Recent bank failures in the United States have highlighted the need for regulation to force commercial banks to transparently disclose and realistically assess their investment accounts. In India, regulations related to bank investments are conservative but date back to 2000. There is a need to bring them up to speed with global accounting practices while ensuring that banks do not rely too heavily on their investment books to cover their profits or mask losses from rising interest rates. The Reserve Bank of India’s new directives on classification, valuation and functioning of commercial banks’ investment portfolios, which will come into effect from April 1, 2024, strike this delicate balance.
The move is well-timed as the bank is financially strong enough to absorb any short-term fluctuations from the accounting changes. The new norms significantly increase banks’ operational flexibility in selecting and managing investment businesses. At the same time, they monitor them more closely. Currently, banks can keep up to 23% of their total investments in the held-to-maturity (HTM) category, where investment gains or losses are not marked to market. Under the new specifications, this cap on HTM will be removed. Banks will also be allowed to place their non-SLR investments into the HTM bucket. But whenever a bank decides to sell more than 5% of HTM securities in any year, it needs prior approval from the Reserve Bank of India (RBI). The rule may force banks to think twice before overloading HTM portfolios to avoid interest rate risk.
The permanent value loss of HTM needs to be recognized in the profit and loss account (P&L). Likewise, the 90-day period for holding securities held for trading (HFT) has been removed. But banks need to regularly account for profits and losses in this segment. Notional losses on banks’ available-for-sale (AFS) portfolios will now be taken out of the profit and loss account and charged directly to the balance sheet, reducing volatility in banks’ reported profits. However, cross-category transfers between HTM and AFS instruments, which currently required only bank board approval, now require prior approval from the Reserve Bank of India. This allows the central bank to keep a close eye on the type and amount of treasury operations carried out by banks to gauge their financial health. The Treasury may now need to operate around the clock as many decisions previously made only by its board now require regulatory approval.
The biggest difference between Indian banks and Western banks is that Indian banks rely more on traditional deposits and loans to build their balance sheets. They don’t get involved in trading stocks, complex financial instruments or derivatives for profit. Nor do they earn huge fees from investment banking. The RBI’s new directive indicates that it is keen to maintain this traditional banking model while seeking to align banks’ accounts with globally accepted accounting standards.