Banks are required to build up of adequate reserves for mark to market (MTM) losses on investments held in AFS and HFT with effect from the year 2018-19. The provisioning for each of these quarters may be spread equally over up to four quarters, commencing with the quarter in which the loss is incurred.
The provisioning amount shall not be less than the lower of the following as per RBI guidelines:(a) net profit on sale of investments during the year (b) net profit for the year less mandatory appropriations.
The amounts debited to the P&L Account for provision is debited under the head ‘Expenditure – Provisions & Contingencies’. The amount shall be transferred to the IFR, until the amount of IFR is at least 2 percent of the HFT and AFS portfolio, on a continuing basis. Where feasible, this should be achieved within a period of 3 years.
How it works?
The annual provision requirement on account of depreciation in the AFS and HFT categories shall be debited to the P&L Account and an equivalent amount (net of tax benefit, if any, and net of consequent reduction in the transfer to Statutory Reserve), may be transferred from the IRA to the P&L Account.
To understand the above in a better way we explain here with below example.
A bank has incurred Rs.200000/- mark to market (MTM) losses on investments of Rs.1000000/-held in Held for Trading (HFT).
In this case bank will debit Rs.200000/- to the P&L Account under the head ‘Expenditure – Provisions & Contingencies’ and credit to Investment account. In this manner the investment will come down to Rs.800000 => (Rs.1000000-200000). Then Rs.200000/- will be debited IFR account and credited to P&L account.
A bank may, at its discretion, draw down the balance available in IFR in excess of 2 percent of its HFT and AFS portfolio, for credit to the balance of profit/loss as disclosed in the profit and loss account at the end of any accounting year. In the event the balance in the IFR is less than 2 percent of the HFT and AFS investment portfolio, a draw down will be permitted subject to the following conditions:
(a) The drawn down amount is used only for meeting the minimum CET1/Tier 1 capital requirements by way of appropriation to free reserves or reducing the balance of loss, and
(b) The amount drawn down is not more than the extent the MTM provisions made during the aforesaid year exceeds the net profit on sale of investments during that year.
The amount transferred from IFR to P &L will be shown ‘below the line’ of Profit and loss account. The balance in the IFR which is transferred ‘below the line’ in the Profit and Loss Appropriation Account to Statutory Reserve, General Reserve or balance of Profit & Loss Account which would be eligible to be reckoned as Tier I capital.