Important Terms of Investments
The following are some of the terms, which are commonly used in relation to investments of banks.
Approved Securities
Section 5(a) of the Banking Regulation Act, 1949 defines ‘approved securities’ to mean securities in which a trustee may invest money under clauses (a) to (d) and (f) of section 20 of the Indian Trusts Act, 1882. Approved securities comprise primarily the securities issued or guaranteed by the Central or State Government, or any other security expressly authorised by the Central Government by notification in the official gazette.
Prudential Exposure Limits
As per RBI guidelines banks cannot participate in the equity of financial services ventures including stock exchanges, depositories, etc., without obtaining the prior specific approval of the Reserve Bank of India, notwithstanding the fact that such investments may be within the ceiling prescribed under Section 19(2) of the Banking Regulation Act. RBI has (vide its Circular no. DBR.No.FSD.BC.37/24.01.001/2015-16 dated September, 2015) permitted banks which have CRAR of 10 per cent or more and have also made net profit as of March 31 of the previous year that they need not approach RBI for prior approval for equity investments in cases where after such investment, the holding of the bank remains less than 10 per cent of the investee company’s paid up capital, and the holding of the bank, along with its subsidiaries or joint ventures or entities continues to remain less than 20 per cent of the investee company’s paid up capital. Financial Services Companies have been defined in Annex I to the Master Circular DBR.No.FSD.BC.19/ 24.01.001/2015-16 dated July 1, 2015. The investment will continue to be subject to prudential limits as mentioned in Para 3.1 (a) and (c) of Master Circular DBR.No.FSD.BC.19/24.01.001/2015-16 on ‘Para-banking Activities’ dated July 1, 2015.
The auditor needs to check compliance with above mentioned circulars, while auditing the treasury operations of the bank.
Subsidiary General Ledger (SGL)
This is a ledger maintained by the Public Debt Office (PDO) of RBI in which accounts of different banks are maintained regarding their holding of Government securities.
Repo and Reverse Repo Transaction
Repo and Reverse Repo is a one of the mechanisms of lending and borrowing, wherein Repo means borrowing of money (against placing of Government security as collateral) and Reverse Repo means lending of money (against receipt of Government security as collateral) at a transaction value equivalent to the market rate of the security as on the date on which the transaction is made, at an agreed rate of interest and tenure. The underlying security though transferred from one beneficiary to other counter party, the risk/rewards related to such underlying security remains with the lender of the security.
RBI has banks allowed to undertake repo in corporate debt securities and issued ‘Repo in Corporate Debt Securities (Reserve Bank) Directions, 2015’ on 3rd February 2015.
RBI vide its circular no. RBI/2015-2016/403 FMRD.DIRD. 10 /14.03.002/2015- 16 dated 19th May, 2016 on “Repo/Reverse Repo Transactions with RBI” (effective from 3rd October 2016) has decided to: (a) align the accounting norms to be followed by market participants for repo/reverse repo transactions under LAF and the Marginal Standing Facility (MSF) of RBI with the accounting guidelines prescribed for market repo transactions.
Accordingly, all repo/ reverse transactions are required to be accounted as lending and borrowing transactions with effect from 3rd October 2016. Banks shall classify the balances in Repo A/c under Schedule 4 (Borrowing). Similarly, the balances in Reverse Repo A/c shall be classified under Schedule 7 (Balances with banks and money at call and short notice). The balances in Repo interest expenditure A/c and Reverse Repo interest income A/c shall be classified under Schedule 15 (Interest expended) and under Schedule 13 (Interest earned) respectively.
RBI vide notification RBI/2016-2017/156 FMOD.MAOG No. 117/01.01.001/2016-17 dated November 25, 2016 has decided that the Oil Bonds issued by GOI will qualify as eligible securities for Repos, Reverse Repos and MSF, on E-Kuber system.
In terms of RBI notification no. RBI/2016-17/49 FMRD.DIRD.6/14.03.002/2016- 17 dated August 25, 2016, repo transactions are now allowed between the permitted entities, namely, (a) SGL A/c holders; (b) A SGL A/c holder and its own gilt account holder (GAH); (c) A SGL A/c holder and a GAH under another custodian; (d) GAHs under the same custodian; and (e) GAHs under two different custodians, subject to the conditions as specified in the said notification.
Short Sale
Short Sales is defined as sale of securities which one does not own, i.e., selling of a security without possessing stock of such securities. A bank can also undertake ‘notional short sale’ wherein it can sell a security short from HFT even though the stock of said security is held under HFT / AFS / HTM category. Thus, short sales include actual as well as ‘notional’ short sale. A short sale can be undertaken by the bank subject to certain conditions as stipulated by RBI and within specified limits. Securities which are sold short are invariably required to be delivered on the settlement. A bank may meet the delivery obligation for a security sold short, by utilising the securities acquired under ‘reverse repo’ mechanism (except under RBI’s Liquidity Adjustment. Facility). Even though reverse repos can be rolled over, short sale position needs to be covered within a maximum period of three months including day of trade.
STRIPS
STRIP is the acronym for “Separate Trading of Registered Interest and Principal Securities”. Stripping is the process of separating a standard coupon-bearing bond into its individual coupon and principal components. For example, a 5 year coupon bearing bond can be stripped into 10 coupons and one principal instrument, all of which henceforth would become zero coupon bonds.
When Issued Securities
When, as and if issued’ (commonly known as ‘when-issued’ (WI)) security refers to a security that has been authorized for issuance but not yet actually issued. ‘WI’ trading takes place between the time a new issue is announced and the time it is actually issued. All ‘when issued’ transactions are on an ‘if’ basis, to be settled if and when the actual security is issued. The NDS-OM members have been permitted to transact on ‘When Issued’ basis in Central Government dated securities, subject to the guidelines of RBI.
Certificate of Deposit (CD)
It is a negotiable money market instrument and issued in dematerialized form or as a Usance Promissory Note against funds deposit at a bank or eligible Financial Institution for a specified time period. CDs can be issued by a bank with a maturity period which is not less than 7 days and not more than one year, from the date of issue and should have a minimum deposit size from a single subscriber not less than Rs. 1 lakh. CDs may be issued at a discount to face value or at a fixed / floating coupon rate.
Banks have to maintain appropriate reserve requirements, i.e., CRR and SLR, on the issue price of the CDs. There is no lock-in period for the CDs. Though, NRIs may also subscribe to CDs (but only on non-repatriable basis), such CDs cannot be endorsed to another NRI in the secondary market. Banks/FIs may account the issue price under the Head “CDs issued” and show it under deposits. Accounting entries towards discount will be made as in the case of “Cash Certificates”. Commercial Paper (CP)
It is an unsecured money market instrument issued in the form of a promissory note by Corporates, PDs, FIs subject to compliance with the case of “Cash Certificates”
Commercial Paper (CP)
It is an unsecured money market instrument issued in the form of a promissory note by Corporates, PDs, FIs subject to compliance with the guidelines issued by RBI. The tenure of CP should not be less than 7 days and not more than one year, from the date of issue.
Options (Call/Put) are not permitted on CP. Also, underwriting or coacceptance to the issue of CP is not allowed. The minimum credit rating shall be ‘A3’ as per rating symbol and definition prescribed by SEBI, which should be ensured by the issuers.