Investment Fluctuation Reserve (IFR), Market Risk & Investment Reserve Account (IRA)
The RBI’s Master Circular specifies the following guidelines with respect to IFR and IRA:
Investment Fluctuation Reserve
(i) Banks were advised to build reserves towards investment fluctuation, of a minimum 5% of the investment portfolio within 5 years period.
(ii) To ensure smooth transition to Basel II norms, banks have been advised to build adequate reserve towards capital charge for market risks in a phased manner over a two year period (a) In respect of securities included in the HFT category, open gold
position limit, open foreign exchange position limit, trading positions in derivatives and derivatives entered into for hedging trading book exposures by March 31, 2005; and
(b) In respect of securities included in the AFS category by March 31, 2006.
(iii) As advised by RBI in October, 2005, Banks maintaining capital of at least 9 per cent of the risk weighted assets for both credit risk and market risks for both HFT (of items – open gold position limit, open foreign exchange position limit, trading positions in derivatives and derivatives entered into for hedging trading book exposures) and AFS category as on March 31, 2006 may treat the entire balance of IFR as Tier I capital, may transfer the balance in the IFR ‘below the line’ in the Profit & Loss Appropriation account to statutory reserve, general reserve or balance of Profit and Loss Account.
Investment Reserve Account
(iv) Provisions created for depreciation on investments in the AFS and HFT categories if found excessive should be credited to the Profit & Loss Account and equivalent amount (net of taxes, if any and net of transfer to Statutory Reserve as applicable to such excess provision) should be appropriated to an Investment Reserve Account in Schedule 2 – “Reserves and Surplus” under the head “Revenue and Other Reserves” and would be eligible for inclusion under Tier II within the overall ceiling of 1.25% of total risk weighted assets prescribed for general provisions/ Loss Reserves.
(v) The Investment Reserve Account can be utilised in the manner prescribed in the Master Circular.
(vi) The amounts debited to the Profit & Loss Account for provision should be debited under the head “Expenditure – Provisions & Contingencies”. The amount transferred from the Investment Reserve Account to the Profit & Loss Account should be shown as “below the line” item in the Profit and Loss Appropriation Account after determining the profit for the year. Provision towards any erosion in the value of an asset is an item of charge on the profit and loss account and hence should appear in that account before arriiving at the profit for the accounting period. Adoption of the following would not only be adoption of a wrong accounting principle but would, also result in a wrong statement of the profit for the accounting period:
(a) the provision is allowed to be adjusted directly against an item of reserve without being shown in the profit and loss account,or
(b) a bank is allowed to draw down from the Investment Reserve Account before arriving at the profit for the accounting period (i.e., above the line), or
(c) a bank is allowed to make provisions for depreciation on investment as a below the line item, after arriving at the profit for the period, Hence none of the above options are permissible.
(vii) The withdrawal from the Investment Reserve Account cannot be used for dividend declaration. Dividends should be payable only out of current year’s profit. However, the balance in the Investment Reserve Accounttransferred ‘below the line’ in the Profit and Loss Appropriation Account to Statutory Reserve, General Reserve or balance of Profit & Loss Account would be eligible to be reckoned as Tier I capital.
The auditor should also examine whether the bank, as required by the RBI, is maintaining separate accounts for the investments made by it on its own Investment Account, on PMS clients’ account, and on behalf of other constituents (including brokers). As per the RBI guidelines, banks are required to get their investments under PMS separately audited by external auditors. The auditor should review the report of such external auditors, if available, and check whether the discrepancies pointed out in the report have been adequately dealt with. The auditor should also verify that PMS transactions are carried out through a separate SGL account, and that there is no switching between the bank’s own investment account and PMS clients’ account except in accordance with the guidelines laid down by the RBI in this regard.
Investments should not normally be held by any other person (as laid down in the City Equitable Fire Insurance Co. case). If any investments are so held, proper enquiry should be made to ensure that there is some justification for it, e.g., shares may be held by brokers for the purpose of transfer or splitting-up etc. Shares may also be lodged with the companies concerned for transfer etc. When investments are held by any other person on behalf of the bank, the auditor should obtain a certificate from him. The certificate should state the reason for holding the investment (e.g., in safe custody or as security). The receipt originally issued by such person while taking delivery of the investment is not adequate for audit purposes. In the case of inscribed stock also, a certificate should be obtained which should certify the holding of the bank as at the date of the balance sheet.
Where securities lodged for transfer have not been received back within a reasonable period, or where share certificates, etc., have not been received within a reasonable period of the lodging of the allotment advice, the auditor should examine whether adequate follow-up action has been taken. He may, in appropriate cases, also enquire from the issuers, or their registrars, about the reasons for the delay. In cases where the issuer/registrar has refused to register the transfer of securities in the name of the bank, the auditor should examine the validity of the title of the bank over such securities.
If certain securities are held in the names of nominees, the auditor should examine whether there are proper transfer deeds signed by the holders and also an undertaking from them that they hold the securities on behalf of the bank. The auditor may also check compliance with Section 89 of the Companies Act, 2013 – Declaration in respect of beneficial interest in any share.
While examining the investment portfolio, the auditor should pay special attention to securities whose maturity dates have already expired. It is possible that income on such investments may also not have been received. In case the amount of such investments or the income accrued thereon is material, the auditor should seek an explanation from the management on this aspect. They should also consider whether the income accrued requires reversal as also whether any provision for loss in respect of such investments is required. Similarly, where income on any security is long overdue, the auditor should consider whether provision is required in respect of such income accrued earlier.
The auditor should check whether the overdue amount in respect of matured investment is disclosed as Investment or other assets. Since the investments had already matured, the overdue amount should be disclosed as Other Assets and not Investments.