The Hindu Business Line : Investment fluctuation reserve as Tier-I capital<br>PSBs press demand with RBI again

Bankers said this was necessary since all banks were expected to shift to the operational risk and market risk guidelines prescribed under the Basel II guidelines.

Banks' investment volatility is referred to as market risks. Operational risks are attributed to internal systems, processes, people and external factors. Bankers said that this transition would require greater Tier I capital — equity plus reserves.

Currently, only IFR (investment fluctuation reserve) in excess of the 5 per cent of the investment portfolio is treated as Tier 1 capital. IFR is a below-the-line item and is a charge on net profit. Bankers had raised the issue of treating the IFR as part of Tier I in the past also, though the RBI turned down the proposal since it was created as a revaluation reserve.

But bankers said that the IFR, however, was now becoming redundant. One reason for the IFR's redundancy was the fact that most banks have completed derisking of their investment portfolios - the HFT (held-for-trading) and AFS (available-for-sale) categories.

Derisking implied that banks had shrunk the average maturities of both AFS and HFT to under two years. For some of the larger private banks, the average tenor was just about one year even after including the HTM categories; few were interested in long-dated securities at a time when the interest rate outlook was bearish.

Moreover, bankers last year had shifted substantial chunks of their securities portfolios to the held-to-maturity (HTM) category, reaching the IFR targets well before the deadline of 2006. Most banks were able to breach the 5 per cent target partly on account of the RBI reprieve. This was because under the current guidelines, there is no IFR requirement for securities categorised as HTM.

But bankers said that once Basel II operational risk and market risk guidelines become effective, even HTM securities would come within its purview. Consequently, bankers said, that if the present trend in yields continued, they would be required to make large capital allocations for even HTM securities, which currently comprised about 25 per cent of the demand and time liabilities.

Bankers said that it was this fear that was preventing bankers from becoming active in the debt markets. Most banks were just selling their securities and bringing them down to the barest statutory requirement ahead of the new norms.

Above all, bankers were also worried about the impact of the depreciation on their portfolios with the 10-year yield-to-maturity (YTM) dipping to 7.2 per cent down from 6.75 per cent from the last day of the first quarter. Although most banks have brought down their average tenors, they still use the 10-year YTM for reference. Besides, what also worried bankers was that even for shorter-dated securities, between one and five years, YTMs had hardened. This meant that they would still end up with large depreciation provisions if the current trend continued.

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