RBI No. 2004-05/ 51 DBOD No. BP. BC. 11 / 21.04.141 / 2004-05 DT.17/07/2004

Master Circular-Prudential norms for classification,valuation and operation of investment portfolio by banks

Please refer to the Master Circular No. DBOD. BP. BC. 21/ 21.04.141/ 2002-03dated September 2, 2003 consolidating instructions/ guidelines issued to banks till 30June 2003 on matters relating to prudential norms for classification, valuation andoperation of investment portfolio by banks. The Master Circular has been suitablyupdated by incorporating instructions issued up to 30 June 2004 and has also beenplaced on the RBI web-site (http://www.rbi.org.in).

2. It may be noted that all relevant instructions on the above subject contained incirculars listed in the Appendix have been consolidated. We advise that this revisedMaster Circular supercedes the instructions contained in these circulars issued bythe RBI.

Yours faithfully,

sd/-

(C R Muralidharan)
Chief General Manager-in-Charge

Encls: As above

MASTER CIRCULAR-PRUDENTIAL NORMS FOR CLASSIFICATION, VALUATION AND OPERATION OF INVESTMENT PORTFOLIO BY BANKS1. Introduction

With the introduction of prudential norms on capital adequacy, income recognition, asset classificationand provisioning requirements, the financial position of banks in India has improved in the last fewyears. Simultaneously, trading in securities market has improved in terms of turnover and the range ofmaturities dealt with. In view of these developments and taking into consideration the evolvinginternational practices, Reserve Bank of India has issued guidelines on classification, valuation andoperation of investment portfolio by banks from time to time as detailed below:

1.2 Investment Policy

i) Banks should frame and implement a suitable investment policy to ensure that operations insecurities are conducted in accordance with sound and acceptable business practices. Whileframing the investment policy, the following guidelines are to be kept in view by the banks;

(a) No sale transaction should be put through without actually holding the security in itsinvestment account i.e. under no circumstances, banks should hold an oversold position in anysecurity. However, banks may sell a government security already contracted for purchase,provided:

i. the purchase contract is confirmed prior to the sale,

ii. the purchase contract is guaranteed by CCIL or the security is contracted for purchasefrom the Reserve Bank and,

iii. the sale transaction will settle either in the same settlement cycle as the preceding purchase contract, or in a subsequent settlement cycle so that the delivery obligation under the sale contract is met by the securities acquired under the purchase contract (e.g. when a security is purchased on T+0 basis, it can be sold on either T+0 or T+1 basis on the day of the purchase; if however it is purchased on T+1 basis, it can be sold on T+1 basis on the day of purchase or on T+0 or T+1 basis on the next day).

For purchase of securities from the Reserve Bank through Open Market Operations(OMO), no sale transactions should be contracted prior to receiving the confirmation ofthe deal/advice of allotment from the Reserve Bank.

Banks should exercise abundant caution to ensure adherence to these guidelines. Theconcurrent auditors should specifically verify the compliance with these instructions.The concurrent audit reports should contain specific observations on the compliancewith the above instructions and should be incorporated in the monthly report to theChairman and Managing Director/Chief Executive Officer of the bank and the halfyearly review to be placed before the Board of Directors. CCIL will make available to allmarket participants as part of its daily reports, the time stamp of all transactions asreceived from NDS. The mid office/back office and the auditors may use thisinformation to supplement their checks/scrutiny of transactions for compliance with theinstructions. Any violation noticed in this regard should immediately be reported to theconcerned regulatory department of the Reserve Bank and the Public Debt Office(PDO), Reserve Bank of India, Mumbai. Any violation noticed in this regard wouldattract penalties as currently applicable to the bouncing of Subsidiary General Ledger(SGL) forms even if the deal has been settled because of the netting benefit under DVPIII, besides attracting further regulatory action as deemed necessary.

(b) Banks successful in the auction of primary issue of government securities, may enter intocontracts for sale of the allotted securities in accordance with the terms and conditionsas per Annexure - I

(c) All the transactions put through by a bank, either on outright basis or ready forwardbasis and whether through the mechanism of Subsidiary General Ledger (SGL)Account or Bank Receipt (BR), should be reflected on the same day in its investmentaccount and, accordingly, for SLR purpose wherever applicable.

(d) The brokerage on the deal payable to the broker, if any, (if the deal was put throughwith the help of a broker) should be clearly indicated on the notes/ memoranda put upto the top management seeking approval for putting through the transaction and aseparate account of brokerage paid, broker-wise, should be maintained.

(e) For issue of BRs, the banks should adopt the format prescribed by the Indian Banks'Association (IBA) and strictly follow the guidelines prescribed by them in this regard.The banks, subject to the above, could issue BRs covering their own sale transactionsonly and should not issue BRs on behalf of their constituents, including brokers.

(f) The banks should be circumspect while acting as agents of their broker clients forcarrying out transactions in securities on behalf of brokers.

(g) Any instance of return of SGL form from the Public Debt Office of the Reserve Bank forwant of sufficient balance in the account should be immediately brought to ReserveBank's notice with the details of the transactions.

(h) Banks desirous of making investment in equity shares / debentures should observe thefollowing guidelines:

i. Build up adequate expertise in equity research by establishing a dedicatedequity research department, as warranted by their scale of operations;

ii. Formulate a transparent policy and procedure for investment in shares, etc.,with the approval of the Board.

iii. The decision in regard to direct investment in shares, convertible bonds and debentures should be taken by the Investment Committee set up by the bank’s Board. The Investment Committee should be held accountable for the investments made by the bank.

ii) With the approval of respective Boards, banks should clearly lay down the broad investment objectives to be followed while undertaking transactions in securities on their own investment account and on behalf of clients, clearly define the authority to put through deals, procedure to be followed for obtaining the sanction of the appropriate authority, procedure to be followed while putting through deals, various prudential exposure limits and the reporting system. While laying down such investment policy guidelines, banks should strictly observe Reserve Bank's detailed instructions on the following aspects:

(a) Ready Forward (buy back) deals (Paragraph 1.2.1)

(b) Transactions through Subsidiary General Ledger A/c (Paragraph 1.2.2)

(c) Use of Bank Receipts (Paragraph 1.2.3)

(d) Retailing of Government securities (Paragraph 1.2.4)

(e) Internal Control System (Paragraph 1.2.5)

(f) Dealings through Brokers (Paragraph 1.2.6)

(g) Audit, Review and Reporting (Paragraph 1.2.7)

(h) Non- SLR investments (Paragraph 1.2.8)

iii) A copy of the Internal Investment Policy Guidelines, duly framed by the bank with theapproval of its Board, should be forwarded to the Reserve Bank (if not already done) certifying thatthe same is in accordance with the RBI guidelines and that, the same has been put in place.

iv) The aforesaid instructions will be applicable mutatis mutandis, to the subsidiaries and mutualfunds established by banks, except where they are contrary to or inconsistent with, specificregulations of Securities and Exchange Board of India and Reserve Bank of India governing theiroperations.

1.2.1. Ready Forward Contracts in Government Securities.

(i) In terms of the notification No. S.O. 131(E) dated January 22, 2003 issued by Reserve Bank of Indiaunder powers derived under Section 29A of the Securities Contracts (Regulation) Act (SCRA), 1956,the terms and conditions subject to which ready forward contracts (including reverse ready forwardcontracts) may be entered into, are as under:

(a) Ready forward contracts may be undertaken only in (i) Dated Securities and Treasury Billsissued by Government of India and (ii) Dated Securities issued by State Governments.

(b) Ready forward contracts in the above mentioned securities may be entered into by:

i) persons or entities maintaining a Subsidiary General Ledger (SGL) account with Reserve Bank of India, Mumbai and

ii) the following categories of entities who do not maintain SGL accounts with the Reserve Bank of India but maintain gilt accounts (i.e gilt account holders) with a bank or any other entity (i.e. the custodian) permitted by the Reserve Bank of India to maintain Constituent Subsidiary General Ledger (CSGL) account with its Public Debt Office, Mumbai:


a) Any scheduled bank,
b) Any primary dealer authorised by the Reserve Bank of India,
c) Any non-banking financial company registered with the Reserve Bank of India, other than Government companies as defined in Section 617 of the Companies Act, 1956,
d) Any mutual fund registered with the Securities Exchange Board of India,
e) Any housing finance company registered with the National Housing Bank, and
f) Any insurance company registered with the Insurance Regulatory and Development Authority.

(c) All persons or entities specified at (ii) above can enter into ready forward transactions among themselves subject to the following restrictions :

i) An SGL account holder may not enter into a ready forward contract with its own constituent. That is, ready forward contracts should not be undertaken between a custodian and its gilt account holder.

ii) Any two gilt account holders maintaining their gilt accounts with the same custodian (i.e., the CSGL account holder) may not enter into ready forward contracts with each other, and

iii) Cooperative banks may not enter into ready forward contracts with the nonbanking financial companies.

(d) All ready forward contracts shall be reported on the Negotiated Dealing System (NDS). Inrespect of ready forward contracts involving gilt account holders, the custodian (i.e., theCSGL account holder) with whom the gilt accounts are maintained will be responsible forreporting the deals on the NDS on behalf of the constituents (i.e. the gilt account holders).

(e) All ready forward contracts shall be settled through the SGL Account / CSGL Account maintained with the Reserve Bank of India, Mumbai, with the Clearing Corporation of India Ltd. (CCIL) acting as the central counter party for all such ready forward transactions.

(f) The custodians should put in place an effective system of internal control and concurrent audit to ensure that :

i) ready forward transactions are undertaken only against the clear balance of securities in the gilt account,

ii) all such transactions are promptly reported on the NDS, and iii) other terms and conditions referred to above have been complied with.

(g) The RBI regulated entities can undertake ready forward transactions only in securities held in excess of the prescribed Statutory Liquidity Ratio (SLR) requirements.

(h) No sale transaction shall be put through without actually holding the securities in the portfolio by a seller of securities in the first leg of a ready forward transaction.

(i) Securities purchased under the ready forward contracts shall not be sold during the period of the contract.

(ii) The above terms and conditions will be the relevant terms and conditions specified by the Reserve Bank of India under its notification No.S.O.131(E) dated January 22, 2003 issued in exercise of the powers conferred on the Reserve Bank of India under Section 16 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) vide Government of India Notification No.183(E) dated 1st March, 2000, issued under Section 29A of the Act, ibid.

(iii) Prohibition against buy-back arrangements

a) Double ready forward deals in Government securities including treasury bills are strictly prohibited.

b) No ready forward and double ready forward deals should be put through even among banks and even on their investment accounts in other securities such as public sector undertakings bonds, units of UTI, etc.

(c) Similarly, no ready forward and double ready forward deals should be entered into in any securities including Government securities, on behalf of other constituents including brokers.

(iv) The guidelines for uniform accounting for Repo / Reverse Repo transactions are furnished in Paragraph 4.

1.2.2 Transactions through SGL account

The following instructions should be followed by banks for purchase/ sale of securities through SGLA/c under the Delivery Versus Payment (DVP) System wherein the transfer of securities takes placesimultaneously with the transfer of funds. It is, therefore, necessary for both the selling bank and thebuying bank to maintain current account with the RBI. As no Overdraft facility in the current accountwould be extended, adequate balance in current account should be maintained by banks for effectingany purchase transaction.

i) All transactions in Govt. securities for which SGL facility is available should be put through SGL A/cs only.

ii) Under no circumstances, a SGL transfer form issued by a bank in favour of another bank should bounce for want of sufficient balance of securities in the SGL A/c of seller or for want of sufficient balance of funds in the current a/c of the buyer.

iii) The SGL transfer form received by purchasing banks should be deposited in their SGL A/cs.immediately i.e. the date of lodgement of the SGL Form with RBI shall be within one working day afterthe date of signing of the Transfer Form. While in cases of OTC trades, the settlement has to be onlyon ‘spot’ delivery basis as per Section 2(i) of the Securities Contract Act, 1956,in cases of deals onthe recognised Stock Exchanges, settlement should be within the delivery period as per their rules,bye laws and regulations. In all cases, participants must indicate the deal/trade/contract date in Part Cof the SGL Form under 'Sale date'. Where this is not completed the SGL Form will not be acceptedby the Reserve Bank of India (RBI).

iv) No sale should be effected by way of return of SGL form held by the bank.

v) SGL transfer forms should be signed by two authorised officials of the bank whose signatures should be recorded with the respective PDOs of the Reserve Bank and other banks.

vi) The SGL transfer forms should be in the standard format prescribed by the Reserve Bank and printed on semi-security paper of uniform size. They should be serially numbered and there should be a control system in place to account for each SGL form.

vii) If a SGL transfer form bounces for want of sufficient balance in the SGL A/c, the (selling) bank which has issued the form will be liable to the following penal action against it :

a) The amount of the SGL form (cost of purchase paid by the purchaser of the security) would be debited immediately to the current account of the selling bank with the Reserve Bank.

b) In the event of an overdraft arising in the current account following such a debit, penal interest would be charged by the Reserve Bank on the amount of the overdraft at a rate of 3 percentage points above the Discount and Finance House of India's (DFHI) call money lending rate on the day in question. However, if the DFHI's closing call money rate is lower than the prime lending rate of banks, as stipulated in the Reserve Bank's interest rate directive in force, the applicable penal rate to be charged will be 3 percentage points above the prime lending rate of the bank concerned, and

c) If the bouncing of the SGL form occurs thrice, the bank will be debarred from trading with the use of the SGL facility for a period of 6 months from the occurrence of the third bouncing. If, after restoration of the facility, any SGL form of the concerned bank bounces again, the bank will be permanently debarred from the use of the SGL facility in all the PDOs of the Reserve Bank.

d) The bouncing on account of insufficient balance in the current account of the buyingbank would be reckoned (against the buying bank concerned) for the purpose of debarmentfrom the use of SGL facility on par with the bouncing on account of insufficient balance inSGL a/c. of the selling bank (against selling bank). Instances of bouncing in both theaccounts (i.e SGL a/c and current a/c) will be reckoned together against the SGL accountholder concerned for the purpose of debarment (i.e three in a half-year for temporarysuspension and any bouncing after restoration of SGL facility, for permanent debarment.)1.2.3 Use of Bank Receipt (BR)

i) The banks should follow the following instructions for issue of BRs :

(a) No BR should be issued under any circumstances in respect of transactions in Govt. securities for which SGL facility is available.

(b) Even in the case of other securities, BR may be issued for ready transactions only, under the following circumstances:

i. The scrips are yet to be issued by the issuer and the bank is holding the allotment advice.

ii. The security is physically held at a different centre and the bank is in a position to physically transfer the security and give delivery thereof within a short period.

iii. The security has been lodged for transfer / interest payment and the bank is holding necessary records of such lodgements and will be in a position to give physical delivery of the security within a short period.

(c) No BR should be issued on the basis of a BR (of another bank) held by the bank and notransaction should take place on the basis of a mere exchange of BRs held by the bank.(d) BRs could be issued covering transactions relating to banks’ own Investments Accounts only,and no BR should be issued by banks covering transactions relating to either the Accounts ofPortfolio Management Scheme (PMS) Clients or Other Constituents' Accounts, including brokers.

(e) No BR should remain outstanding for more than 15 days.

(f) A BR should be redeemed only by actual delivery of scrips and not by cancellation of thetransaction/set off against another transaction. If a BR is not redeemed by delivery of scrips withinthe validity period of 15 days, the BR should be deemed as dishonoured and the bank which hasissued the BR should refer the case to the RBI, explaining the reasons under which the scripscould not be delivered within the stipulated period and the proposed manner of settlement of thetransaction.

(g) BRs should be issued on semi-security paper, in the standard format (prescribed by IBA),serially numbered and signed by two authorised officials of the bank, whose signatures arerecorded with other banks. As in the case of SGL forms, there should be a control system inplace to account for each BR form.

(h) Separate registers of BRs issued and BRs received should be maintained and arrangementsshould be put in place to ensure that these are systematically followed up and liquidated withinthe stipulated time limit.

(i) The banks should also have a proper system for the custody of unused B.R. Forms and theirutilisation. The existence and operations of these controls at the concerned offices/ departmentsof the bank should be reviewed, among others, by the statutory auditors and a certificate to thiseffect may be forwarded every year to the Regional Office of DBS, under whose jurisdiction theHead Office of the bank is located.

(j) Any violation of the instructions relating to BRs would invite penal action, which could includeraising of reserve requirements, withdrawals of refinance facility from the Reserve Bank anddenial of access to money markets. The Reserve Bank may also levy such other penalty as itmay deem fit in accordance with the provisions of the Banking Regulation Act, 1949.

1.2.4 Retailing of Government Securities

The banks may undertake retailing of Government securities with non-bank clients subject to thefollowing conditions:

i) Such retailing should be on outright basis and there is no restriction on the period between sale and purchase.

ii) The retailing of Government securities should be on the basis of ongoing market rates/ yield curve emerging out of secondary market transactions.

iii) No sale of Government securities should be effected by banks unless they hold the securities

in their portfolio either in the form of physical scrips or in the SGL Account maintained with the Reserve Bank of India.

iv) Immediately on sale, the corresponding amount should be deducted by the bank from its investment account and from its SLR assets.

v) Banks should put in place adequate internal control checks/ mechanisms as indicated in paragraph 1.2.5.

vi) These transactions should be subjected to concurrent audit by internal auditors/ external auditors and results of their audit should be placed before the CMD of the bank every month. These audit reports are also to be submitted to a separately constituted Cell on supervision of funds management operations in banks in RBI.

1.2.5 Internal Control System

i) The banks should observe the following guidelines for internal control system in respect of investment transactions :

(a) There should be a clear functional separation of (i) trading, (ii) settlement, monitoringand control and (iii) accounting. Similarly, there should be a functional separation of tradingand back office functions relating to banks' own Investment Accounts, Portfolio ManagementScheme (PMS) Clients' Accounts and other Constituents (including brokers’) accounts. ThePortfolio Management service may be provided to clients, subject to strictly following theguidelines in regard thereto (covered in paragraph 1.3.3). Further, PMS Clients Accountsshould be subjected to a separate audit by external auditors.

(b) For every transaction entered into, the trading desk should prepare a deal slip whichshould contain data relating to nature of the deal, name of the counter-party, whether it is adirect deal or through a broker, and if through a broker, name of the broker, details of security,amount, price, contract date and time. The deal slips should be serially numbered andcontrolled separately to ensure that each deal slip has been properly accounted for. Once thedeal is concluded, the dealer should immediately pass on the deal slip to the back office forrecording and processing. For each deal there must be a system of issue of confirmation tothe counterparty. The timely receipt of requisite written confirmation from the counterparty,which must include all essential details of the contract, should be monitored by the backoffice.

(c) Once a deal has been concluded, there should not be any substitution of the counterparty bank by another bank by the broker, through whom the deal has been entered into;likewise, the security sold/purchased in the deal should not be substituted by another security.

(d) On the basis of vouchers passed by the back office (which should be done afterverification of actual contract notes received from the broker/ counterparty and confirmation ofthe deal by the counterparty), the Accounts Section should independently write the books ofaccount.

(e) In the case of transaction relating to PMS Clients’ Accounts (including brokers), allthe the relative records should give a clear indication that the transaction belongs to PMSClients/ other constituents and does not belong to bank's own Investment Account and thebank is acting only in its fiduciary/ agency capacity.

(f) (i) Records of SGL transfer forms issued/ received, should be maintained.

(ii) Balances as per bank's books should be reconciled at quarterly intervals with thebalances in the books of PDOs. If the number of transactions so warrant, thereconciliation should be undertaken more frequently, say on a monthly basis. Thisreconciliation should be periodically checked by the internal audit department.

(iii) Any bouncing of SGL transfer forms issued by selling banks in favour of the buyingbank, should immediately be brought to the notice of the Regional Office of Department ofBanking Supervision of RBI by the buying bank.

(iv) A record of BRs issued/ received should be maintained.

(v) A system for verification of the authenticity of the BRs and SGL transfer formsreceived from the other banks and confirmation of authorised signatories should be put inplace.

(g) Banks should put in place a reporting system to report to the top management, on aweekly basis, the details of transactions in securities, details of bouncing of SGL transferforms issued by other banks and BRs outstanding for more than one month and a reviewof investment transactions undertaken during the period.

(f) Banks should not draw cheques on their account with the Reserve Bank for third partytransactions, including inter-bank transactions. For such transactions, bankers' cheques/pay orders should be issued.

(g) In case of investment in shares, the surveillance and monitoring of investment should bedone by the Audit Committee of the Board, which shall review in each of its meetings, thetotal exposure of the bank to capital market both fund based and non-fund based, indifferent forms as stated above and ensure that the guidelines issued by RBI arecomplied with and adequate risk management and internal control systems are in place;

(h) The Audit Committee should keep the Board informed about the overall exposure tocapital market, the compliance with the RBI and Board guidelines, adequacy of riskmanagement and internal control systems;

(i) In order to avoid any possible conflict of interest, it should be ensured that thestockbrokers as directors on the Boards of banks or in any other capacity, do not involvethemselves in any manner with the Investment Committee or in the decisions in regard tomaking investments in shares, etc., or advances against shares.

(j) The internal audit department should audit the transactions in securities on an on goingbasis, monitor the compliance with the laid down management policies and prescribedprocedures and report the deficiencies directly to the management of the bank.

(k) The banks' managements should ensure that there are adequate internal control andaudit procedures for ensuring proper compliance of the instructions in regard to theconduct of the investment portfolio. The banks should institute a regular system ofmonitoring compliance with the prudential and other guidelines issued by the RBI. Thebanks should get compliance in key areas certified by their statutory auditors and furnishsuch audit certificate to the Regional Office of Department of Banking Supervision of RBIunder whose jurisdiction the HO of the bank falls.

1.2.6 Engagement of brokers

i) For engagement of brokers to deal in investment transactions, the banks should observe thefollowing guidelines :

(a) Transactions between one bank and another bank should not be put through thebrokers' accounts. The brokerage on the deal payable to the broker, if any (if the deal wasput through with the help of a broker), should be clearly indicated on the notes/ memorandumput up to the top management seeking approval for putting through the transaction andseparate account of brokerage paid, broker-wise, should be maintained.

(b) If a deal is put through with the help of a broker, the role of the broker should berestricted to that of bringing the two parties to the deal together.

(c) While negotiating the deal, the broker is not obliged to disclose the identity of thecounterparty to the deal. On conclusion of the deal, he should disclose the counterparty andhis contract note should clearly indicate the name of the counterparty.

(d) On the basis of the contract note disclosing the name of the counterparty, settlement ofdeals between banks, viz. both fund settlement and delivery of security, should be directlybetween the banks and the broker should have no role to play in the process.

(e) With the approval of their top managements, banks should prepare a panel of approvedbrokers which should be reviewed annually, or more often if so warranted. Clear-cut criteriashould be laid down for empanelment of brokers, including verification of theircreditworthiness, market reputation, etc. A record of broker-wise details of deals put throughand brokerage paid, should be maintained.

(f) A disproportionate part of the business should not be transacted through only one or a fewbrokers. Banks should fix aggregate contract limits for each of the approved brokers. A limitof 5% of total transactions (both purchase and sales) entered into by a bank during a yearshould be treated as the aggregate upper contract limit for each of the approved brokers. Thislimit should cover both the business initiated by a bank and the business offered/ brought tothe bank by a broker. Banks should ensure that the transactions entered into throughindividual brokers during a year normally did not exceed this limit. However, if for any reasonit becomes necessary to exceed the aggregate limit for any broker, the specific reasonstherefor should be recorded, in writing, by the authority empowered to put through the deals.Further, the board should be informed of this, post facto. However, the norm of 5% would notbe applicable to banks’ dealings through Primary Dealers.

(g) The concurrent auditors who audit the treasury operations should scrutinise the businessdone through brokers also and include it in their monthly report to the Chief Executive Officerof the bank. Besides, the business put through any individual broker or brokers in excess ofthe limit, with the reasons therefor, should be covered in the half-yearly review to the Board ofDirectors/ Local Advisory Board. These instructions also apply to subsidiaries and mutualfunds of the banks.

Explanation :Certain clarifications on the instructions are furnished in the Annexure II.

ii) Inter-bank securities transactions should be undertaken directly between banks and no bankshould engage the services of any broker in such transactions.

Exceptions:

Note (i)
Banks may undertake securities transactions among themselves or with non bank clients throughmembers of the National Stock Exchange (NSE), OTC Exchange of India (OTCEI) and the StockExchange, Mumbai(BSE). If such transactions are not undertaken on the NSE, OTCEI or BSE, thesame should be undertaken by banks directly, without engaging brokers.

Note (ii)
Although the Securities Contracts (Regulation) Act, 1956 defines the term `securities' to mean corporateshares, debentures, Govt. securities and rights or interest in securities, the term `securities' wouldexclude corporate shares. The Provident/ Pension Funds and Trusts registered under the IndianTrusts Act, 1882, will be outside the purview of the expression `non-bank clients' for the purpose ofnote (i) above.

1.2.7 Audit, review and reporting of investment transactions

The banks should follow the following instructions in regard to audit, review and reporting ofinvestment transactions :

a) Banks should undertake a half-yearly review (as of 30 September and 31 March) of theirinvestment portfolio, which should, apart from other operational aspects of investment portfolio,clearly indicate and certify adherence to laid down internal investment policy and proceduresand Reserve Bank guidelines, and put up the same before their respective Boards within amonth, i.e by end-April and end-October.

b) A copy of the review report put up to the Bank's Board, should be forwarded to the ReserveBank (concerned Regional Office of DBS) by 15 November and 15 May respectively.

c) In view of the possibility of abuse, treasury transactions should be separately subjected to aconcurrent audit by internal auditors and the results of their audit should be placed before theCMD of the bank once every month. Banks need not forward copies of the above mentionedconcurrent audit reports to Reserve Bank of India. However, the major irregularities observedin these reports and the position of compliance thereto may be incorporated in the half yearlyreview of the investment portfolio.

1.2.8 Non- SLR investments

i) Banks have made significant investment in privately placed unrated bonds and, in certain cases, inbonds issued by corporates who are not their borrowers. While assessing such investment proposalson private placement basis, in the absence of standardised and mandated disclosures, includingcredit rating, banks may not be in a position to conduct proper due diligence to take an investmentdecision. Thus, there could be deficiencies in the appraisal of privately placed issues.

Disclosure requirements in offer documents

ii) The risk arising from inadequate disclosure in offer documents should be recognised and banksshould prescribe minimum disclosure standards as a policy with Board approval. In this connection,Reserve Bank of India had constituted a Technical Group comprising officials drawn from treasurydepartments of a few banks and experts on corporate finance to study, inter-alia, the methods ofacquiring, by banks, of non-SLR investments in general and private placement route, in particular, andto suggest measures for regulating these investments. The Group had designed a format containingthe minimum disclosure requirements as well as certain conditionalities regarding documentation andcreation of charge for private placement issues, which may serve as a 'best practice model' for thebanks. The details of the Group’s recommendations are given in the Annexure III and banks mayintroduce with immediate effect a suitable format of disclosure requirements on the lines of therecommendations of the Technical Group with the approval of their Board.

Internal assessment

iii) With a view to ensuring that the investments by banks in issues through private placement, both ofthe borrower customers and non-borrower customers, do not give rise to systemic concerns, it isnecessary that banks should ensure that their investment policies duly approved by the Board ofDirectors are formulated after taking into account the following aspects:

a) The Boards of banks should lay down policy and prudential limits on investments inbonds and debentures including cap and on private placement basis, sub limits for PSUbonds, corporate bonds, guaranteed bonds, issuer ceiling, etc.

(b) Investment proposals should be subjected to the same degree of credit risk analysis asany loan proposal. Banks should make their own internal credit analysis and rating even inrespect of rated issues and should not entirely rely on the ratings of external agencies. Theappraisal should be more stringent in respect of investments in instruments issued by nonborrowercustomers.

(c) Strengthen their internal rating systems which should also include building up of asystem of regular (quarterly or half-yearly) tracking of the financial position of the issuer witha view to ensuring continuous monitoring of the rating migration of the issuers/issues.

(d) As a matter of prudence, banks should stipulate entry level minimum ratings/ qualitystandards and industry-wise, maturity-wise, duration-wise, issuer-wise etc. limits to mitigatethe adverse impacts of concentration and the risk of illiquidity.

(e) The banks should put in place proper risk management systems for capturing andanalysing the risk in respect of these investments and taking remedial measures in time.

(iv) Some banks / FIs have not exercised due precaution by reference to the list of defaulterscirculated / published by RBI while investing in bonds, debentures, etc., of companies. Banks may,therefore, exercise due caution while taking any investment decision to subscribe to bonds,debentures, shares etc., and refer to the ‘Defaulters List’ to ensure that investments are not made incompanies / entities who are defaulters to banks / FIs. Some of the companies may be undergoingadverse financial position turning their accounts to sub-standard category due to recession in theirindustry segment, like textiles. Despite restructuring facility provided under RBI guidelines, the bankshave been reported to be reluctant to extend further finance, though considered warranted on meritsof the case. Banks may not refuse proposals for such investments in companies whose director’sname(s) find place in the defaulter companies list circulated by RBI at periodical intervals andparticularly in respect of those loan accounts, which have been restructured under extant RBIguidelines, provided the proposal is viable and satisfies all parameters for such credit extension.

Prudential guidelines on investment in Non-SLR securities Coverage

1.2.9 These guidelines cover banks’ investments in non-SLR securities issued by corporates, banks,FIs and State and Central Government sponsored institutions, SPVs etc, including, capital gainsbonds, bonds eligible for priority sector status. The guidelines will apply to investments both in theprimary market as well as the secondary market.

1.2.10 The guidelines will not apply to the following categories of non-SLR investments :

(i) Securities issued directly by the Central and State Governments, which are not reckoned for SLR purpose,

(ii) Investments in equity shares.

(iii) Units of equity oriented mutual fund schemes, viz., those schemes where any part of the corpus can be invested in equity

(iv) Venture capital funds

(v) Commercial Paper

(vi) Certificates of Deposit

1.2.11 Definitions of a few terms used in these guidelines have been furnished in Annexure IV with aview to ensure uniformity in approach while implementing the guidelines.

Regulatory requirements

1.2.12 Banks should not invest in Non-SLR securities of original maturity of less than one-year, otherthan Commercial Paper and Certificates of Deposits which are covered under RBI guidelines.

1.2.13 Banks should undertake usual due diligence in respect of investments in non-SLR securities.Present RBI regulations preclude banks from extending credit facilities for certain purposes. Banksshould ensure that such activities are not financed by way of funds raised through the non-SLRsecurities.

Listing and rating requirements

1.2.14 Banks must not invest in unrated non-SLR securities.

1.2.15 The Securities Exchange Board of India (SEBI) vide their circular dated September 30, 2003have stipulated requirements that listed companies are required to comply with, for making issue ofdebt securities on a private placement basis and listed on a stock exchange. According to this circularany listed company, making issue of debt securities on a private placement basis and listed on astock exchange, has to make full disclosures (initial and continuing) in the manner prescribed inSchedule II of the Companies Act 1956, SEBI (Disclosure and Investor Protection) Guidelines, 2000and the Listing Agreement with the exchanges. Furthermore, the debt securities shall carry a creditrating of not less than investment grade from a Credit Rating Agency registered with the SEBI.

1.2.16 Accordingly, while making fresh investments in non-SLR debt securities, banks should ensurethat such investment are made only in listed debt securities of companies which comply with therequirements of the SEBI circular dated September 30, 2003, except to the extent indicated inparagraphs 1.2.17 and 1.2.18 below.

Fixing of prudential limits

1.2.17 Bank’s investment in unlisted non-SLR securities should not exceed 10 per cent of its totalinvestment in non-SLR securities as on March 31, of the previous year. The unlisted non-SLRsecurities in which banks may invest up to the limits specified above, should comply with thedisclosure requirements as prescribed by the SEBI for listed companies.

1.2.18 Bank’s investment in unlisted non-SLR securities may exceed the limit of 10 per cent, by anadditional 10 per cent, provided the investment is on account of investment in securitisation papersissued for infrastructure projects, and bonds/debentures issued by Securitisation Companies andReconstruction Companies set up under the Securitisation and Reconstruction of Financial Assetsand Enforcement of Security Interest Act, 2002 and registered with RBI. In other words investmentexclusively in securities specified in this paragraph could be up to the maximum permitted limit of 20per cent of non-SLR investment.

1.2.19 Investment in Security Receipts issued by Securitisation Companies / ReconstructionCompanies registered with RBI and investments in Asset Backed Securities (ABS) and MortgageBacked Securities (MBS) which are rated at or above the minimum investment grade, will not bereckoned as 'unlisted non-SLR securities' for computing compliance with the prudential limitsprescribed in the guidelines. However, there will be close monitoring of exposures to ABS on a bankspecific basis based on monthly reports to be submitted to RBI as per proforma as separately advisedby the Department of Banking Supervision.

1.2.20 For the purpose of the prudential limits prescribed in the guidelines, the denominator viz., 'non-SLR investments', would include investment under the following four categories in Schedule 8 to thebalance sheet viz., 'shares', 'bonds & debentures', 'subsidiaries/joint ventures' and 'others'.

1.2.21 Banks which have exposure to investments in unlisted non-SLR securities in excess of theprudential limit prescribed above as on March 31, 2003 should not make any fresh investment in suchsecurities till they ensure compliance with the above prudential limit.

Transition

1.2.22 Considering the time required by issuers to get their existing unlisted debt issues listed on thestock exchanges, the following transition time is provided:

(i) Investment by banks in units of mutual fund schemes where the entire corpus is invested indebt securities will be outside the purview of the above guidelines until December 31,2004.

(ii) With effect from January 1, 2005 only investment in units of such mutual fund schemeswhich have an exposure to unlisted securities of less than 10 per cent of the corpus of thefund will be treated on par with listed securities for the purpose of compliance with theprudential limits prescribed in the above guidelines.

(iii) Banks may invest until March 31, 2004 in the existing unlisted securities (those issued onor before November 30, 2003). With effect from April 1, 2004 banks may also invest in theabove category of unlisted securities until December 31, 2004 provided the issuers haveapplied to the stock exchange(s) for listing and the security is rated minimum investmentgrade.

(iv) Banks may also invest in unlisted securities issued after November 30, 2003 up to 10 percent of the incremental non-SLR investments over the outstanding non-SLR investmentsas on November 30, 2003 up to December 31, 2004.

With effect from January 1, 2005 only banks whose investment in unlisted non-SLR securitiesare within the prudential limits prescribed in the above guidelines may make fresh investmentin such securities and up to the prudential limits.

Role of Boards

1.2.23 Banks should ensure that their investment policies duly approved by the Board of Directors areformulated after taking into account all the relevant issues specified in these guidelines on investmentin non-SLR securities. Banks should put in place proper risk management systems for capturing andanalysing the risk in respect of non-SLR investment and taking remedial measures in time. Banksshould also put in place appropriate systems to ensure that investment in privately placed instrumentsis made in accordance with the systems and procedures prescribed under respective bank’sinvestment policy.

1.2.24 Boards of banks should review the following aspects of non-SLR investment at least atquarterly intervals:

a) Total business (investment and divestment) during the reporting period.

b) Compliance with the prudential limits prescribed by the Board for non-SLR investment.

c) Compliance with the prudential guidelines issued by Reserve Bank on non-SLR securities.

d) Rating migration of the issuers/ issues held in the bank’s books and consequent diminution in the portfolio quality.

e) Extent of non performing investments in the non-SLR category.

Disclosures

1.2.25 In order to help in the creation of a central database on private placement of debt, a copy of alloffer documents should be filed with the Credit Information Bureau (India) Ltd. (CIBIL) by the investingbanks. Further, any default relating to interest/ instalment in respect of any privately placed debtshould also be reported to CIBIL by the investing banks along with a copy of the offer document.

1.2.26 Banks should disclose the details of the issuer composition of non-SLR investments and thenon-performing non-SLR investments in the ‘Notes on Accounts’ of the balance sheet, as indicated inAnnexure V.

Trading and settlement in debt securities

1.2.27 As per the SEBI guidelines, all trades with the exception of the spot transactions, in a listed debtsecurity, shall be executed only on the trading platform of a stock exchange. In addition to complyingwith the SEBI guidelines, banks should ensure that all spot transactions in listed and unlisted debtsecurities are reported on the NDS and settled through the CCIL from a date to be notified by RBI.

Direct investment in shares, convertible bonds and debentures etc.

1.2. 28 The bank’s aggregate exposure to the capital markets covering direct investment by a bank inequity shares, convertible bonds and debentures and units of equity oriented mutual funds; advancesagainst shares to individuals for investment in equity shares (including IPOs/ESOPs ), bonds anddebentures, units of equity-oriented mutual funds etc and secured and unsecured advances tostockbrokers and guarantees issued on behalf of stockbrokers and market makers; should not exceed5 per cent of their total outstanding advances (including Commercial Paper) as on March 31 of theprevious year. Within this overall ceiling, banks investment in shares, convertible bonds anddebentures and units of equity oriented mutual funds should not exceed 20 percent of its networth.

While making investment in equity shares etc., whose prices are subject to volatility, the banks shouldkeep in view the following guidelines :

a) The ceiling for investment in shares, etc., as stated in the above paragraph (i.e., 20 per centof net worth), is the maximum permissible ceiling and a bank’s Board of Directors is free toadopt a lower ceiling for the bank, keeping in view its overall risk profile and corporatestrategy.

b) Banks may make investment in shares directly taking into account the in-house expertiseavailable within the bank as per the investment policy approved by the Board of Directorssubject to compliance with the risk management and internal control systems indicated below.

c) Banks may also make investment in units of UTI and SEBI - approved other diversified mutualfunds with good track records as per the investment policy approved by the Board ofDirectors. Such investments should be in specific schemes of UTI / Mutual Funds and notby way of placement of funds with UTI / Mutual Funds for investment in the capital market ontheir behalf.

d) Underwriting commitments taken up by the banks in respect of primary issues through bookbuilding route would also be within the above overall ceiling.

e) Investment in equity shares and convertible bonds and debentures of corporate entities shouldas hitherto, be reckoned for the purpose of arriving at the prudential norm of single-borrowerand borrower-group exposure ceilings.

1.3 General

1.3.1 Reconciliation of holdings of Govt. securities, etc.

Banks should furnish to the Reserve Bank the statement of the reconciliation of bank's investments(held in own Investment account, as also under PMS) as at the end of every accounting year dulycertified by the bank's auditors. Further, the statement should reach Reserve Bank within one monthfrom the close of the accounting year. The aforementioned requirement of reconciliation may besuitably included by banks in the letters of appointment which may be issued to the bank's externalauditors, in future. The format for the statement and the instructions for compiling thereto are given inAnnexure VI.

1.3.2 Transactions in securities - Custodial functions

While exercising the custodial functions on behalf of their merchant banking subsidiaries, thesefunctions should be subject to the same procedures and safeguards as would be applicable to otherconstituents. Accordingly, full particulars should be available with the subsidiaries of banks of themanner in which the transactions have been executed. Banks should also issue suitable instructionsin this regard to the department/office undertaking the custodial functions on behalf of theirsubsidiaries.

1.3.3 Portfolio Management on behalf of clients

i) The general powers vested in banks to operate PMS and similar schemes have beenwithdrawn. No bank should, therefore, restart or introduce any new PMS or similar scheme in futurewithout obtaining specific prior approval of the Reserve Bank.

ii) The following conditions are to be strictly observed by the banks operating PMS or similarscheme with the specific prior approval of RBI:

(a) PMS should be entirely at the customer's risk, without guaranteeing, eitherdirectly or indirectly, a pre-determined return.

(b) Funds should not be accepted for portfolio management for a period less thanone year.

(c) Portfolio funds should not be deployed for lending in call/ notice money, interbankterm deposits and bills rediscounting markets and lending to/placement with corporatebodies.

(d) Banks should maintain clientwise account/record of funds accepted formanagement and investments made thereagainst and the portfolio clients should be entitledto get a statement of account.

(e) Bank's own investments and investments belonging to PMS clients should be keptdistinct from each other, and any transactions between the bank's investment accountand client's portfolio account should be strictly at market rates.

(f) There should be a clear functional separation of trading and back office functionsrelating to banks’ own investment accounts and PMS clients' accounts.

iii) PMS clients' accounts should be subjected by banks to a separate audit by external auditors as covered in paragraph 1.2.5 (i) (a).

iv) Banks should note that violation of RBI's instructions will be viewed seriously and will invite deterrent action against the banks which will include raising of reserve requirements, withdrawal of facility of refinance from the Reserve Bank and denial of access to money markets, apart from prohibiting the banks from undertaking PMS activity.

v) Further, the aforesaid instructions will apply, mutatis mutandis, to the subsidiaries of banks except where they are contrary to specific regulations of the Reserve Bank or the Securities and Exchange Board of India, governing their operations.

vi) Banks/ merchant banking subsidiaries of banks operating PMS or similar scheme with the specific prior approval of the RBI are also required to comply with the guidelines contained in the SEBI (Portfolio Managers) Rules and Regulations, 1993 and those issued from time to time.

1.3.4 Investment Portfolio of banks - transactions in Government Securities

In the light of fraudulent transactions in the guise of Government securities transactions in physicalformat by a few co-operative banks with the help of some broker entities, it has been decided toaccelerate the measures for further reducing the scope of trading in physical forms. These measuresare as under:

(i) For banks which do not have SGL account with RBI, only one CSGL account can be opened.

(ii) In case the CSGL accounts are opened with a scheduled commercial bank, the account holder has to open a designated funds account (for all CSGL related transactions) with the same bank.

(iii) The entities maintaining the CSGL / designated funds accounts will be required to ensure availability of clear funds in the designated funds accounts for purchasesand of sufficient securities in the CSGL account for sales before putting through the transactions.

(iv) No transactions by the bank should be undertaken in physical form with any broker.

(v) Banks should ensure that brokers approved for transacting in Government securities are registered with the debt market segment of NSE/BSE/OTCEI.

2. Classification

i) The entire investment portfolio of the banks (including SLR securities and non-SLR securities)should be classified under three categories viz. ‘Held to Maturity’, ‘Available for Sale’ and ‘Held forTrading’. However, in the balance sheet, the investments will continue to be disclosed as per theexisting six classifications viz. a) Government securities, b) Other approved securities, c) Shares, d)Debentures & Bonds, e) Subsidiaries/ joint ventures and f) Others (CP, Mutual Fund Units, etc.).

ii) Banks should decide the category of the investment at the time of acquisition and the decisionshould be recorded on the investment proposals.

2.1 Held to Maturity

i) The securities acquired by the banks with the intention to hold them up to maturity will be classifiedunder Held to Maturity.

ii) The investments included under 'Held to Maturity' should not exceed 25 per cent of the bank’s totalinvestments. The banks may include, at their discretion, under 'Held to Maturity' category securitiesless than 25 per cent of total investment.

iii) The following investments will be classified under ‘Held to Maturity’ but will not be counted for thepurpose of ceiling of 25% specified for this category:

a) Re-capitalisation bonds received from the Government of India towards their re-capitalisationrequirement and held in their investment portfolio. This will not include re-capitalisation bondsof other banks acquired for investment purposes.

b) Investment in subsidiaries and joint ventures. [A joint venture would be one in which the bank,along with its subsidiaries, holds more than 25% of the equity.]

c) The investments in debentures/ bonds, which are deemed to be in the nature of an advance.Debentures/ bonds must be treated in the nature of an advance when:


1. The debenture/bond is issued as part of the proposal for project finance and the tenure of the debenture is for a period of three years and above
   or
   The debenture/bond is issued as part of the proposal for working capital finance and the tenure of the debenture/ bond is less than a period of one year
   and



2. the bank has a significant stake i.e.10% or more in the issue
   and


3. the issue is part of a private placement, i.e. the borrower has approached the bank/FI andnot part of a public issue where the bank/FI has subscribed in response to an invitation.


The debentures/ bonds deemed to be in the nature of advance will be subject to the usualprudential norms applicable to advances.

iv) Profit on sale of investments in this category should be first taken to the Profit & Loss Account and thereafter be appropriated to the ‘Capital Reserve Account’. Loss on sale will be recognised in the Profit & Loss Account.

2.2 Available for Sale & Held for Trading

i) The securities acquired by the banks with the intention to trade by taking advantage of the shortterm price/ interest rate movements will be classified under Held for Trading.

ii) The securities which do not fall within the above two categories will be classified under Available for Sale

iii) The banks will have the freedom to decide on the extent of holdings under Available for Sale and Held for Trading categories. This will be decided by them after considering various aspects such as basis of intent, trading strategies, risk management capabilities, tax planning, manpower skills, capital position.

iv) The investments classified under Held for Trading category would be those from which the bankexpects to make a gain by the movement in the interest rates/ market rates. These securities are tobe sold within 90 days.

v) Profit or loss on sale of investments in both the categories will be taken to the Profit & LossAccount.

2.3 Shifting among categories

i) Banks may shift investments to/from Held to Maturity category with the approval of the Board ofDirectors once a year. Such shifting will normally be allowed at the beginning of the accounting year.No further shifting to/ from this category will be allowed during the remaining part of that accountingyear.

ii) Banks may shift investments from Available for Sale category to Held for Trading category withthe approval of their Board of Directors/ ALCO/ Investment Committee. In case of exigencies, suchshifting may be done with the approval of the Chief Executive of the bank/ Head of the ALCO, butshould be ratified by the Board of Directors/ ALCO.

iii) Shifting of investments from Held for Trading category to Available for Sale category is generallynot allowed. However, it will be permitted only under exceptional circumstances like not being able tosell the security within 90 days due to tight liquidity conditions, or extreme volatility, or marketbecoming unidirectional. Such transfer is permitted only with the approval of the Board of Directors/ALCO/ Investment Committee.

iv) Transfer of scrips from one category to another, under all circumstances, should be done at theacquisition cost/ book value/ market value on the date of transfer, whichever is the least, and thedepreciation, if any, on such transfer should be fully provided for.

3. Valuation

3.1 Held to Maturity

i) Investments classified under Held to Maturity category need not be marked to market and will becarried at acquisition cost unless it is more than the face value, in which case the premium should beamortised over the period remaining to maturity.

ii) Banks should recognise any diminution, other than temporary, in the value of their investments insubsidiaries/ joint ventures which are included under Held to Maturity category and provide therefor.Such diminution should be determined and provided for each investment individually.

3.2 Available for Sale

i) The individual scrips in the Available for Sale category will be marked to market at the quarterly orat more frequent intervals. While the net depreciation under each classification referred to in item 2(i)above should be recognised and fully provided for, the net appreciation under each classificationreferred to in item 2(i) above should be ignored. The book value of the individual securities would notundergo any change after the revaluation.

[Note: Securities under this category shall be valued scrip-wise and depreciation/ appreciationshall be aggregated for each classification referred to in item 2(i) above. Net depreciation, ifany, shall be provided for. Net appreciation, if any, should be ignored. Net depreciationrequired to be provided for in any one classification should not be reduced on account of netappreciation in any other classification.]

ii) The provisions required to be created on account of depreciation in the Available for Sale categoryin any year should be debited to the Profit & Loss Account and an equivalent amount (net of taxbenefit, if any, and net of consequent reduction in the transfer to Statutory Reserve) or the balanceavailable in the Investment Fluctuation Reserve Account, whichever is less, shall be transferred fromthe Investment Fluctuation Reserve Account to the Profit & Loss Account. In the event provisionscreated on account of depreciation in the Available for Sale category are found to be in excess of therequired amount in any year, the excess should be credited to the Profit & Loss Account and anequivalent amount (net of taxes, if any, and net of transfer to Statutory Reserves as applicable to suchexcess provision) should be appropriated to the Investment Fluctuation Reserve Account to be utilisedto meet future depreciation requirement for investments in this category. The amounts debited to theProfit & Loss Account for provision and the amount credited to the Profit & Loss Account for reversalof excess provision should be debited and credited respectively under the head “Expenditure –Provisions & Contingencies”. The amounts appropriated from the Profit & Loss Account and theamount transferred from the Investment Fluctuation Reserve to the Profit & Loss Account should beshown as ‘below the line’ items after determining the profit for the year.

3.3 Held for Trading

The individual scrips in the Held for Trading category will be marked to market at monthly or at morefrequent intervals as in the case of those in the Available for Sale category. The book value of theindividual securities in this category would not undergo any change after marking to market.

3.4 Investment Fluctuation Reserve

(i) With a view to building up of adequate reserves to guard against any possible reversal ofinterest rate environment in future due to unexpected developments, banks are advisedto build up Investment Fluctuation Reserve (IFR) of a minimum 5 per cent of theinvestment portfolio within a period of 5 years. IFR should be computed with reference toinvestments in two categories, viz., “Held for Trading” and “Available for Sale”. It will notbe necessary to include investment under “Held to Maturity” category for the purpose ofcomputation of IFR. However, banks are free to build up a higher percentage of IFR up to10 per cent of the portfolio depending on the size and composition of their portfolio, withthe approval of their Board of Directors.

(ii) Banks should transfer maximum amount of the gains realized on sale of investment insecurities to the IFR.

(iii) The IFR, consisting of realized gains from the sale of investments from the twocategories, viz., “Held for Trading” and “Available for Sale”, would be eligible for inclusionin Tier 2 capital as hitherto.

(iv) Transfer to IFR shall be as an appropriation of net profit “below the line” afterappropriation to statutory reserve.

3.5 General

3.5.1 The equity shares in the bank's portfolio should be marked to market preferably on a dailybasis, but at least on a weekly basis.

3.5.2 In respect of securities included in any of the three categories where interest/ principal is inarrears, the banks should not reckon income on the securities and should also make appropriateprovisions for the depreciation in the value of the investment. The banks should not set-off thedepreciation requirement in respect of these non-performing securities against the appreciation inrespect of other performing securities.