RBI lifeline allows banks to stagger bond portfolio losses to four quarters

The Reserve Bank of India has thrown a lifeline to banks that posted huge treasury losses in the third quarter and faced the prospect of posting losses in the fourth quarter too.

The central bank has allowed them to spread the provisioning towards the depreciation of the bond portfolio over four quarters, commencing from the quarter in which the loss was first incurred.

This relaxation also comes in the backdrop of the possibility of banks facing huge provisioning burden towards bad loans in the fourth quarter.

Bond yields have risen sharply over the past six months on concerns of excess government bond supply. This, in turn, has meant that banks have had to incur losses on their bond portfolios by marking down prices. Bond prices are inversely correlated to yields.

Yields on the 10-year Government Security (6.79 per cent security maturing in 2027) jumped from 6.51 per cent at end of the first quarter of FY2018 to 7.32 per cent at the end of third quarter of FY2018. At the end of the fourth quarter, the yield had moved up to 7.55 per cent.

Besides allowing banks to stagger the bond investment depreciation provisioning over four quarters, the RBI has asked them to build up reserves to protect themselves against an increase in yields. Banks have been advised to create an Investment Fluctuation Reserve (IFR), which will be eligible for inclusion in Tier 2 capital, with effect from the year 2018-19. “With a view to addressing the systemic impact of sharp increase in the yields on Government Securities, it has been decided to grant banks the option to spread provisioning for mark to market (MTM) losses on investments held in AFS (Available For Sale) and HFT (Held For Trading) for the quarters ended December 31, 2017 and March 31, 2018,” the RBI said in a circular to banks.

Investments in the AFS category are marked to market at quarterly or at more frequent intervals. Securities are classified under the AFS category if a bank intends to sell them before maturity. Net depreciation, if any, is provided for, while net appreciation, if any, is ignored. Investments in the HFT category have to be sold within 90 days of investment and are marked to market at monthly or at more frequent intervals and provided for as in the case of those in the AFS category.

Bankers say half the provision made towards depreciation in the bond portfolio in the third quarter will get released (or can be written back) and this could support the bottomline.

As for an Investment Fluctuation Reserve, the RBI said the investment reserve should be at least 2 per cent of the HTM and AFS portfolio; an amount not less than the lower of the following: (a) net profit on sale of investments during the year (b) net profit for the year less mandatory appropriations, should be transferred to the reserve; and where feasible, reserve should be built up within three years.

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