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October 12, 2001
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RBI plans reserve to cushion investment value fluctuations

BS Banking Bureau

The Reserve Bank of India is toying with the idea of directing banks to create a special reserve as a cushion for any adverse movements in the value of their investment portfolios that may be triggered off by interest rate volatility.

This reserve is to be funded from a small portion of their net profit every year. The issue came up for discussion with select bank chairmen last week.

Banks have been asked to furnish details of their statutory liquidity ratio portfolio and the impact of a rate cut on their portfolios. Banks currently hold around 38 per cent of their total assets in SLR securities, as against the RBI stipulated minimum of 25 per cent.

If the price of a security instrument falls below the price at which banks bought it, they are required to make provisioning to make good the gap in prices.

Conversely, if the prices rise higher than the acquisition price, banks can take the appreciation benefits on their books. The RBI's proposed investment reserve is intended to cushion the bank's balance sheets from such gyrations of the market.

As an alternative, the RBI discussed the possibility of transferring the appreciation benefits to the special reserve, instead of letting it flow to the balance sheet first.

At present, 25 per cent of banks' investments are to be marked as "held to maturity" and do not require to be marked to market. Banks are at a liberty to classify the remaining 75 per cent as "available for sale" and "available for trading".

Whereas AFS securities are supposed to be marked to market on a yearly basis and AFT securities on a monthly basis, the RBI wants banks to move both categories to a uniform monthly marking cycle.

Till now, only a handful of public sector banks, including the State Bank of India, as a matter of accounting prudence, did not claim the appreciation benefit to bloat their net profits but used it to offset the depreciation blow whenever security prices fell.

The RBI ushered in the new system of valuing investment portfolios in September last year. Till that time, banks kept 75 per cent of the portfolio in the current and 25 per cent in the permanent category.

After the September 2000 norms, the profit on the sale of investments in the "held to maturity" category was to be taken to the profit and loss account first and thereafter appropriated to the capital reserve account. The mark to market loss was to be immediately recognised in the profit and loss account.

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