Authors:
The proposed rules are a major enchancment over the extant rules and deal with most of the inadequacies and incongruities current within the latter. One of many proposed modifications, which is the requirement for improved granularity in categorising and disclosing data associated to investments would assist in bettering the transparency of the banks’ standing by way of each threat publicity and monetary place. These proposed modifications are in accordance with the suggestions in our paper on the transparency of banks’ disclosure regime the place we proposed, amongst different suggestions, that banks ought to disclose the quantities of investments within the varied classes – Held-to-Maturity (HTM), Out there-for-Sale (AFS), Held-for-Commerce (HFT), and the assumptions and methodologies used within the valuation of securities of their funding e book[1].
The Dialogue Paper additionally permits banks to carry non-SLR securities, equivalent to company bonds, of their HTM portfolio. Earlier, banks eager to diversify needed to essentially maintain such devices of their buying and selling e book, both as AFS or HFT. This strategy subjected them to market worth volatility, regardless of whether or not the intent of the financial institution was to carry such devices to maturity, or not. This strategy thus disincentivised banks from diversifying their exposures utilizing debt devices. The proposed regulation permits them to maneuver away from an unique “originate-and-hold-to-maturity” technique, thereby bettering their capability to handle focus dangers higher[2]. Furthermore, it might additionally permit them to enhance the liquidity of their steadiness sheets.
We additionally commend the RBI’s strategy of outlining the background, rationale, and guiding ideas of the rules earlier than detailing the rules themselves. Nevertheless, we level out sure inconsistencies and omissions within the proposed rules that might undermine the achievement of its goal.
We current detailed suggestions on the Dialogue Paper within the type of solutions to the ten questions posed throughout the Dialogue Paper. For issues that fall exterior the scope of the primary 9 questions, we embrace particular feedback within the tenth reply.
Query 1: Are there any necessary points pertaining to the funding portfolio that ought to be taken up for consideration?
The proposed modifications within the classification and valuation norms for devices in banks’ funding portfolio search to convey the regulatory framework nearer to the requirements prescribed within the Indian Accounting Requirements (Ind-AS) and the Worldwide Monetary Reporting Requirements (IFRS)[3]. Moreover, the proposed rules additionally make the classification of devices stringent compared to the extant directions, which permit for a laxer classification of devices at preliminary recognition and in addition permit for relative ease of their reclassification later[4].
Because the Dialogue Paper states in paragraph 5.3, one of many causes to evaluate the extant norms is as a result of blurred distinction between the classes – AFS and HFT – of what’s seen because the buying and selling e book[5]. The shortage of a definite separation between the 2 classes has led to most buying and selling being carried out out of AFS portfolio reasonably than HFT, thus distorting the buying and selling e book[6]. The proposed rules search to treatment this by permitting solely these monetary devices that fulfill the Solely Funds of Principal and Curiosity on Principal Excellent (SPPI) criterion to be held within the AFS portfolio[7]. Additionally, the securities held within the AFS portfolio will be held to maturity or bought with none restriction[8]. The intent seems to be, subsequently, to permit banks to carry, or promote, securities for Asset Legal responsibility Administration (ALM) functions with out having to topic them to a better valuation frequency, as is relevant for the HFT portfolio. (Per the extant directions, securities held within the AFS portfolio are required to be marked-to-market (MTM) on a quarterly foundation, whereas for these within the HFT class, the MTM requirement is every day[9]). Nevertheless, with none express restriction on the sale of securities within the AFS portfolio, the arbitrage current within the extant pointers would proceed to persist, albeit for a smaller subset of securities.
For example, these devices that are held by the financial institution with the intent of buying and selling[10], however which additionally meet the SPPI criterion, can nonetheless be traded out of the proposed AFS portfolio, which has a decrease valuation frequency requirement. Basically, on this case, whereas the financial institution is topic to market threat – within the type of short-term worth volatility – the total extent of threat just isn’t captured when devices are positioned within the AFS portfolio, as a substitute of HFT. This, in flip, obfuscates the true ranges of threat which the financial institution is uncovered to, and may doubtlessly restrict the effectiveness of the financial institution’s general threat administration technique. Due to this fact, to make sure that devices held for buying and selling are usually not misclassified as AFS, it’s important that the RBI embrace express limitations on the sale of securities within the AFS portfolio in order that it might probably higher obtain its acknowledged goal and forestall the distortion of the buying and selling e book.
Query 2: Are there some other overarching ideas that the RBI ought to take into account whereas updating the present framework?
The guiding ideas outlined for updating the present framework of rules are an necessary side of the Dialogue Paper as they type the idea for the present as nicely any potential future revision(s)/modification(s) to the norms. Whereas the proposed ideas are largely related for the efficient regulation of the funding portfolio, we share beneath a priority relating to the framing of one of many ideas.
Guiding Precept (e) reads – ‘The problems particular to the Indian context ought to be addressed and given due weightage within the revised framework[11].’ As readability on the that means and interpretation of the time period ‘Indian context’ just isn’t offered within the tenet itself, there may be scope for ambiguity within the interpretation of this precept. Furthermore, it could be apt to think about Guiding Precept e) as an implicit precept that guides the framing of not simply the proposed norms on this Dialogue Paper, however of all of RBI’s rules. The RBI might as a substitute present the rationale for any context-specific norms which can have been drafted, why there was a must deviate from international requirements, and an evaluation laying out the prices and advantages of such norms to monetary service suppliers. Such an articulation of contextual components (if any) would scale back the potential ambiguity within the interpretation of the precept whereas additionally preserving financial substance.
Query 3: Ought to banks be given the irrevocable choice at preliminary recognition (or on transition to this framework) to categorise their investments in fairness shares of their subsidiaries, associates, and joint ventures beneath FVTPL or AFS like some other fairness instrument as a substitute of the necessary classification as HTM proposed above?
Fairness investments in such ventures are more likely to be long-term and strategic in nature, with none goal of buying and selling for capital appreciation. Due to this fact, it might seem applicable to protect financial institution steadiness sheets from quick time period fluctuations of the funding’s market worth. Thus, a classification of most such investments as HTM is legitimate.
Nevertheless, if a financial institution had been to make use of a portion of those investments for the aim of buying and selling, even with the exemption of such securities from the sale threshold limits beneath the HTM class[12], the accounting norms on beneficial properties arising from gross sales out of HTM[13] preclude the financial institution from totally making the most of modifications in honest worth of those investments. Due to this fact, the proposal of necessary classification of a financial institution’s investments in fairness shares of their subsidiaries, associates, and joint ventures as HTM could also be restrictive and even seen as impinging on the financial institution’s freedom to pursue its enterprise technique.
Additional, it’s important that these shares be usually assessed to verify for any everlasting diminution of worth. Due to this fact, it’s helpful that the proposed pointers deal with this side via the quarterly evaluation of HTM securities for impairment. We elaborate, within the reply to Query 5, how these impairment assessments will be improved to supply a good presentation of the banks’ monetary statements.
Query 5: Clause 9(a) of the Reserve Financial institution of India (Classification, Valuation and Operation of Funding Portfolio of Business Banks) Instructions, 2021 (i.e., the Grasp Route) offers sure assessments for impairment. Is there a necessity for specifying extra indicators of potential impairment?
The extant directions pertaining to the prudential norms on the classification and valuation of funding portfolio give a prescribed set of circumstances beneath which impairment is decided. Per the extant directions, the necessity to decide whether or not impairment has occurred shall come up within the following circumstances[14]:
- On the taking place of an occasion which means that impairment has occurred which, on the minimal, shall embrace:
- the corporate has defaulted in compensation of its debt obligations.
- the mortgage quantity of the corporate with any financial institution has been restructured.
- the credit standing of the corporate has been downgraded to beneath funding grade.
- The corporate has incurred losses for a steady interval of three years and the networth has consequently been decreased by 25 % or extra.
- Within the case of a brand new firm or a brand new mission when the initially projected date of reaching the breakeven level has been prolonged i.e., the corporate or the mission has not achieved break-even throughout the gestation interval as initially envisaged.
On condition that, beneath Indian Typically Accepted Accounting Rules, impairment itself is predicated on incurred loss and never anticipated loss (as in Ind-AS), the relevance of the impairment train is additional decreased when there may be solely a restricted set of circumstances beneath which impairment is assessed. Additionally, many of those prescribed circumstances – equivalent to when the corporate has defaulted in compensation of its debt obligations, and when the mortgage quantity of the corporate has been restructured – are these which might be triggered after the occasion of default.
The relevance and usefulness of the impairment check will be additional improved if these impairment assessments are forward-looking. Whereas the extant directions point out that these are the ‘minimal’ options that must be thought-about, it might be prudent to incorporate extra assessments that higher consider impairment or a major improve in credit score threat like these specified by Ind-AS requirements[15]. A few of these are:
a) Important modifications in exterior market indicators of credit score threat such because the credit score unfold and market data associated to the borrower, equivalent to antagonistic modifications within the costs of a borrower’s debt and fairness devices.
b) Important modifications in aspects of the borrower’s working outcomes that transcend simply networth, equivalent to declining revenues or margins, elevated steadiness sheet leverage, administration issues, or different elements that considerably have an effect on the borrower’s capability to service their debt obligations.
c) Important modifications within the worth of the collateral supporting the asset or within the high quality of third-party ensures or credit score enhancements which could cut back the borrower’s incentive to make the scheduled contractual cost.
Query 6: Is the definition of ‘lively market’ as given above with illustrative examples satisfactory? Are there some other markets that may very well be thought-about as ‘lively markets’? Feedback could also be supplied with rationale.
Whereas the definition of ‘lively markets’ as laid out in paragraph 7.29 is satisfactory at a precept degree, there’s a lack of readability within the given illustrative examples. For example, it’s unclear what is supposed by ‘recognised inventory exchanges for SENSEX/NIFTY shares.’ It isn’t clear whether or not all recognised inventory exchanges, and the shares traded in them, ought to be thought-about as lively markets or that solely shares of entities which might be a part of SENSEX/NIFTY which might be traded in recognised inventory exchanges be thought-about as lively markets? Within the case of the latter, the definition of an ‘lively market’ can be reasonably restrictive as fairness shares not included within the benchmark indices might even have satisfactory liquidity. For example, the 1-month common buying and selling quantity of Vodafone Concept’s shares is 42 Crore variety of shares, whereas the equal determine for Reliance Industries, which is a part of the SENSEX (BSE 30), is 68 Lakh variety of shares[16]. We suggest that, along with illustrative examples, there even be an indicative record of options (equivalent to a low bid-ask unfold or every day buying and selling volumes above a threshold) that an ‘lively market’ for an asset or a legal responsibility may possess.
Query 7: Is the definition of ‘unobservable inputs’ as given above with the illustrative examples satisfactory?
In paragraph 7.30, the illustrative instance for the investments whose valuation is presumed to be primarily based on unobservable inputs contains mutual funds that make investments greater than 10% of their corpus in unquoted devices[17]. That is unduly restrictive because the regulation treats the valuation of unquoted devices on par with that of mutual funds, whose items are listed, and but have 10% or extra of their corpus in unquoted devices. The liquidity of the mutual fund unit is extra pertinent than the valuation of the underlying securities themselves.
Query 8: Ought to the IFR proceed? In that case, at what degree ought to it’s set and the way a lot time ought to be given to banks to realize that degree?
Because the Dialogue Paper mentions, the rationale for the Funding Fluctuation Reserve (IFR) is to guard banks from curiosity cycles. Traditionally, RBI has given particular dispensation to banks on events when the rate of interest cycle turned antagonistic. For example, throughout instances of sustained rises in G-sec yields, banks had been allowed to, in 2005, shift securities from different classes into HTM, and in 2013, defer recognition of valuation losses by six months[18]. Defending its portfolio towards antagonistic market actions is prudent threat administration for a financial institution and all banks ought to make use of applicable threat administration methods to realize the identical. It isn’t the regulator’s remit to design and implement operational threat administration methods for banks nor ought to it present particular dispensations going ahead. Thus, each the IFR and any associated regulatory forbearance ought to be discontinued.
Query 10: Are there any proposals you don’t agree with? If sure, please present separate feedback for every proposal you don’t totally agree with mentioning the proposal quantity, the precise paragraph quantity and causes for disagreement. Feedback can be helpful, in the event that they clearly articulate implementation difficulties or conceptual points together with different proposals.
The next factors record our issues relating to particular factors within the proposal.
- Paragraph 7.4 particulars the kind of securities that may be categorized as HTM. The record doesn’t embrace debt devices with floating price coupons linked to a market-determined rate of interest. These devices meet the SPPI criterion and if the financial institution had been to have an intent to carry such devices to maturity, they need to be allowed to be categorized as HTM. Nevertheless, as such devices are usually not included within the illustrative examples in paragraph 7.4, it’s unclear whether or not these devices qualify to be categorized as HTM.
- In paragraph 7.6, within the illustrative record of devices that must be categorised as FVTPL, solely investments in pass-through certificates (PTCs) representing the fairness tranche of a securitisation transaction are included. The paragraph additionally states that investments in different senior and mezzanine tranches shall must be reviewed for his or her compliance with the SPPI criterion[19]. Nevertheless, it’s unclear whether or not such investments (PTCs of senior or mezzanine tranches) will be held in HTM, if the intent is to carry them to maturity. The shortage of a transparent directive relating to PTCs would act as a barrier for banks to develop their (HTM) investments in PTCs. This in flip can doubtlessly block liquidity sources for these establishments which straight originate belongings, particularly within the precedence sector[20].
- Paragraph 7.6 which supplies the illustrative record of devices that must be categorised as FVTPL lists ‘Securitisation receipts’ as one of many devices[21]. The rules must explicitly specify that securitisation receipts are from the sale of non-standard belongings, and never that of normal belongings.
- Paragraph 5.3 mentions that the uneven remedy of the AFS/HFT portfolios within the present framework is without doubt one of the causes for revising it. Nevertheless, the rules then stipulate that the preliminary valuation of devices that aren’t quoted and can’t be valued via market variables, will probably be executed in an uneven method. The rationale given (in paragraph 7.10) for the uneven remedy is that the BR Act (Banking Regulation Act, 1949) requires banks to recognise all losses and bills earlier than paying out dividends[22]. Nevertheless, that also doesn’t clarify why beneficial properties must be amortised over the interval of the asset’s lifetime and never recognised immediately. If the RBI’s rationale behind persevering with the uneven remedy is a matter of following the precept of prudence, it should explicitly state so. Additionally, a transparent distinction must be made between unrealised and realised losses/beneficial properties.
Concluding Remarks
The proposed rules, if and when carried out, would achieve addressing a number of main and long-standing points with the present framework on banks’ funding portfolio. We wholeheartedly welcome a number of vital modifications within the pointers pertaining to a) the eligibility of non-SLR securities to be held in HTM b) the categorisation of investments into honest worth hierarchies and c) the elevated requirement for disclosures within the notes to accounts. Nevertheless, there are nonetheless some points, if left unaddressed, would diminish the importance and effectivity of the proposed measures. For example, the norms on the hierarchy of valuation strategies are held again by the dearth of readability on the interpretation and utility of the definition of lively markets. The allowing of non-SLR securities to be categorized as HTM should even be bolstered by strong impairment assessments, and readability on the eligibility of particular devices equivalent to PTCs of senior and mezzanine tranches. Furthermore, the excellence between the buying and selling e book classes must be clear sufficient to deal with the buying and selling e book distortions.
Nonetheless, it’s laudable that the proposed pointers would convey the Reserve Financial institution’s pointers on valuation of the funding portfolio nearer in step with that of worldwide requirements of accounting and threat administration[23]. This is able to additionally ease the method of future implementation of Ind-AS for banks. Along with bettering the regulation and disclosure regime on the entity degree, the proposed modifications would have a optimistic impact from a systemic threat perspective as nicely. With the proposed modifications on eligibility of non-SLR securities to be categorized as HTM, banks can higher handle their focus dangers and in addition enhance the liquidity of their steadiness sheets. Additional, as banks are vital contributors within the investor market, this proposed change might additionally support within the improvement of the bond market, which in flip would have far-reaching optimistic results on systemic stability and monetary market resilience.
[1] Srinivas, Madhu, et al. ” Assessing Transparency of Indian Banking System’s Public Danger Disclosure Regime – A Regulation Primarily based Method.” 2021. Dvara Analysis.
[2] Danger administration technique for giant branch-based banks to ship credit score extra successfully to low-income households and small companies. Supply – Chapter 4.2, Committee on Complete Monetary Companies for Small Companies and Low-Revenue Households. 2014. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/CFS070114RFL.pdf
[3] Paragraph 5.2, Ibid.
[4] Part 5, Ibid
[5] Paragraph 5.3 level (e), Ibid.
[6] Ibid
[7] Part 7, Ibid
[8] Ibid
[9] Paragraphs 7.12 and seven.15, Ibid.
[10] That’s, holding the securities for brief time period resale or to learn from short-term worth actions, or to lock in arbitrage earnings.
[11] Part 6, Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks. January 2022. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DISCUSSIONPAPER9604DB243FA84169847AC576EBEB593B.PDF
[12] Per Paragraph 7.20 within the Dialogue Paper, if a financial institution had been to decide on to promote or disinvest from the investments in subsidiaries, associates and joint ventures, it’s free to take action because the sale of such securities is exempt from the brink restrict (5 % of the opening carrying worth of the HTM portfolio) of mixture gross sales out of HTM.
[13] Paragraph 7.20, Ibid.
[14] 9 (a) (v), Grasp Route – Classification, Valuation and Operation of Funding Portfolio of Business Banks, 2021. August 2021. RBI Grasp Instructions. Retrieved from: https://rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12153
[15] B5.5.17, Indian Accounting Commonplace (Ind AS) 109 – Monetary Devices. Retrieved from: https://www.mca.gov.in/Ministry/pdf/INDAS109.pdf
[16] As on Feb 9, 2022. Retrieved from: https://www.moneycontrol.com/india/stockpricequote/telecommunications-service/vodafoneidealimited/IC8;
https://www.moneycontrol.com/india/stockpricequote/refineries/relianceindustries/RI;
[17] Paragraph 7.30 level (a), Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks. January 2022. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DISCUSSIONPAPER9604DB243FA84169847AC576EBEB593B.PDF
[18] Heads I Win, Tails the Regulator Dispenses, Understanding and Managing Curiosity Price Danger at Banks – Speech by Viral V Acharya, Deputy Governor. January 2018. RBI Speeches and Interview. Retrieved from: https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1053
[19] Paragraph 7.6 level (a), Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks. January 2022. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DISCUSSIONPAPER9604DB243FA84169847AC576EBEB593B.PDF
[20] Advice 4.10, Committee on Complete Monetary Companies for Small Companies and Low-Revenue Households. 2014. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/CFS070114RFL.pdf
[21] Paragraph 7.6 level (b), Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks. January 2022. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DISCUSSIONPAPER9604DB243FA84169847AC576EBEB593B.PDF
[22] Paragraph 7.10, Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks. January 2022. RBI Publications. Retrieved from: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DISCUSSIONPAPER9604DB243FA84169847AC576EBEB593B.PDF
[23] Part 4, Ibid.
Cite this Merchandise:
APA
Neelam, A., & Srinivas, M. (2022). Suggestions on the Reserve Financial institution of India’s Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks dated 14 January 2022. Retrieved from Dvara Analysis.
MLA
Neelam, Amulya and Madhu Srinivas. “Suggestions on the Reserve Financial institution of India’s Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks dated 14 January 2022.” 2022. Dvara Analysis.
Chicago
Neelam, Amulya, and Madhu Srinivas. 2022. “Suggestions on the Reserve Financial institution of India’s Dialogue Paper on Overview of Prudential Norms for Classification, Valuation and Operations of Funding Portfolio of Business Banks dated 14 January 2022.” Dvara Analysis.
