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In the dynamic world of finance, fixed income portfolios held by banks play a pivotal role. These portfolios encompass a diverse range of financial instruments, including government and corporate bonds, and are a crucial source of income and stability for financial institutions. Recently, the fixed income landscape has witnessed significant changes driven by regulatory reforms. These changes have far-reaching implications on how banks manage their fixed income portfolios and, by extension, on the broader financial market. In this article, we delve into the impact of these regulatory changes and explore their implications for banks and the bond market.

The Historical Structure of Fixed Income Portfolios

Historically, banks have categorized their fixed income (FI) portfolios into three segments:

1. Held Till Maturity (HTM)

In the HTM segment, banks hold portfolios until the securities within them mature. This means that banks are committed to holding these securities until they reach their specified maturity dates. The primary motivation behind holding investments in the HTM category is the intention to collect interest and principal payments over the life of the investment.

Bank Fixed Income Portfolios

2. Available For Sale (AFS)

The AFS category allows banks to hold portfolios with the intention of selling them in the future. The decision to sell may be based on a variety of factors, including changes in market conditions or adjustments to a bank’s Asset Liability Management (ALM) strategy. Unlike the HTM category, securities in the AFS category are not held until maturity, giving banks more flexibility in managing these assets.

3. Held For Trading (HFT)

In the HFT category, banks actively trade fixed income securities. The primary purpose of this segment is to generate trading profits. Banks can buy and sell securities within the HFT portfolio with greater frequency and flexibility compared to the other categories. HFT portfolios are more dynamic, as they respond to market conditions and trading opportunities.

Recent Regulatory Changes

Recent regulatory changes have reshaped the fixed income portfolio landscape and have significant implications for banks. These changes can be categorized into several key areas:

1. HTM Portfolio Limits

One of the noteworthy changes is the relaxation of limits on the HTM portfolio. Historically, banks were restricted in their ability to allocate a specific portion of their Net Demand and Time Liability (NDTL) to the HTM category. However, this restriction has been lifted, providing banks with greater flexibility in managing their HTM portfolios.

2. Corporate Bonds in HTM

Another significant change is the inclusion of corporate bonds in the HTM category. Previously, only specific types of securities were eligible for HTM classification. With this change, corporate bonds can be categorized and held in the HTM portfolio. This provides banks with more options for their fixed income investments and may impact the demand for corporate bonds.

3. HFT Portfolio Limits

The regulatory framework has also seen adjustments in the HFT portfolio category. The previous requirement that HFT securities must be held for a maximum of 90 days has been removed. Banks can now trade securities in the HFT category without the previous time constraint.

4. Re-Classification Restrictions

In the past, banks had the flexibility to re-classify their fixed income portfolios at the beginning of each financial year. However, recent changes impose restrictions on this re-classification. Re-classification can now only occur with special approval from the board and the Department of Supervision (DoS).

Valuation Approach

The revised regulatory framework also impacts the valuation approach for fixed income portfolios. Under the new guidelines:

1. HTM Portfolio Valuation

Securities in the HTM portfolio are to be valued at their acquisition cost. Unlike the AFS and HFT categories, there is no requirement for Mark to Market (MTM) valuation. Premiums and Discounts on these securities are amortized, reflecting the intention to hold them until maturity.

2. AFS Portfolio Valuation

The AFS portfolio is valued at fair value, and again, Premiums and Discounts are amortized. However, this amortization is subject to changes in fair value, reflecting the potential future sale of these securities.

3. HFT Portfolio Valuation

The HFT portfolio is also to be valued at fair value. Similar to the AFS category, Premiums and Discounts on these securities are amortized. The fair value approach for the HFT category reflects the active trading nature of these securities.

Accounting Methodology Changes

In addition to changes in the classification and valuation of fixed income portfolios, the regulatory framework also introduces changes in accounting methodology:

1. AFS Portfolio Accounting

For the AFS portfolio, banks are now required to create an AFS reserve in the Capital Account. MTM Gain/Loss is adjusted against this reserve. This means that MTM changes do not directly impact the Profit and Loss (P&L) account for the quarter. The AFS reserve acts as a buffer, providing stability to the P&L statement.

2. HFT Portfolio Accounting

In the case of the HFT portfolio, both MTM losses and gains can be directly recognized in the P&L statement. This marks a departure from the previous accounting methodology where only losses were recognized. The ability to recognize gains in the P&L statement is significant for banks trading in the HFT category.

Mandatory Disclosures

Transparency is a key aspect of the regulatory changes. Banks are now required to make additional disclosures, including:

1. Sales from HTM Holdings

Banks must mention in the notes to their financial statements if they have made sales from their HTM holdings. This disclosure provides insight into the dynamics of the HTM portfolio and its stability.

2. Book Value and Fair Value Disclosure

Starting from the financial year 2026, banks are mandated to disclose both the book value and fair value of their entire fixed income book. This enhanced disclosure requirement aims to provide greater transparency regarding the valuations of the fixed income portfolios.

Likely Impact of Regulatory Changes

The regulatory changes introduced have far-reaching implications, influencing various aspects of banks’ fixed income portfolios and the broader bond market. Some of the likely impacts include but are not limited to:

1. Corporate Bonds in HTM

With the inclusion of corporate bonds in the HTM category, there is potential for increased demand for these securities. Corporate bonds held in the HTM category offer an additional return if held until maturity, making them an attractive option for banks seeking stable returns.

2. Enhanced Liberty in HTM Portfolios

The relaxation of limits in the HTM portfolio means that banks have greater freedom to add to their HTM portfolios when attractive yield levels are available. This flexibility allows banks to optimize their portfolio returns based on market conditions.

3. Duration-Based Shifts

Market conditions play a significant role in determining portfolio composition. In a scenario with a flat yield curve, banks may show increased demand for short-duration bonds, resulting in the addition of shorter-duration bonds to the HTM portfolio. Conversely, in a steep yield curve scenario, there is a higher likelihood of increased demand for longer-dated securities.

4. Enhanced Demand for Illiquid G-Secs

The potential for higher yields may lead to increased demand for illiquid Government Securities (G-Secs). This is particularly relevant as banks search for attractive yields, and the fixed income portfolio changes allow them to explore different asset classes.

5. Symmetric Accounting Initiatives

One of the significant accounting changes is the symmetric accounting of bond and Overnight Index Swap (OIS) trades. This development may encourage banks to explore Forward Rate Agreements (FRA) and Bond-OIS trades more actively. Under this approach, both MTM gains and losses will impact the P&L account. Banks can realize gains without the need to sell underlying bonds, providing greater flexibility in managing their portfolios.

In conclusion, the recent regulatory changes have introduced significant alterations to banks’ fixed income portfolios. These changes have a profound impact on banks’ portfolio management strategies and the dynamics of the bond market. Banks need to adapt to these modifications and ensure compliance with the new regulations for a seamless transition in their fixed income operations. As the financial landscape continues to evolve, staying informed and agile in managing fixed income portfolios is crucial for banks to thrive in this changing environment. The adjustments brought about by the new regulatory framework represent both challenges and opportunities for financial institutions, and their ability to navigate this evolving landscape will be key to their success in the future.


Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement


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July 2024