Investment Portfolio of Banks
All commercial banks invest. What they do is that they take the money received from the regular banking transactions and put them in investments. To manage the funds properly they need an investment portfolio so which allows them to utilize the funds in an effective manner and also generate enough profits. The investments made by the bank are structured around objectives and goals of the bank in general.
Looking at these points we may classify the banks need to maintain an investment portfolio into the following categories. We also look at how the banks mange them. Investment portfolio of banks contains:
-Investments held in Maturity
-Investments available for sale
-And investments held for trading
But, in the balance sheet the investments will be classified under the following 6 categories
- Government securities
- Other approved securities
- Debentures and bonds
- Subsidiaries and joint venture
- Mutual fund units etc
Banks take the decision of where to invest at the time of acquisition of the investment.
Let’s look at these in detail:
- Investment held till maturity
These contain the investments acquired with intent to hold up to maturity. Up to 25% of all bank investments can to HTM. Some investments which can be counted under HTM but are not counted in 25% are Re-capitalisation bonds received by government. Re-capitalisation bonds of other banks will not be included. Investment in subsidiaries and joint ventures and also long term bonds with a minimum maturity of 7 years issued by infrastructure companies will not be counted. Post that, banks can continue classifying the investment under HTM category even if residual maturity falls below 7 %.
Banks can exceed 25% in these conditions:
-The investments over the 25% are SLR securities.
-Or the SLR securities does not exceed 24.50% by June 2013, 24% by September 2013, 23.50% by December 2013, 23% by march end of their demand and time liabilities as on Friday of preceding fortnight.
Banks can hold the following securities
- SLR up to 25% of DTL
- Non-SLR including HTM as on September 2 2004.
- Re-capitalization bonds by government of India towards re-capitalization requirement.
- Fresh investment in Subsidiaries and joint ventures.
- RIDF, SIDBI, RHDF deposits
- Investment in log term bonds (7yrs maturity) by infrastructure companies.
- Investments for Sale and securities held in Trading
- Taking advantage of short-term price movements when banks intend to trade securities they are called held for trading securities (HFT).
- Other securities, apart from the above 2 are called available for sale (AFS).
- Banks have freedom of deciding on the extent of holdings under both these categories, HFT and AFS.
- Banks consider intent, trading strategies, risk management, tax planning etc to decide the same.
- When banks expect to gain by rise and fall in interest rates or market rates they classify investments under HFT.
- These securities can be sold within 90 days from day of purchase.
- Profit and loss on sale of investments in both categories is taken to the profit and loss account.
MOVING AMONG CLASSIFICATIONS
- i) Banks may move speculations to/from HTM with the endorsement of the Top managerial staff once a year. Such moving will regularly be permitted toward the start of the bookkeeping year. No further moving to/from HTM will be permitted amid the remaining piece of that bookkeeping year. In any case, so as to empower banks to move their SLR securities from the HTM classification to AFS/ HFT once in each one, it has been chosen to permit such moving toward the start of each one quarter amid 2013-14.
- ii) If the estimation of offers and exchanges of securities to/from HTM class surpasses 5 every penny of the book estimation of speculations held in HTM classification toward the start of the year, banks ought to unveil the business sector estimation of the ventures held in the HTM classification and show the overabundance of book esteem over business sector esteem for which procurement is not made. This divulgence is obliged to be made in ‘Notes to Accounts’ in banks’ evaluated Yearly Monetary Proclamations.
iii) Banks may move ventures from AFS to HFT with the endorsement of their Top managerial staff/ ALCO/ Speculation Board of trustees. If there should arise an occurrence of exigencies, such moving may be finished with the approbation of the CEO of the bank/Leader of the ALCO, yet ought to be endorsed by the Governing body/ ALCO.
The three objectives of portfolio management which a commercial or other bank should follow follows: liquidity, safety and income. These banks could follow all three objectives or may sacrifice one to increase the other.
A business bank needs a higher level of liquidity in its advantages. The benefits that can be transformed into prepared money may be of imperativeness to the bank. A bank must strike a harmony between the gainfulness and liquidity as though it tries to keep more liquidity the bank’s benefits may endure and the other way around. There are likewise various confinements put in through regulations that farthest point the span of benefits a bank can gain. Various sorts of benefits are accessible to a manage an account with diverse measures of liquidity.
1.) The most imperative is cash accessible in real money.
2.) Next comes the stores with the national bank, treasury bills and other fleeting bills issues by the focal and state governments and substantial firms
3.) Call advances other business banks or merchants in government securities.
The lesser fluid resources are the advances that the bank gives to its buyers, which can’t be changed over into money at interest. The accessibility of speculations and the expense of acquiring deal with the bank’s capacity to convey fluid resources. On the off chance that it can acquire sums whenever without trouble easily (investment rate), it will evacuate all fluid resources. Anyhow on the off chance that it is not certain if to acquire trusts or the expense of getting is high, the bank will keep more fluid resources in its portfolio.
- Safety:The commercial banks or banks in general need to operate under conditions of uncertainty and risk. As they are uncertain about the cost of borrowings and income in the future. It also faces the risk of a consumer not paying back its debt along with interest in time, or the market risk where the debt it owes to other entities may face interest payment increase.
Due to these risks present in the operation of banks, the bank needs to maintain the safety of assets. Also it cannot take large risks as it is prohibited by law. Also, it cannot only invest in safety assets as that will not allow the bank to grow and ascertain more credit. It is important that the bank estimates risk and maintains a balance between safety investments and risk investments, while also considering short and long run gains and losses.
The principle objectives of a bank are to earn more profit. It is essential to earn profit in order to meet the operational requirement of funds as well as the payment of interest and loans. However, it cannot afford to keep lots of cash in its coffers. This would mean that the bank is not investing and therefore foregoing an opportunity to earn.
But the conflict between profitability and liquidity may not be very sharp. Liquidity and safety are primary considerations are profitability is subsidiary for the very existence of banks depends on the first two.
Looking at the considerations above the bank may want to invest in the type of investments below.
Non SLR Securities.
Central & State Government Securities
these are securities by the Government for raising an open credit or as advised in the authority Gazette. They comprise of Government Promissory Notes, its Bearer Bonds, Stocks or Bonds held in Bond Ledger Account, and can be as Treasury Bills or Dated Government Securities.
The RBI holds occasional open barters for G-Secs, State Development Loans & T-Bills. SBI DFHI Ltd. is a main Primary Dealer in Government Securities.
The banks consider them as a safe speculation as they are given by the Government and danger identified with them is insignificant. Additionally there is sure measure of liquidity connected to these in light of the fact that they are promptly sellable in the business.
Other Approved Securities
AS per the regulation of the RBI, other approved securities will be valued using the YTM method and over and above 25 basis points of government security.
These are the budgetary instruments issued by corporate or the Government which permit them to acquire cash from the business sector. Banks put resources into these ties or debentures as they can return an extraordinary benefit inside a short compass of time by putting resources into mass. On the other hand, there is no security in these as they are issued by corporate and subject to the benefits the eventual fate of the securities in decided. According to RBI rules these are to be esteemed on a YTM premise.
The debentures and obligations of diverse organizations have distinctive appraisals, and may be esteemed over the legislature securities by 25 premise focuses. This is not a fluid speculation.
Banks likewise like to give the corporate credits as opposed to purchasing the securities as there is more security and conviction in the reimbursement of advances.
Banks hold the investment in preference shares issued by the organization conducting an IPO. The preference shares are usually sold to big investors, which include banks. The banks help the organizations by buying these preference shares. The bank benefits by gaining assets of the organization. While a certain amount of safety also is attributed with preference shares as the preference share holder gets an advantage if the company is dissolved. It is also a liquid investment at most times if the company whose shares are bought is doing well in the market.
These are also rated by the rating agencies and the bank could decide whether to go for the investment or not. The banks also receive preferred dividends i.e. when the dividend is declared the banks are the first ones to receive it. The valuation of preference shares is controlled by the RBI guidelines. These include:
- The rate of YTM should not be more than the GOI securities.
- The rate of YTM should be decided as per the rating of the shares. The unrated preference shares should be bought at the same rate as the rated shares.
The equity shares in which the banks invest in is the same as the equity shares traded on the market. Since the bank has huge funds at its disposal it can but a large number of shares. These are valued at a daily basis depending on the price in the stock indices. When the shares are bought the banks become owners in the assets of the company and therefore it is considered a safe investment.
When the stock prices are rising the banks have a chance to go in for a profit and sell the shares but the banks try to take them as long term liquid investments and prefer to hold them.
The shared trusts are turning into a real piece of the speculation arrangement of banks. Banks who have their own common stores may contribute their stores through these shared trusts. This gives a settled salary separated from giving a safe venture. While not fluid, the stores give a stable pay to the banks.
The legislature and RBI likewise sways the banks to be more members in the shared store market which permits individuals to additionally be a piece of the venture situation of the nation.
Interest in Mutual trust Units ought to be esteemed according to Stock Exchange citations, or are esteemed according to the most recent repurchase costs of the store.
All in all, we see that banks put resources into different sorts of instruments for distinctive reasons like to keep up the liquidity, security and productivity in the business sector and how the national bank has provided for a few rules on the venture arrangement of banks. Through this we can figure out how really the banks utilize the stores as a part of its records to viably put and make its vicinity in the business sector felt.
-Mirza Farhan and Pradnya (XIMB Batch 16)