Recent bank failures in the US have underlined the need for regulations that force commercial banks to transparently disclose and realistically value their investment books. In India, regulations relating to bank investments are conservative, but date back to the year 2000. There was a need to bring them up to date with global accounting practices, while ensuring that banks did not over-rely on their investment books to pad up their profits, or disguise losses from rising rates. RBI’s new directive on the classification, valuation and operation of commercial bank investment portfolios, set to take effect from April 1, 2024, strikes this fine balance.
The move is timed well because bank financials are in the pink of health to absorb any short term blips from the accounting changes. The new norms significantly increase the operational flexibility available to banks on choosing and managing their investment operations. At the same time, they subject them to tighter monitoring. Banks are currently allowed to hold up to 23 per cent of their total investments in the Held-to-Maturity (HTM) category — a category where gains or losses on investments aren’t marked to market. Under the new norms, this ceiling on HTM will be removed. Banks will be allowed to park their non-SLR investments also in the HTM bucket. But RBI’s prior approval will be needed every time a bank decides to sell more than 5 per cent of its HTM securities in any year. This provision may force banks to think twice before overloading their HTM portfolios to shield from rate risk.
Permanent loss of value in HTM is required to be recognised in profit and loss account (P&L). Likewise, the 90-day deadline for holding securities under the held-for-trading (HFT) category has been removed. But banks will need to regularly account for gains or losses on this segment. Notional losses on banks’ available for sale (AFS) portfolio will now be kept off P&L and taken straight to the balance sheet, thereby reducing swings in banks’ reported profits. But then, inter-category transfers between HTM and AFS instruments, which currently require only bank Board approval, will now need prior clearance from the RBI. This enables the central bank to keep tabs on the type and quantum of treasury operations carried out by banks to gauge their financials. Treasury departments may now need to function round-the-clock because many decisions earlier taken only by their Boards, will now require a go-ahead from the regulator.
The biggest difference between banks in India and their Western counterparts, is that Indian banks rely more on the traditional business of deposit-taking and lending to build their balance sheets. They do not dabble in stocks, sophisticated financial instruments or derivatives trading for their profits. Nor do they earn out-sized fees from investment banking operations. RBI’s new directives show that it is keen to stay with this traditional banking model, while seeking to align banks’ books with globally accepted accounting standards.