Ref DBS.FID No.C 9 /01.02.00/2000-01

09 November 2000

Chairmen / Chief Executives of
all India Term Lending & Refinance Institutions.

Dear Sir,

From time to time FIs have been advised regarding classification and valuation of investments by them. The existing instructions on the classification and valuation of the investment portfolio have been reviewed to bring them in consonance with the best international practices.

2. During the last few years the Indian financial system, in general, has witnessed a sea change. FIs/Banks are now on a better footing than before in terms of capital adequacy, investment management, income recognition, asset classification, provisioning for non-performing assets and other such prudential issues. At the same time, trading in the securities market has improved in terms of turnover and maturities dealt with. In view of these developments and taking into consideration the evolving international practices, an Informal Group in the Bank has reviewed the existing instructions on the classification and valuation of the investments portfolio. The Group studied the international practices in accounting of investments in the light of the international accounting standards and submitted its Report in October 1999.

3. Revised Guidelines

The guidelines on classification and valuation of investments by FIs have been revised on the basis of the recommendations of the Informal Group so that they are in consonance with the best international practices. In supersession of our earlier circulars in regard to classification and valuation of different types of investments by FIs it is advised that the revised guidelines as given in this circular may be followed.

3.1 The highlights of the revised guidelines are given below:

• The revised guidelines furnished in the Annexure will be effective from the half year ended March 31, 2001.

• The FIs are required to classify their entire investment portfolio as on March 31, 2001, under three categories viz. ‘Held to Maturity’, ‘Available for Sale’ and ‘Held for Trading’.

• The investments will be classified as i) Government securities ii)other approved securities iii) Shares iv) Debentures & Bonds v) Subsidiaries/ joint ventures vi) Others (CP, Mutual Fund Units, etc.).

• The investments under the Available for Sale and Held for Trading categories should be marked to market as prescribed or at more frequent intervals.

• The investments under the Held to Maturity category need not be marked to market.

• Classification of investments, shifting of investments among the three categories, valuation of the investments, methodology for booking profit/ loss on sale of investments and providing for depreciation should be in accordance with the guidelines in the Annexure.

• The risk-weights assigned to the various securities at present including those for 'market risk', would remain unchanged.

3.2 The classification of the existing investments among the three categories may be done at the book value of the respective securities as on March 31, 2001. Subsequent valuation of the securities included under the ‘Held for Trading’ and the ‘Available for Sale’ categories may be revalued as specified in the revised guidelines. The first such revaluation may be done as on March 31, 2001 for the securities under the ‘Held for Trading’ category. Securities under the ‘Available for Sale’ category may also be revalued as on that date if the FI proposes to revalue this category at intervals more frequent than ‘annual’ intervals.

3.3 FIs should formulate an Investment Policy with the approval of their Board of Directors to take care of the requirements on classification, shifting and valuation of investments under the revised guidelines. Besides, the Policy should adequately address risk-management aspects, ensure that the procedures to be adopted by the banks under the revised guidelines are consistent, transparent and well documented to facilitate easy verification by inspectors and statutory auditors.

Yours faithfully

(K.C. Bandyopadhyay)
Chief General Manager

Encls: 6 pages

1) The entire investment portfolio of the FIs will be classified under three categories viz. ‘Held to Maturity’, ‘Available for Sale’ and ‘Held for Trading’.

[Definitions: The securities acquired by the FIs with the intention to hold them till maturity will be classified under Held to Maturity. The securities acquired by the FIs with the intention to trade by taking advantage of the short-term price/ interest rate movements etc. will be classified under Held for Trading. The securities which do not fall within the above two categories will be classified under Available for Sale]

2) FIs should decide the category of the investment at the time of acquisition and the decision should be recorded on the investment proposals.

3) The investments included under "Held to Maturity" should not exceed 25 per cent of the total investments. The FIs may include, at their discretion, under Held to Maturity category securities less than 25 per cent of total investment.

4) The following investments will be included under "Held to Maturity" but will not be counted for the purpose of ceiling of 25% for the category:

1. Investment in subsidiaries and joint ventures. [A joint venture would be one in which the FI, along with its subsidiaries, holds more than 25% of the equity.]
2. The investments in debentures/ bonds, which are deemed to be in the nature of an advance.

Debentures/ bonds must be treated in the nature of an advance when:

• The debenture/bond is issued as part of the proposal for project finance and the tenure of the debenture is for a period of three years and above

The debenture/bond is issued as part of the proposal for working capital finance and the tenure of the debenture is less than a period of one year

• the FI has a significant stake i.e.10% or more in the issue

• the issue is part of a private placement, i.e. the borrower has approached the bank/FI and not part of a public issue where the bank/FI has subscribed in response to an invitation.

The debentures/bonds deemed to be in the nature of advance will be subject to the usual prudential norms applicable to advances.

5) Profit on sale of investments in this category should be first taken to the Profit & Loss Account and thereafter be appropriated to the ‘Capital Reserve Account’. Loss on sale will be recognised in the Profit & Loss Account.

6) The FIs will have the freedom to decide on the extent of holdings under Available for Sale and Held for Trading categories. This will be decided by them after considering various aspects such as basis of intent, trading strategies, risk management capabilities, tax planning, manpower skills, capital position.

7) The investments classified under Held for Trading category would be those from which the FI expects to make a gain by the movement in the interest rates/ market rates. These securities are to be sold within 90 days. If the FI is not able to sell the security within 90 days due to exceptional circumstances such as tight liquidity conditions, or extreme volatility, or market becoming unidirectional, the security should be shifted to the Available for Sale category subject to items (11) and (12) below.

8) Profit or loss on sale of investments in both the categories will be taken to the Profit & Loss Account.

9) FIs may shift investments to/from Held to Maturity category with the approval of the Board of Directors once a year. Such shifting will normally be allowed at the beginning of the accounting year. No further shifting to/from this category will be allowed during the remaining part of that accounting year.

10) FIs may shift investments from Available for Sale category to Held for Trading category with the approval of their Board of Directors/ ALCO/ Investment Committee. In case of exigencies, such shifting may be done with the approval of the Chief Executive of the FI/ Head of the ALCO, but should be ratified by the Board of Directors/ ALCO.

11) Shifting of investments from Held for Trading category to Available for Sale category is generally not allowed. However, it will be permitted only under exceptional circumstances as mentioned at item 7 above, subject to depreciation, if any, applicable on the date of transfer, with the approval of the Board of Directors/ ALCO/ Investment Committee.

12) Transfer of scrips from one category to another, under all circumstances, should be done at the acquisition cost/ book value/ market value on the date of transfer, whichever is the least, and the depreciation, if any, on such transfer should be fully provided for.

13) Investments classified under Held to Maturity category need not be marked to market and will be carried at acquisition cost unless it is more than the face value, in which case the premium should be amortised over the period remaining to maturity.

14) FIs should recognise any diminution, other than temporary, in the value of their investments in subsidiaries/ joint ventures which are included under Held to Maturity category and provide therefor. Such diminution should be determined and provided for each investment individually.

15) The individual scrips in the Available for Sale category will be marked to market at the year-end or at more frequent intervals. The net depreciation under each classification mentioned below should be recognised and fully provided for as indicated in item 16 below, the net appreciation under these classifications should be ignored. The book value of the individual securities would not undergo any change after the revaluation.

The classifications of investment will be (i) Government securities (ii) Other approved securities (iii) Shares (iv) Debentures & Bonds (v) Subsidiaries / joint ventures (vi) Others (CP, Mutual Fund Units, etc.).

[Note: Securities under this category shall be valued scrip-wise and depreciation/ appreciation shall be aggregated for each classification as above. Net depreciation, if any, shall be provided for. Net appreciation, if any, should be ignored. Net depreciation required to be provided for in any one classification should not be reduced on account of net appreciation in any other classification.]

16) The provisions required to be created on account of depreciation in the Available for Sale category in any year should be debited to the Profit & Loss Account and an equivalent amount (net of tax benefit, if any) or the balance available in the Investment Fluctuation Reserve Account, whichever is less, shall be transferred from the Investment Fluctuation Reserve Account to the Profit & Loss Account. In the event provisions created on account of depreciation in the Available for Sale category are found to be in excess of the required amount in any year, the excess should be credited to the Profit & Loss Account and an equivalent amount (net of taxes, if any) should be appropriated to the Investment Fluctuation Reserve Account to be utilised to meet future depreciation requirement for investments in this category. The amounts debited to the Profit & Loss Account for provision and the amount credited to the Profit & Loss Account for reversal of excess provision should be debited and credited respectively under the head "Expenditure – Provisions & Contingencies". The amounts appropriated from the Profit & Loss Account and the amount transferred from the Investment Fluctuation Reserve to the Profit & Loss Account should be shown as ‘below the line’ items after determining the profit for the year.

17) The individual scrips in the Held for Trading category will be revalued at monthly or at more frequent intervals and the net appreciation/ depreciation under each of the six classifications referred to in item 15 above will be recognised in the income account. The book value of the individual scrip will change with the revaluation.

18) General

In respect of securities included in any of the three categories where interest/ principal is in arrears, FIs should not reckon income on the securities and should also make appropriate provisions for the depreciation in the value of the investment. FIs should not set-off the depreciation requirement in respect of these non-performing securities against the appreciation in respect of other performing securities

19) The ‘market value’ for the purpose of periodical valuation of investments included in the Available for Sale and the Held for Trading categories would be the market price of the scrip as available from the trades/ quotes on the stock exchanges, price of SGL Account transactions, price list of RBI, prices declared by Primary Dealers Association of India (PDAI) Jointly with the Fixed Income Money Market and Derivative Association of India (FIMMDA) periodically. In respect of unquoted securities, the procedure as detailed below should be adopted.

20) The FIs should value the unquoted Central Government Securities on the basis of the prices/YTM rates put out by the PDAI / FIMMDA at periodical intervals.

21) Treasury Bills should be valued at carrying cost.

22) State Government securities will be valued applying the YTM method by marking it up by 25 basis points above the yields of the Central Government Securities of equivalent maturity put out by PDAI / FIMMDA periodically.

23) The Other 'approved' Securities will be valued applying the YTM method by marking it up by 25 basis points above the yields of the Central Government Securities of equivalent maturity put out by PDAI / FIMMDA periodically.

24) All debentures/bonds other than debentures/bonds which are in the nature of advance should be valued on the YTM basis. Such debentures may be of different companies having different ratings. These will be valued with appropriate mark-up over the YTM rates for Central Government securities as put out by PDAI / FIMMDA periodically. The mark-up will be graded according to the ratings assigned to the debentures/bonds by the rating agencies subject to the following :-

1. The rate used for the YTM for rated debentures/bonds should be at least 50 basis points above the rate applicable to a Government of India loan of equal maturity.
2. The rate used for the YTM for unrated debentures/bonds should not be less than the rate applicable to rated debentures/bonds of equivalent maturity. The Mark-up for the unrated debentures/bonds should appropriately reflect the credit risk borne by the FI.
3. Where interest/ principal on the debenture/bond is in arrears, the provision should be made for the debentures/bonds as in the case of debentures/bonds treated as advances. The depreciation/ provision requirement towards debentures where the interest is in arrears or principal is not paid as per due date, shall not be allowed to be set-off against appreciation against other debentures/ bonds.

Where the debenture/bond is quoted and there have been transactions within 15 days prior to the valuation date, the value adopted should not be higher than the rate at which the transaction is recorded on the stock exchange.

25) The valuation of preference shares should be on YTM basis. The preference shares will be issued by companies with different ratings. These will be valued with appropriate mark-up over the YTM rates for Central Government securities put up by the PDAI / FIMMDA periodically. The mark-up will be graded according to the ratings assigned to the preference shares by the rating agencies subject to the following:

a) The YTM rate should not be lower than the coupon rate/ YTM for a GOI loan of equal maturity.

b) The rate used for the YTM for unrated preference shares should not be less than the rate applicable to rated preference shares of equivalent maturity. The mark-up for the unrated preference shares should appropriately reflect the credit risk borne by the FI.

c) Investments in preference shares as part of the project finance may be valued at par for a period of two years after commencement of production or five years after subscription whichever is earlier.

d) Where investment in preference shares is as part of rehabilitation, the YTM rate should not be lower than 1.5% above the coupon rate/ YTM for GOI loan of equal maturity.

e) Where preference dividends are in arrears, no credit should be taken for accrued dividends and the value determined on YTM should be discounted by at least 15% if arrears are for one year, and more if arrears are for more than one year. The depreciation/ provision requirement arrived at in the above manner in respect of non-performing shares where dividends are in arrears shall not be allowed to be set-off against appreciation against other preference shares.

f) The preference share should not be valued above its redemption value.

g)When a preference share has been traded on stock exchange within 15 days prior to the valuation date, the value should not be higher than the price at which the share was traded.

26) (i) Investment in equity shares as part of the project finance may be valued at cost for a period of two years after commencement of production or five years after subscription whichever is earlier.

(ii) In respect of other investments in equity shares valuation may be done as per the market value which would be the market price of the script as available from the trades / quotes on the stock exchange. Those scripts for which current quotations are not available or where the shares are not quoted on Stock Exchange, should be valued at break-up value (without considering revaluation reserves, if any) which is to be ascertained from the company's latest balance sheet (which should not be more than one year prior to the date of valuation). In case the latest balance sheet is not available the shares are to be valued at rupee one per company.

27) Investment in quoted Mutual Fund Units should be valued as per Stock Exchange quotations. Investment in non-quoted Mutual Fund Units is to be valued on the basis of the latest re-purchase price declared by the Mutual Fund in respect of each particular Scheme. In case of funds with a lock-in period, where repurchase price/ market quote is not available, Units could be valued at NAV. If NAV is not available, then these could be valued at cost, till the end of the lock-in period. Wherever the re-purchase price is not available the Units could be valued at the NAV of the respective scheme.

28) Commercial paper should be valued at the carrying cost.