Master Direction - Classification, Valuation and Operation of Investment Portfolio of Commercial Banks (Directions), 2023

 

 

Updates on RBI’s investment valuation update and our system preparedness.

Introduction:

On September 12, 2023, the Reserve Bank of India (RBI) issued a new circular to all commercial banks (excluding Regional Rural Banks) regarding the Master Direction - Classification, Valuation and Operation of Investment Portfolio of Commercial Banks (Directions), 2023. The circular emphasised the importance of having a well-structured investment policy for effective portfolio management.

 The directions are expected to improve the quality of banks' financial reporting, enhance disclosures, boost the corporate bond market, simplify the use of derivatives for hedging, and strengthen the overall risk management framework of banks.

One of the important changes includes the creation of a new category called FVTPL (HFT shall be a separate investment subcategory within FVTPL). This is due to significant developments in global standards for the classification, measurement, and valuation of investments. The new category provides a clear roadmap for achieving investment objectives, including updates and reviews, and aligning financial goals with global standards for investment classification, measurement, and valuation.

The updated guidelines consist of a principle-based approach to categorizing investment portfolios. There are also stricter rules surrounding transfers to and from the held to maturity (HTM) category, as well as sales out of HTM. Additionally, non-SLR (statutory liquidity ratio) securities may now be included in HTM, provided certain conditions are met, and gains and losses will be recognized symmetrically.

  UpDebts.com

At UpDebt, we've already made changes to our system to accommodate new risk measure parameters and created a new FVTPL category. This means that our clients are ready well in advance of the April 1st, 2024, implementation date, avoiding last-minute preparations and rush.

 The circular reinstates the old procedure as well as some new parameters to follow, important

objectives of the portfolio, such as capital preservation, income generation, or capital appreciation.

 The changing area at the portfolio CONSTRUCTION LEVEL.

1.       Risk Management plays an important role now with Risk Tolerance measures which determine the organization's risk tolerance and risk appetite.

2.       Entry-Level Minimum Credit Ratings/Quality Standards: Specify minimum credit ratings or quality standards for assets within the portfolio. These ratings should be industry-specific if applicable.

3.       Industry-wise Risk: Identify and manage risks associated with specific industries within the portfolio.

4.       Maturity-wise Risk: Set guidelines for the maturity profile of investments, considering short-term and long-term needs.

5.       Duration-wise Risk: Define duration limits to manage interest rate risk.

6.       Issuer-wise Risk: Establish limits on exposure to specific issuers to diversify credit risk.

 

The changes at the portfolio MANAGEMENT LEVEL

 ·         Risk Management Systems expertise ensures in-house expertise in investment management, risk assessment, and compliance with regulatory requirements.

·         Risk Monitoring: Implement a robust risk monitoring system that includes ongoing assessment of portfolio risk factors and timely adjustments when necessary. Which falls under the Investment Committee with the roll of Define the responsibilities and composition of the Investment Committee, which should oversee the implementation of the investment policy.

·         Decision-Making Process: Detail the decision-making process for approving investment proposals and any exceptions to the policy.

 The changes at the portfolio REPORTING LEVEL

The second important process is Valuation and Reporting:

·         Valuation Guidelines: Outline the methodology for valuing portfolio assets, which should be in accordance with industry standards or regulatory requirements.

·         Reporting Systems: Specify the frequency and content of investment portfolio reports to ensure transparency and accountability. Which include and highlight Prudential Limits:

·         Investment Limits: Set prudential limits on asset allocation, issuer exposure, and other relevant parameters to maintain a diversified portfolio.

·         Concentration Risk: Address concentration risk by establishing maximum exposure limits for specific assets or sectors.

 Additionally, the new system requires internal credit analysis. Describe the process for conducting credit assessment and due diligence on potential investments.

In conclusion, a well-structured investment policy is essential for effective portfolio management reviews and updates are crucial to ensure the policy remains relevant and aligned with the organization's financial goals.

To adhere to the new regulations, extensive modifications need to be made within the bank's infrastructure as well as externally at the service provider level. As a service provider at UpDebt, we possess the necessary expertise, and our system is fully equipped to handle any additional requirements.