Accounting and Provisioning by Urban Co-operative Banks
Income Recognition
Urban Co-operative Banks (UCBs) should recognize income on an accrual basis for:
- Government Securities and corporate bonds with regular interest payments and no arrears.
- Securities guaranteed by the Central or State Government with regular interest payments.
- Shares of corporate/co-operative institutions, provided the dividend is declared and the right to payment is established.
Income from mutual fund units should be booked on a cash basis. Broken period interest paid for Government and approved securities should be treated as an expense, not as part of the acquisition cost.
Investment Fluctuation Reserve (IFR)
Creation of IFR and Minimum Requirement
- UCBs should create an “Investment Depreciation Reserve (IDR)” for depreciation in ‘AFS’ or ‘HFT’ investments, charged to the Profit & Loss Account.
- Excess IDR can be credited to the Profit & Loss Account and an equivalent amount transferred to the IFR.
- UCBs should build IFR from realized gains on investment sales, subject to net profit availability.
- A minimum IFR of 5% of the investment portfolio in HFT and AFS categories is required. UCBs can opt for a higher percentage with Board approval.
- Maximum gains from investment sales should be transferred to IFR until the 5% minimum is met.
- IFR can be included in Tier II capital.
- Unrealized gains should not be accounted for in the Income Account or IFR.
Draw-down from IFR
- UCBs can use excess IFR for credit to the Profit & Loss Account, mainly for meeting depreciation requirements on investments.
- Draw-down below 5% is allowed under certain conditions, like meeting Tier I capital requirements.
- Accounting for IDR and IFR should follow specific principles, including debiting and crediting under “Expenditure – Provisions & Contingencies”.
Non-Performing Investments (NPI)
- Securities with overdue interest/principal should not accrue income and must be provisioned for depreciation.
- An investment becomes NPI if interest or principal remains unpaid for over 90 days.
- Shares valued at Re.1 due to non-availability of financials are considered NPI.
- Investments in securities issued by an NPA issuer are also treated as NPI.
- Conversions of debt into equity or other instruments are treated as NPA from the start.
- State Government Guaranteed securities become NPI after 90 days of unpaid dues. Central Government Guaranteed investments are not classified as NPI until the guarantee is repudiated. However, this does not apply to income recognition.
Separate Trading of Registered Interest and Principal Securities (STRIPS) Accounting and Valuation
STRIPS are to be treated as zero coupon bonds for valuation and accounting purposes, following the guidelines set out in these directions.
When valuing STRIPS at the start, market-based discount rates should be used. If market rates for zero-coupon bonds aren’t available, then the zero coupon yields published by FBIL can be used.
For accounting purposes, when STRIPS are created or recombined, entries should be made at face value in the SGL accounts. If a participant requests to create STRIPS, their SGL account will be debited by the face value of the Government Security. It will also be credited with the total face value of both the Coupon STRIPS and the Principal STRIPS.
On the day of creating STRIPS, they should be recorded in the participant’s accounts at their discounted value. At the same time, the related Government Security should be removed from the records. The process is reversed for recombining STRIPS. The value of STRIPS (both coupon and principal) is calculated using the Zero Coupon Yield Curve and adjusted so that there’s no profit or loss. This adjustment is based on the lower of the book value or market value of the original security compared to the total market value of all the STRIPS created from it.
Banks can create STRIPS from Government Securities in their Available for Sale (AFS) or Held for Trading (HFT) investment portfolios. If STRIPS are made from securities in the Held to Maturity (HTM) portfolio, these securities must first be moved to the AFS/HFT category. The lower of the book value or market value is then used to adjust the value of the STRIPS to match the book value or market value of the original security. This ensures no profit or loss from the creation of STRIPS. Any increase in value from moving the security from HTM is not considered.
Before a security is turned into STRIPS, its market value must be assessed. Any increase in value is ignored, but any decrease must be recognized if the market value is less than the book value. This decrease is not combined with other calculations of net investment appreciation or depreciation in the AFS/HFT category. The lower of the book value or market value is used for adjusting the STRIPS’ value.
The adjustment principle applies to both the creation and recombination of STRIPS and is based on the clean price of the security, excluding accrued interest. This is because accrued interest is already accounted for as income or expenditure. The same principle is used when STRIPS are bought from the market.
The book value of STRIPS, which are considered as zero coupon bonds, must be valued and adjusted to market conditions as per these directions. This includes updating the book value for any accrued interest before marking to market.
Investment Portfolio of Primary (Urban) Co-operative Banks
Shifting Among Categories in the Investment Portfolio of UCBs
Valuation of Investments of Urban Co-operative Banks
Investments in Government Securities by Urban Co-operative Banks
Investment in Non-SLR Securities by Urban Co-operative Banks
Placement of Deposits with Other Banks/Institutions by Urban Co-operative Banks
Restrictions on holding shares in other Co-operative Societies
