The Hindu Business Line : RBI may hike investment fluctuation reserve

Already most of the banks have reached the prescribed IFR threshold of 5 per cent of their respective investments. The deadline for complying with IFR guideline is April 2006. But all the banks, including the weak ones, were expected to reach the 5 per cent IFR well before the deadline, banking sources said.

The sources said that the Reserve Bank of India (RBI) proposal stemmed from worries about the possibility of a steep depreciation in Government securities values in the coming months. Already the 10-year yield-to- maturity has dropped by over 1.7 per cent since April this year. It was poised to top 7 per cent by the end of this fiscal.

Therefore, the sources said, the RBI preferred an increase in the IFR to help banks overcome any sharp volatility in the securities markets. Few bankers were averse to this proposal of raising the IFR, though most of them wanted it to be treated as part of the owned funds. This was because bankers felt that the reserves could be created out of their recoveries of non-performing assets.

The sources added that the RBI was also prepared to consider upgradation of the IFR to tier one capital.

Currently banks are asked to treat IFR only as tier two capital though most of them have repeatedly demanded that it be treated as tier one. Tier one capital comprises the owned funds of the banks and tier two of subordinated debt with maturities in excess of five years and revaluation reserves. The original IFR guidelines were issued when yields were softening. The original reason for treatment of IFR as tier two was that it was only a revaluation of investments and therefore technically not part of owned funds. With securities beginning to depreciate, this reason no longer applied, the bankers said.Bankers said that the RBI had accepted the bank contention, since the IFR was a charge on the banks' profits. So far the RBI had declined bankers demands for drawing on the IFR for meeting the depreciation provision or amortising the depreciation over predetermined time frame. Although banks were making profits in core operations, the rise in the YTM had resulted in steep losses due to depreciation and impacting their net profits. The losses were despite the change in the nomenclature for valuation of securities during the second quarter of the current fiscal. The changed nomenclature implied that the banks would be allowed to treat up to 25 per cent of their demand and time liabilities as part of the held-to-maturity securities. But most banks are already well over this figure, since their investment-deposit ratio is about 44 per cent.

Banks said that treatment of the IFR would allow them to obtain a better pricing for their planned equity issues. This was partly because the book value of the banking shares would automatically rise. Besides, the treatment of IFR would also result in the banks improving their capital-to-risk- weighted asset ratio from the current figures. This would also allow them to expand their risk-weighted assets.

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