Investments for Rural Cooperative Banks

Department of Supervision and Institutional Development Department

NABARD Telangana Regional Office
Investments Informed investment
Structure of the workshop Decisions which are
compliant with
RBI/NABARD
guidelines

Understand how
to choose
investments
Understand your current
Portfolio of investments

Understanding the
regulatory guidelines and accordingly
modify your investment policy`

Understanding the
Importance
 Section 5(b) of the Banking Regulation Act, 1949 - “Banking"

Major portion of Assets

SLR Requirement
Loans and Advances (“Time Taking”)
IMPORTAN
CE Non-SLR investments – Substitute of Credit? – Prudence!

Low interest rate regime – Implications on investments as an

important part of the asset portfolio.

3
 On
ers Pur
t h cha
O se

Shift
ing
Regulatory

dte
Guidelines

nlis
U
ed/
List
.
Cur
r/Pe nquo
r o. /U
Qu
 Avenues: SLR

 State Development Loans

 GOI dated securities
 Treasury Bills
Regulatory
- BR Act, 1949(AACS) and RBI Circular dated October 13, 2016 Guidelines
 Avenues: Non-SLR

 "A" or equivalent and higher

rated Commercial Papers
(CPs), debentures and bonds.
 Units of Debt and Money
Market Mutual Funds. Regulatory
 Shares of Market Guidelines
Infrastructure Companies
(MICs), e.g. CCIL, NPCI, SWIFT
etc.
- RBI Circular dated July 14, 2016
 Avenues – Restrictions: Non-SLR

 Perpetual Debt Instruments.

 Mutual funds other than Debt and Money
Market Mutual Funds.
 Except Debt Mutual Funds and Money Market
Mutual Funds, and CPs, investment shall be in
instruments with an original maturity of over Regulatory
one year. Guidelines
 Investment in CDs will be treated as inter-
bank deposits and shall not be reckoned for
computing the limit on Non-SLR investments
prescribed at 2.1 above.
 Classification

 On acquisition, security should On

Pur
be classified as “Permanent” or cha
se
“Current”.
 The classification is to be based

Shift
on the intent of holding the

ing
security till maturity/ possibilities
of trading the security.
 Normally, securities in Regulatory
‘Permanent’ category are not Guidelines
supposed to be sold.
 All Non-SLR only “Current”.
 Classification - Shifting

When?
 In the beginning of the year, with the
On
approval of Board of Directors. Pur
c has
e

Shifting from “Current” to “Permanent”

 To be shifted at lower of the market

Shift
value/book value.

g in
 Depreciation should be provided for
and appreciation to be ignored.
Regulatory
Shifting from “Permanent” to “Current”
 To be shifted at Guidelines
amortized/acquisition cost and the
securities have to be assessed
immediately for market value and
resultant depreciation provided, if
any.
 Valuation – Current/Permanent

Current
 Mark to Market should be done
atleast once a quarter.
 The market values of various
securities? (Next Slide)

Permanent
 Carried at acquisition cost unless Regulatory

ted
Guidelines

nlis
it is more than the face value, in

d/U
which case the premium should

e
List
be amortised over the period Cur
r/Pe nquo
.
r o. /U
remaining to maturity. Qu
Valuation – Quoted/Un-quoted
(Non-SLR)

Quoted
 market price of the scrip as
available from the trades/quotes
on the stock exchanges (limit:
transaction within 15 days prior to
the valuation date, FIMMDA) Regulatory

ted
Unquoted
Guidelines

nlis
 Valued on the YTM basis (Mark

d/U
e
List
up over government securities). .
Cur quo
 Based on external rating of the r/Pe
r o. /U n
Qu
bond.

 There are some Special Bonds like tax free

bonds need to be grossed up by tax rate
Valuation – Quoted/Un-quoted
(Non-SLR)

Unlisted

Investment in unlisted securities is

subject to minimum rating Ä

Limit under unlisted securities is 10% of Regulatory

ted
total non-SLR investments of the bank Guidelines

nlis
d/U
e
List
Listed .
Cur
r/Pe nquo
Can be taken directly – market rate r
Qu
o. /U
Prudential Limits

Single/Group counter- party

exposure. Ot hers

Non-SLR investments shall not

exceed 10% of the total deposits of
a bank as on March 31 of the
preceding financial year.
Regulatory
Guidelines
G-Securities yields vs Bank Fixed Deposits

# RBI has opened up the G-Secs for retail participation

What are the risks involved in investments?
• Default Risk
• Liquidity Risk
• Interest Rate Risk
• Reinvestment Risk
 Bonds – Price vs Interest Rates

• ₹10 Lakh
• Bond prices — not including
Coupon Rate: 10%
• accrued interest — vary
Invest Date of investment – 01 January 2016;
• inversely to market interest
Coupons paid semi-annually;
• rates.
Maturity in 3 years

What happens later?

636months;
months; 1
12 months;
18
24
30
Lakh/2
0.5 Lakh
= 0.5
+
0.5 Lakh
10Lakh
Lakh
 Interest Rate Regimes –
Decreasing

What happens to price of the

security?
 Prices of the securities would
increase. Why?
 Because now the market is
ready to pay more as they are
getting higher interest rates
than the prevailing market
rates
So What?
 Ones who invested earlier
at a higher interest rate can
disinvest their portfolio at a
higher price.
Basics of investment in bonds

• YTM, Current Yield, Price

• The price of a bond is the sum of the present value of all future (remaining) cash
flows.
• YTM is the expected rate of return of a bond if it is held till maturity.
• Current yield is simply the coupon rate divided by the price of the security.
• YTM and Coupon Yield:
• Market Price < Face Value: Bond sells at discount: YTM > Coupon Yield
• Market Price > Face Value: Bond sells at premium: YTM< Coupon Yield
• Market Price = Face Value: Bond sells at PAR: YTM= Coupon Yield
• Bonds with longer effective maturities, are more sensitive to changes in interest rates.
• Duration of a bond is a measure of time taken to recover the initial investment in present
value terms (Pay back period). At the same time, it is a measure of sensitivity of a bond’s
price to changes in interest rates.
• Modified duration is the change in value of the security to one per cent change in interest
rates (Yield).
 CALCULATION OF YTM IN EXCEL; YTM vs Coupon Yield

10% coupon

3 year residual period left

Bond Issue Bond Trading
Price: 100 Today at 103.00

Calculation of yield

FACEVALUE 100 PRICE 100

REDEMPTION VALUE(% of PAR) 100 YIELD 0.0700
ANNUAL COUPON RATE 7%
SETTLEMENT DATE 10-Oct-19 YIELD(B8,B9,B7,D5,B6,B10,B11)
MATURITY DATE 30-Oct-22
PAYMENT FREQUENCY 2
BASIS 4

7.00
Strategies for choosing investments
• What is the objective?
• Stable Income from surplus funds
• Reducing the risk of interest rate movements.
• Profit Booking

• Two Categories
• Passive – Without consideration of market movements and not intending for
sale/trade of securities for booking profits. (Holding till Maturity)
• Active – Betting on the change in interest rate movements for higher rate of
returns.
Passive Strategies
Strategy 1: Lazy
When you do not bother about anything except coupon payment and
maturity.
• Ideal for banks not having sufficient expertise in investments.
• This strategy works well only in a decreasing/stable interest rate environment.
• If you want to minimize interest rate risk, then select funds with low modified
duration (2 years or less is generally accepted as low risk appetite).
• More suitable for investments under Permanent/HTM
5-Year Yield Movements
in Government
Securities (10 Y)

The max and min yields in

the last five years were in
2014 at little over 9 and in
2017 at little below 6.4.
The above range shows high
fluctuation over a medium
term.
Yield movements in
the last one year

The yields have decreased

from little over 8 to little
over 6.6 in the last one year.
Passive Strategies
Strategy 2: Indexing
Indexing –
• An index is a group of securities defining a market segment. For example:
NIFTY Composite G-Sec Index, NIFTY Short Duration G-Sec Index,NIFTY
Medium Duration G-Sec Index.
• Factsheet
• One can choose to mimic the investment portfolio of the index.
• Upside: Less need to track market movements; Less expertise needed;
• Downside: More transaction costs for a investment portfolio of a CCB;
• More suitable for investments under Current/AFS
Active Strategies
Strategy 1: Immunization
Immunization is a strategy of managing a portfolio of assets such that the
business is immune to interest-rate fluctuations.
Cash Flow Matching – Purchase a zero coupon bond with face value =
obligation (Are they available for required maturity?)
Target Date Immunization Strategy - This involves holding a portfolio of bonds
that will accumulate in value to V at time T at the current market rate of
interest.
Duration Matching
A zero surplus at Io (present market interest rate) is said to be immunized,
if the surplus remains non-negative for small changes in interest rates on
either directions.
Liability driven investing – Reddington Immunization
Full Immunization Strategy
ACTIVE STRATEGIES – STRATEGY 2
• BETTING
The goal is to maximize returns (outperform the market)
• A strategy where the investment manager decides to bet on the movement in interest rates
• This strategy is ideal for securities which are to be kept in current(HFT) category.
• Pros
• Better flexibility
• Better risk management
• Cons
• Performance depends on the skill of the manager
• Higher Costs
• Key-man risk
 THANK YOU

Regards,
“Risk comes from not knowing what you are Team DoS and Team IDD
doing”

- Warren Buffet