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Dvara Analysis Weblog | Suggestions on the Reserve Financial institution of India’s Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks dated 14 January 2022

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Authors:

Amulya Neelam
Madhu Srinivas

The proposed rules are a major enchancment over the extant rules and tackle lots of the inadequacies and incongruities current within the latter. One of many proposed adjustments, which is the requirement for improved granularity in categorising and disclosing info associated to investments would assist in enhancing the transparency of the banks’ standing by way of each danger publicity and monetary place. These proposed adjustments are in accordance with the suggestions in our paper on the transparency of banks’ disclosure regime the place we proposed, amongst different suggestions, that banks ought to disclose the quantities of investments within the varied classes – Held-to-Maturity (HTM), Accessible-for-Sale (AFS), Held-for-Commerce (HFT), and the assumptions and methodologies used within the valuation of securities of their funding guide[1].

The Dialogue Paper additionally allows banks to carry non-SLR securities, akin to company bonds, of their HTM portfolio. Earlier, banks desirous to diversify needed to essentially maintain such devices of their buying and selling guide, both as AFS or HFT. This strategy subjected them to market value volatility, regardless of whether or not the intent of the financial institution was to carry such devices to maturity, or not. This strategy thus disincentivised banks from diversifying their exposures utilizing debt devices. The proposed regulation permits them to maneuver away from an unique “originate-and-hold-to-maturity” technique, thereby enhancing their capacity to handle focus dangers higher[2]. Furthermore, it might additionally permit them to enhance the liquidity of their stability sheets.

We additionally commend the RBI’s strategy of outlining the background, rationale, and guiding ideas of the rules earlier than detailing the rules themselves. Nevertheless, we level out sure inconsistencies and omissions within the proposed rules that would undermine the achievement of its goal.

We current detailed suggestions on the Dialogue Paper within the type of solutions to the ten questions posed throughout the Dialogue Paper. For issues that fall exterior the scope of the primary 9 questions, we embrace particular feedback within the tenth reply.

Query 1: Are there any essential points pertaining to the funding portfolio that needs to be taken up for consideration?

The proposed adjustments within the classification and valuation norms for devices in banks’ funding portfolio search to deliver the regulatory framework nearer to the requirements prescribed within the Indian Accounting Requirements (Ind-AS) and the Worldwide Monetary Reporting Requirements (IFRS)[3]. Moreover, the proposed rules additionally make the classification of devices stringent compared to the extant directions, which permit for a laxer classification of devices at preliminary recognition and in addition permit for relative ease of their reclassification later[4].

Because the Dialogue Paper states in paragraph 5.3, one of many causes to overview the extant norms is as a result of blurred distinction between the classes – AFS and HFT – of what’s considered because the buying and selling guide[5]. The dearth of a definite separation between the 2 classes has led to most buying and selling being performed out of AFS portfolio somewhat than HFT, thus distorting the buying and selling guide[6]. The proposed rules search to treatment this by permitting solely these monetary devices that fulfill the Solely Funds of Principal and Curiosity on Principal Excellent (SPPI) criterion to be held within the AFS portfolio[7]. Additionally, the securities held within the AFS portfolio could be held to maturity or bought with none restriction[8]. The intent seems to be, subsequently, to permit banks to carry, or promote, securities for Asset Legal responsibility Administration (ALM) functions with out having to topic them to a larger valuation frequency, as is relevant for the HFT portfolio. (Per the extant directions, securities held within the AFS portfolio are required to be marked-to-market (MTM) on a quarterly foundation, whereas for these within the HFT class, the MTM requirement is each day[9]). Nevertheless, with none express restriction on the sale of securities within the AFS portfolio, the arbitrage current within the extant tips would proceed to persist, albeit for a smaller subset of securities.

As an illustration, these devices that are held by the financial institution with the intent of buying and selling[10], however which additionally meet the SPPI criterion, can nonetheless be traded out of the proposed AFS portfolio, which has a decrease valuation frequency requirement. Basically, on this case, whereas the financial institution is topic to market danger – within the type of short-term value volatility – the total extent of danger just isn’t captured when devices are positioned within the AFS portfolio, as a substitute of HFT. This, in flip, obfuscates the true ranges of danger which the financial institution is uncovered to, and might doubtlessly restrict the effectiveness of the financial institution’s general danger administration technique. Subsequently, to make sure that devices held for buying and selling are usually not misclassified as AFS, it is crucial that the RBI embrace express limitations on the sale of securities within the AFS portfolio in order that it could higher obtain its acknowledged goal and stop the distortion of the buying and selling guide.

Query 2: Are there another overarching ideas that the RBI ought to think about whereas updating the present framework?

The guiding ideas outlined for updating the present framework of rules are an essential facet of the Dialogue Paper as they type the idea for the present as properly any potential future revision(s)/modification(s) to the norms. Whereas the proposed ideas are largely related for the efficient regulation of the funding portfolio, we share beneath a priority relating to the framing of one of many ideas.

Guiding Precept (e) reads – ‘The problems particular to the Indian context needs to be addressed and given due weightage within the revised framework[11].’ As readability on the which means and interpretation of the time period ‘Indian context’ just isn’t offered within the guideline itself, there may be scope for ambiguity within the interpretation of this precept. Furthermore, it could be apt to think about Guiding Precept e) as an implicit precept that guides the framing of not simply the proposed norms on this Dialogue Paper, however of all of RBI’s rules. The RBI might as a substitute present the rationale for any context-specific norms which can have been drafted, why there was a must deviate from international requirements, and an evaluation laying out the prices and advantages of such norms to monetary service suppliers. Such an articulation of contextual components (if any) would cut back the potential ambiguity within the interpretation of the precept whereas additionally preserving financial substance.

Query 3: Ought to banks be given the irrevocable choice at preliminary recognition (or on transition to this framework) to categorise their investments in fairness shares of their subsidiaries, associates, and joint ventures below FVTPL or AFS like another fairness instrument as a substitute of the necessary classification as HTM proposed above?

Fairness investments in such ventures are more likely to be long-term and strategic in nature, with none goal of buying and selling for capital appreciation. Subsequently, it might seem applicable to protect financial institution stability sheets from quick time period fluctuations of the funding’s market value. Thus, a classification of most such investments as HTM is legitimate.

Nevertheless, if a financial institution had been to make use of a portion of those investments for the aim of buying and selling, even with the exemption of such securities from the sale threshold limits below the HTM class[12], the accounting norms on good points arising from gross sales out of HTM[13] preclude the financial institution from totally benefiting from adjustments in truthful worth of those investments. Subsequently, the proposal of necessary classification of a financial institution’s investments in fairness shares of their subsidiaries, associates, and joint ventures as HTM could also be restrictive and even seen as impinging on the financial institution’s freedom to pursue its enterprise technique.

Additional, it is crucial that these shares be commonly assessed to examine for any everlasting diminution of worth. Subsequently, it’s useful that the proposed tips deal with this facet by way of the quarterly evaluation of HTM securities for impairment. We elaborate, within the reply to Query 5, how these impairment checks could be improved to offer a good presentation of the banks’ monetary statements.

Query 5: Clause 9(a) of the Reserve Financial institution of India (Classification, Valuation and Operation of Funding Portfolio of Business Banks) Instructions, 2021 (i.e., the Grasp Course) supplies sure checks for impairment. Is there a necessity for specifying extra indicators of potential impairment?

The extant directions pertaining to the prudential norms on the classification and valuation of funding portfolio give a prescribed set of circumstances below which impairment is set. Per the extant directions, the necessity to decide whether or not impairment has occurred shall come up within the following circumstances[14]:  

  1. On the taking place of an occasion which means that impairment has occurred which, on the minimal, shall embrace:
    • the corporate has defaulted in compensation of its debt obligations.
    • the mortgage quantity of the corporate with any financial institution has been restructured.
    • the credit standing of the corporate has been downgraded to beneath funding grade.
  2.  The corporate has incurred losses for a steady interval of three years and the networth has consequently been decreased by 25 p.c or extra.
  1.  Within the case of a brand new firm or a brand new venture when the initially projected date of attaining the breakeven level has been prolonged i.e., the corporate or the venture has not achieved break-even throughout the gestation interval as initially envisaged.

Provided that, below Indian Usually Accepted Accounting Rules, impairment itself is predicated on incurred loss and never anticipated loss (as in Ind-AS), the relevance of the impairment train is additional decreased when there may be solely a restricted set of circumstances below which impairment is assessed. Additionally, many of those prescribed circumstances – akin to when the corporate has defaulted in compensation of its debt obligations, and when the mortgage quantity of the corporate has been restructured – are these which might be triggered after the occasion of default.

The relevance and usefulness of the impairment take a look at could be additional improved if these impairment checks are forward-looking. Whereas the extant directions point out that these are the ‘minimal’ options that have to be thought of, it might be prudent to incorporate extra checks that higher consider impairment or a major enhance in credit score danger like these specified by Ind-AS requirements[15]. A few of these are:

a) Important adjustments in exterior market indicators of credit score danger such because the credit score unfold and market info associated to the borrower, akin to hostile adjustments within the costs of a borrower’s debt and fairness devices.

b) Important adjustments in aspects of the borrower’s working outcomes that transcend simply networth, akin to declining revenues or margins, elevated stability sheet leverage, administration issues, or different elements that considerably have an effect on the borrower’s capacity to service their debt obligations.

c) Important adjustments within the worth of the collateral supporting the asset or within the high quality of third-party ensures or credit score enhancements which could scale back the borrower’s incentive to make the scheduled contractual cost.

Query 6: Is the definition of ‘lively market’ as given above with illustrative examples sufficient? Are there another markets that might be thought of as ‘lively markets’? Feedback could also be supplied with rationale.

Whereas the definition of ‘lively markets’ as laid out in paragraph 7.29 is sufficient at a precept stage, there’s a lack of readability within the given illustrative examples. As an illustration, it’s unclear what is supposed by ‘recognised inventory exchanges for SENSEX/NIFTY shares.’ It isn’t clear whether or not all recognised inventory exchanges, and the shares traded in them, needs to be thought of as lively markets or that solely shares of entities which might be a part of SENSEX/NIFTY which might be traded in recognised inventory exchanges be thought of as lively markets? Within the case of the latter, the definition of an ‘lively market’ could be somewhat restrictive as fairness shares not included within the benchmark indices might even have sufficient liquidity. As an illustration, the 1-month common buying and selling quantity of Vodafone Thought’s shares is 42 Crore variety of shares, whereas the equal determine for Reliance Industries, which is a part of the SENSEX (BSE 30), is 68 Lakh variety of shares[16]. We suggest that, along with illustrative examples, there even be an indicative record of options (akin to a low bid-ask unfold or each day buying and selling volumes above a threshold) that an ‘lively market’ for an asset or a legal responsibility would possibly possess.

Query 7: Is the definition of ‘unobservable inputs’ as given above with the illustrative examples sufficient?

In paragraph 7.30, the illustrative instance for the investments whose valuation is presumed to be based mostly on unobservable inputs contains mutual funds that make investments greater than 10% of their corpus in unquoted devices[17]. That is unduly restrictive because the regulation treats the valuation of unquoted devices on par with that of mutual funds, whose items are listed, and but have 10% or extra of their corpus in unquoted devices. The liquidity of the mutual fund unit is extra pertinent than the valuation of the underlying securities themselves.

Query 8: Ought to the IFR proceed? If that’s the case, at what stage ought to or not it’s set and the way a lot time needs to be given to banks to attain that stage?

Because the Dialogue Paper mentions, the rationale for the Funding Fluctuation Reserve (IFR) is to guard banks from curiosity cycles. Traditionally, RBI has given particular dispensation to banks on events when the rate of interest cycle turned hostile. As an illustration, throughout occasions of sustained rises in G-sec yields, banks had been allowed to, in 2005, shift securities from different classes into HTM, and in 2013, defer recognition of valuation losses by six months[18]. Defending its portfolio towards hostile market actions is prudent danger administration for a financial institution and all banks ought to make use of applicable danger administration methods to attain the identical. It isn’t the regulator’s remit to design and implement operational danger administration methods for banks nor ought to it present particular dispensations going ahead. Thus, each the IFR and any associated regulatory forbearance needs to be discontinued.

Query 10: Are there any proposals you don’t agree with? If sure, please present separate feedback for every proposal you don’t totally agree with mentioning the proposal quantity, the precise paragraph quantity and causes for disagreement. Feedback could be helpful, in the event that they clearly articulate implementation difficulties or conceptual points together with different proposals.

The next factors record our issues relating to particular factors within the proposal.

  • Paragraph 7.4 particulars the kind of securities that may be labeled as HTM. The record doesn’t embrace debt devices with floating charge coupons linked to a market-determined rate of interest. These devices meet the SPPI criterion and if the financial institution had been to have an intent to carry such devices to maturity, they need to be allowed to be labeled as HTM. Nevertheless, as such devices are usually not included within the illustrative examples in paragraph 7.4, it’s unclear whether or not these devices qualify to be labeled as HTM.
  • In paragraph 7.6, within the illustrative record of devices that have to be categorised as FVTPL, solely investments in pass-through certificates (PTCs) representing the fairness tranche of a securitisation transaction are included. The paragraph additionally states that investments in different senior and mezzanine tranches shall have to be reviewed for his or her compliance with the SPPI criterion[19]. Nevertheless, it’s unclear whether or not such investments (PTCs of senior or mezzanine tranches) could be held in HTM, if the intent is to carry them to maturity. The dearth of a transparent directive relating to PTCs would act as a barrier for banks to increase their (HTM) investments in PTCs. This in flip can doubtlessly block liquidity sources for these establishments which straight originate belongings, particularly within the precedence sector[20].
  • Paragraph 7.6 which provides the illustrative record of devices that have to be categorised as FVTPL lists ‘Securitisation receipts’ as one of many devices[21]. The rules must explicitly specify that securitisation receipts are from the sale of non-standard belongings, and never that of ordinary belongings.
  • Paragraph 5.3 mentions that the uneven remedy of the AFS/HFT portfolios within the present framework is without doubt one of the causes for revising it. Nevertheless, the rules then stipulate that the preliminary valuation of devices that aren’t quoted and can’t be valued by way of market variables, will probably be carried out in an uneven method. The rationale given (in paragraph 7.10) for the uneven remedy is that the BR Act (Banking Regulation Act, 1949) requires banks to recognise all losses and bills earlier than paying out dividends[22]. Nevertheless, that also doesn’t clarify why good points have to be amortised over the interval of the asset’s lifetime and never recognised immediately. If the RBI’s rationale behind persevering with the uneven remedy is a matter of following the precept of prudence, it should explicitly state so. Additionally, a transparent distinction must be made between unrealised and realised losses/good points.

Concluding Remarks

The proposed rules, if and when carried out, would achieve addressing a number of main and long-standing points with the present framework on banks’ funding portfolio. We wholeheartedly welcome a number of important adjustments within the tips pertaining to a) the eligibility of non-SLR securities to be held in HTM b) the categorisation of investments into truthful worth hierarchies and c) the elevated requirement for disclosures within the notes to accounts. Nevertheless, there are nonetheless some points, if left unaddressed, would diminish the importance and effectivity of the proposed measures. As an illustration, the norms on the hierarchy of valuation strategies are held again by the shortage of readability on the interpretation and utility of the definition of lively markets. The allowing of non-SLR securities to be labeled as HTM should even be bolstered by strong impairment checks, and readability on the eligibility of particular devices akin to PTCs of senior and mezzanine tranches. Furthermore, the excellence between the buying and selling guide classes must be clear sufficient to deal with the buying and selling guide distortions.

Nonetheless, it’s laudable that the proposed tips would deliver the Reserve Financial institution’s tips on valuation of the funding portfolio nearer in keeping with that of world requirements of accounting and danger administration[23]. This is able to additionally ease the method of future implementation of Ind-AS for banks. Along with enhancing the regulation and disclosure regime on the entity stage, the proposed adjustments would have a optimistic impact from a systemic danger viewpoint as properly. With the proposed adjustments on eligibility of non-SLR securities to be labeled as HTM, banks can higher handle their focus dangers and in addition enhance the liquidity of their stability sheets. Additional, as banks are important individuals within the investor market, this proposed change might additionally support within the growth of the bond market, which in flip would have far-reaching optimistic results on systemic stability and monetary market resilience.


[1] Srinivas, Madhu, et al. ” Assessing Transparency of Indian Banking System’s Public Threat Disclosure Regime – A Regulation Based mostly Strategy.” 2021. Dvara Analysis.

[2] Threat administration technique for big branch-based banks to ship credit score extra successfully to low-income households and small companies. Supply – Chapter 4.2, Committee on Complete Monetary Providers for Small Companies and Low-Revenue Households. 2014. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/CFS070114RFL.pdf

[3] Paragraph 5.2, Ibid.

[4] Part 5, Ibid

[5] Paragraph 5.3 level (e), Ibid.

[6] Ibid

[7] Part 7, Ibid

[8] Ibid

[9] Paragraphs 7.12 and seven.15, Ibid.

[10] That’s, holding the securities for brief time period resale or to learn from short-term value actions, or to lock in arbitrage earnings.

[11] Part 6, Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks. January 2022. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DISCUSSIONPAPER9604DB243FA84169847AC576EBEB593B.PDF

[12]  Per Paragraph 7.20 within the Dialogue Paper, if a financial institution had been to decide on to promote or disinvest from the investments in subsidiaries, associates and joint ventures, it’s free to take action because the sale of such securities is exempt from the edge restrict (5 p.c of the opening carrying worth of the HTM portfolio) of mixture gross sales out of HTM.

[13] Paragraph 7.20, Ibid.

[14] 9 (a) (v), Grasp Course – Classification, Valuation and Operation of Funding Portfolio of Business Banks, 2021. August 2021. RBI Grasp Instructions. Retrieved from: https://rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12153

[15] B5.5.17, Indian Accounting Commonplace (Ind AS) 109 – Monetary Devices. Retrieved from: https://www.mca.gov.in/Ministry/pdf/INDAS109.pdf

[16] As on Feb 9, 2022. Retrieved from: https://www.moneycontrol.com/india/stockpricequote/telecommunications-service/vodafoneidealimited/IC8;
https://www.moneycontrol.com/india/stockpricequote/refineries/relianceindustries/RI

[17] Paragraph 7.30 level (a), Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks. January 2022. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DISCUSSIONPAPER9604DB243FA84169847AC576EBEB593B.PDF

[18] Heads I Win, Tails the Regulator Dispenses, Understanding and Managing Curiosity Price Threat at Banks – Speech by Viral V Acharya, Deputy Governor. January 2018. RBI Speeches and Interview. Retrieved from: https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1053

[19] Paragraph 7.6 level (a), Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks. January 2022. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DISCUSSIONPAPER9604DB243FA84169847AC576EBEB593B.PDF

[20] Suggestion 4.10, Committee on Complete Monetary Providers for Small Companies and Low-Revenue Households. 2014. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/CFS070114RFL.pdf

[21] Paragraph 7.6 level (b), Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks. January 2022. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DISCUSSIONPAPER9604DB243FA84169847AC576EBEB593B.PDF

[22] Paragraph 7.10, Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks. January 2022. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DISCUSSIONPAPER9604DB243FA84169847AC576EBEB593B.PDF

[23] Part 4, Ibid.


Cite this Merchandise:

APA

Neelam, A., & Srinivas, M. (2022). Suggestions on the Reserve Financial institution of India’s Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks dated 14 January 2022. Retrieved from Dvara Analysis.

MLA

Neelam, Amulya and Madhu Srinivas. “Suggestions on the Reserve Financial institution of India’s Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks dated 14 January 2022.” 2022. Dvara Analysis.

Chicago

Neelam, Amulya, and Madhu Srinivas. 2022. “Suggestions on the Reserve Financial institution of India’s Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks dated 14 January 2022.” Dvara Analysis.



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