What does revision in banks’ investment classification norms imply for banking?

The Reserve Bank of India has revised the current norms for the classification, valuation, and operation of investment portfolios of commercial banks.

The revised directions include principle-based classification of an investment portfolio, tightening of regulations around transfers to/from held to maturity (HTM) category, and sales out of HTM, among others.

As per the revised norms, banks must classify their entire investment portfolio (except investments in their own subsidiaries, joint ventures, and associates) under three categories, viz., Held to Maturity (HTM), Available for Sale (AFS) and Fair Value through Profit and Loss (FVTPL). Held for Trading (HFT) must be a separate investment sub-category within FVTPL, the RBI said.

The new norms, which are effective from April 1, 2024, and are in line with the global financial reporting standards, are expected to enhance the quality of banks' financial reporting, as well as improve disclosures.

ETCFO spoke to experts to understand the implications of the revised accounting norms for the banking industry.

Setting for Ind-As transition

“The revision in the norms by the RBI is a big step forward in the direction of mandating new accounting standards (Ind-As) for banks. There are three important pieces in the bank’s balance sheet i.e. investments, borrowings, and lending. Through these directions, the RBI has mandated banks to account for investment portfolios in line with the principles-based global financial reporting standards. This change will enhance the overall quality of financial reporting by the banks,” Venkateswaran Narayanan, Partner - Accounting & Reporting Consulting of Uniqus Consultech tells ETCFO.

Ind-As, which are the Indian equivalent of stringent International Financial Reporting Standards (IFRS) have so far been implemented by all sectors including companies except insurance and banking. Their implementation has been deferred twice by the RBI citing pending legislative amendments as well as amid banks’ not-so-encouraging capital adequacy position in the wake of higher provisioning norms required by the new standards.

Narayanan says the rollout of these directions now seems appropriate with banks today being in a relatively better position with respect to their profitability and also their recoveries have improved.

'Banks should gear up'

“While banks have been submitting proforma Ind AS financial statements with RBI, there will be operational challenges in implementing the requirements of the circular. Banks will have to spend time in resources to make implementation a lot more robust by bringing in the rating processes, greater supervision by Boards, and by bringing in internal controls, etc. Those elements will have to be added to the overall framework of running the whole treasury management by banks in India,” adds Uniqus' expert.

As per the new revision norms, banks must make their own internal credit analysis and credit rating even with respect to rated issues and must not entirely rely on the ratings of external credit rating agencies. Also, they are required to ensure robust internal credit rating systems which must also include building up of a system of regular (quarterly or half-yearly) tracking of the financial position of the issuer.

Likewise, banks have to ensure that there are adequate internal control and audit procedures in place in regard to the conduct of the investment portfolio. For instance, they are required to take a half-yearly review (as of March 31 and September 30) of the investment portfolio and they must place that before their Boards within two months, i.e., by end-May and end-November, the revised norms state.

Keyur Dave, Partner, Grant Thorton concurs saying, “The RBI is acting thoughtful of managing the transition to the Ind-As in a very smooth manner…Banks now must take steps of aligning systems, policies, Investments / future growth, board approval in line with the new direction of the regulator.”

Departures still from global standards

Dave stresses that there are still lots of areas currently that are not aligned with Ind AS- 109 (financial instruments) or the global equivalent standard IFRS 9.

Direction from the regulator indeed addresses the classification of investments however other critical areas such as how to fair value of instruments in line with Ind AS 113 (Fair-value accounting), when to assess for reclassification, how to recognize any modification of the instruments, and when to derecognise the investments are yet to be addressed which are core and integral part of Ind AS 109 which at some point must be aligned for and by the banking sector.Keyur Dave, Partner, Grant Thornton

The way ahead

Experts feel now that the RBI has revised the accounting norms for investment portfolios, the next in line would be the final norms for expected credit loss (ECL) framework, another significant piece in the transition to the Indian accounting standards. The RBI already brought a discussion paper earlier this year in January and sought public comments.

The ECL approach requires banks to estimate expected credit losses based on forward-looking estimations rather than wait for credit losses to be incurred before making corresponding loss provisions, which is the practice today. The ECL’s adoption would require banks to make higher provisions.

“The sooner the RBI provides clarity on the expected credit loss framework, the better it will be for the banks to start gearing for the full transition to Ind AS. There are two elephants in the room, investments, and expected credit loss, one has been knocked off, and now is time to address the other. It does seem the regulator is preparing the banks to transition to Ind-As,” Uniqus' Narayanan signs off.