RBI unveils revised investment portfolio guidelines for banks

Subject: Economy

Section: Monetary Policy

Context: RBI unveils revised investment portfolio guidelines for banks.

Key Points:

Reserve Bank of India revised its guidelines on categorizing the investments by banks, to align them with global standards.
The change in norms follow an RBI discussion paper issued in January 2022.
Major changes:
- RBI has removed the 90-day ceiling on holding period of securities under the Held For Trading (HFT) category.
- Similarly, RBI removed the ceiling on the held-to-maturity (HTM) in lenders’ investment portfolios.
- RBI also introduced a new category of investment, fair value through profit and loss (FVTPL) account. The existing HFT category will now be part of FVTPL category, according to the revised guidelines.
- RBI has also barred instruments with loss-absorbing features, such as those qualifying for additional tier 1 or tier 2 capital regulations, equity and preference shares from being held under AFS or HTM categories.
Impact of changes:
- According to bankers, this move will result in banks classifying illiquid bonds and state development loans under HFT but this was not the case previously as they were not sure if they could sell these securities within 90 days of acquiring.
- The directions are expected to enhance the quality of the banks’ financial reporting, improve disclosures, provide a fillip to corporate bond market, facilitate the use of derivatives for hedging, besides strengthening the overall risk management framework of banks.

Investment Portfolio

The main aim of a commercial bank is to seek profit like any other institution. Its capacity to earn profit depends upon its investment policy. Its investment policy, in turn, depends on the manner in which it manages its investment portfolio.
When a bank operates, it acquires and disposes of income-earning assets. These assets plus the bank’s cash make up what is known as its portfolio.
A bank’s earning assets consist of (a) securities issued by the central and state governments, local bodies and government institutions, and (b) financial obligations, such as promissory notes, bills of exchange, etc. issues by firms.
There are three main objectives of portfolio management which a wise bank follows: liquidity, safety and income. The three objectives are opposed to each other. To achieve on the bank will have to sacrifice the other objectives.
For example, if the banks seek high profit, it may have to sacrifice some safety and liquidity. If it seeks more safety and liquidity it may have to give up some income

New framework:

The investment portfolio of banks will now be divided into three categories: FVTPL, HTM and available for sale (AFS).
HFT category was for debt securities purchased by banks with the intent of selling them within a short period.
Under FVTPL, debt instruments are measured at fair value through a profit and loss account.
Banks will have to hold the investments in their FVTPL books which will require more regular accounting work.