RBI's Latest Bank Investment Norms To Reduce Volatility, Say Analysts

The Reserve Bank of India's latest norms governing the classification, valuation, and operation of bank investments will aid in bringing down any volatility in profit and loss accounts. The norms will also help raise bank investment in government bonds, though disclosure requirements will go up, according to analysts.

The new norms call for the creation of three categories of securities within a bank's investment book: Held-To-Maturity, Available-For-Sale and Fair Value Through Profit and Loss.

Among other nuanced changes, the revised framework updates the regulatory guidelines with global standards and best practices while introducing:

• A symmetric treatment of fair-value gains and losses.

• A clearly identifiable trading book under the Held For Trading category.

• Removal of the 90-day ceiling on the holding period under HFT.

• Removal of ceilings in the Held To Maturity category.

• More detailed disclosures on the investment portfolio.

The move is widely considered a means to align the norms for Indian bank investments with the International Financial Reporting Standards.

"Overall, these align the prudential framework with global standards, though retaining some elements linked to the domestic context. We await clarity from banks to estimate the potential impact," Morgan Stanley analysts said in a report on Wednesday.

The norms require that notional gains or losses on securities held in the AFS category be credited or debited to a reserve named AFS reserve instead of the profit and loss account. This will insulate the profit and loss account from volatility owing to a notional change in the value of these securities. The AFS reserve will be considered part of the common equity Tier-1 ratio.

"This direction will be beneficial for PSU banks, especially in a scenario of rising yields, as they have longer duration books," analysts at Investec said.

Even equity investments by banks will no longer be considered HTM and will move to AFS. This could limit the ability of banks to strategically sell their investments to boost profits in lean periods. The new norms require that earnings from the sale of equity investments flow into a capital reserve account and not the P&L.

Changes in the way HTM category bonds are accounted for will also aid in reducing volatility and raising bank investments. While currently bank investments in the HTM category are limited to 19.5% of net demand and time liabilities, the new norms remove this ceiling.

"The recent move will allow banks to invest more in government securities and state development bonds. The new norm is likely to reduce the earning volatility on banks because HTM bonds need not be marked to market," Ajit Kabi, banking analyst at LKP Securities, said.

This is positive for public sector banks, which have relatively lower credit-deposit ratios and a higher liquidity coverage ratio, said Investec.

"...it allows them to improve their investment yield by parking funds in longer duration bonds/corporate bonds without taking near-term Treasury or yield risk or affecting the P&L adversely," the brokerage said.

According to analysts at Motilal Oswal, since these norms come into effect from FY25, interest rates will likely start coming down and the investment books of banks will start moving towards profitability, indicating that there will be limited marked-to-market losses or provisioning requirements.