and valued in accordance with the extant instructions on valuation of banks' investment portfolio, except to the extent that (a) equity may be valued as per market value, if quoted, (b) in cases, where equity is not quoted, valuation may be at breakup value in respect of standard assets and in respect of substandard / doubtful assets, equity may be initially valued at Re1 and at breakup value after restoration / up gradation to standard category. 3.10 Non-Performing Investments (NPI) 3.10.2 An NPI, similar to a non performing advance (NPA), is one where: (i) Interest/ installment (including maturity proceeds) is due and remains unpaid for more than 90 days. (ii) The above would apply mutatis-mutandis to preference shares where the fixed dividend is not paid. If the dividend on preference shares (cumulative or non-cumulative) is not declared/paid in any year it would be treated as due/unpaid in arrears and the date of balance sheet of the issuer for that particular year would be reckoned as due date for the purpose of asset classification. (iii) In the case of equity shares, in the event the investment in the shares of any company is valued at Re.1 per company on account of the non availability of the latest balance sheet in accordance with the instructions contained in paragraph 28 of the Annex to the circular DBOD.BP.BC.32/ 21.04.048/ 2000-01 dated October 16, 2000, those equity shares would also be reckoned as NPI. (iv) If any credit facility availed by the issuer is NPA in the books of the bank, investment in any of the securities, including preference shares issued by the same issuer would also be treated as NPI and vice versa. However, if only the preference shares are classified as NPI, the investment in any of the other performing securities issued by the same issuer may not be classified as NPI and any performing credit facilities granted to that borrower need not be treated as NPA. (v) The investments in debentures / bonds, which are deemed to be in the nature of advance would also be subjected to NPI norms as applicable to investments. (vi) In case of conversion of principal and / or interest into equity, debentures, bonds, etc., such instruments should be treated as NPA abinitio in the same asset classification category as the loan if the loan's classification is substandard or doubtful on implementation of the restructuring package and provision should be made as per the norms. 3.10.3 State Government guaranteed investments The prudential treatment for Central Government Guaranteed bonds has to be identical to Central Government guaranteed advances. Hence, bank’s investments in bonds guaranteed by Central Government need not be classified as non-performing investments (NPI) until the Central Government have repudiated the guarantee when invoked. However, this exemption from classification as NPI is not for the purpose of recognition of income. 4. Uniform accounting for Repo / Reverse Repo transactions 4.2 Market participants may undertake repos from any of the three categories of investments, viz., Held For Trading, Available For Sale and Held To Maturity. 4.3 The economic essence of a repo transaction, viz., borrowing (lending) of funds by selling (purchasing) securities shall be reflected in the books of the repo participants, by accounting the same as collateralized lending and borrowing transaction, with an agreement to repurchase, on the agreed terms. Accordingly, the repo seller, i.e., borrower of funds in the first leg, shall not exclude the securities sold under repo but continue to carry the same in his investment account (please see the illustration given in the Annex) reflecting his continued economic interest in the securities during the repo period. On the other hand, the repo buyer, i.e., lender of funds in the first leg, shall not include the securities purchased under repo in his investment account but show it in a separate sub-head (please see the Annex). The securities would, however, be transferred from the repo seller to repo buyer as in the case of normal outright sale/purchase transactions and such movement of securities shall be reflected using the Repo/Reverse Repo Accounts and contra entries. In the case of repo seller, the Repo Account is credited in the first leg for the securities sold (funds received), while the same is reversed when the securities are repurchased in the second leg. Similarly, in the case of repo buyer, the Reverse Repo Account is debited for the amount of securities purchased (funds lent) and the same is reversed in the second leg when the securities are sold back. 4.4 The first leg of the repo transaction should be contracted at the prevailing market rates. The reversal (second leg) of the transaction shall be such that the difference between the consideration amounts of first and second legs should reflect the repo interest. 4.5 The accounting principles to be followed while accounting for repo / reverse repo transactions are as under: (i) Coupon /DiscountThe repo seller shall continue to accrue the coupon/discount on the securities sold under repo even during the repo period while the repo buyer shall not accrue the same. (ii) Repo Interest Income/Expenditure After the second leg of the repo / reverse repo transaction is over, the difference between consideration amounts of the first leg and second leg of the repo shall be reckoned as Repo Interest Income / Expenditure in the books of the repo buyer / seller respectively ; and the balance outstanding in the Repo Interest Income / Expenditure account should be transferred to the Profit and Loss account as an income or an expenditure . As regards repo / reverse repo transactions outstanding on the balance sheet date, only the accrued income / expenditure till the balance sheet date should be taken to the Profit and Loss account. Any repo income / expenditure for the remaining period should be reckoned for the next accounting period. (iii) Marking to Market 4.6 Accounting Methodology The accounting methodology to be followed along with the illustrations is given in Annexes VIII-1 and VIII-2. Participants using more stringent accounting principles may continue using the same principles. Further, to obviate the disputes arising out of repo transactions, the participants should enter into bilateral Master Repo Agreement as per the documentation finalized by Fixed Income Money Market and Derivatives Association of India (FIMMDA). The Master Repo Agreement finalised by FIMMDA is not mandatory for repo transactions in Government Securities settling through a Central Counter Party (CCP) [eg. Clearing Corporation of India Limited (CCIL)], having various safeguards like haircut, MTM price, margin, Multilateral netting, closing out, right to set off, settlement guarantee fund/ collaterals, defaults, risk management and dispute resolution/ arbitration etc. However, Master Repo Agreement is mandatory for repo transactions in Corporate Debt Securities, which are settled bilaterally without involving a CCP. 4.7 Classification of Accounts 4.8 Disclosure 4.9 Treatment for Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) The regulatory treatment of market repo transactions in Government securities will continue as hitherto, i.e., the funds borrowed under repo will continue to be exempt from CRR/SLR computation and the security acquired under reverse repo shall continue to be eligible for SLR. In respect of repo transactions in corporate debt securities, as already advised vide IDMD.DOD.05/1 1.08.38/2009-10 dated January 8, 2010, 5. General ii) Banks may book income from dividend on shares of corporate bodies on accrual basis provided dividend on the shares has been declared by the corporate body in its Annual General Meeting and the owner's right to receive payment is established. iii) Banks may book income from Government securities and bonds and debentures of corporate bodies on accrual basis, where interest rates on these instruments are predetermined and provided interest is serviced regularly and is not in arrears. iv) Banks should book income from units of mutual funds on cash basis. 5.2 Broken Period Interest 5.4 Investment in Zero Coupon Bonds issued by corporates In view of high credit risk involved in long term Zero Coupon Bonds (ZCBs) issued by corporates ( including those issued by NBFCs) banks should not invest in such ZCBs unless the issuer builds up sinking fund for all accrued interest and keeps it invested in liquid investments/securities (Government bonds). Further, banks should also put in place conservative limits for their investments in ZCBs. |