KARACHI, July 14: The State Bank has issued guidelines on classification of their investment portfolio making it difficult for banks and development finance institutions or DFIs to avoid showing losses booked on their investments.

The Banking Supervision Department of the central bank issued a circular on Wednesday that envisages such conditions for classification of investment portfolio of banks and DFIs that they cannot avoid showing losses on their books.

The circular requires all banks and DFIs to classify their investment portfolios into three key categories namely Held to Maturity, Available for Sale and Held for Trading.

Earlier there was no such requirement in place and a couple of banks were classifying as Held to Maturity their investment in government bonds when the bonds' prices moved up.

The banks involved in this practice were actually trying to avoid showing losses on their investment in the bonds, and thus concealing a key fact from their shareholders.

The SBP circular says that now the banks and DFIs will classify their investment into any of the above-stated three categories at the time of making this investment.

Senior bankers say that the purpose of this requirement is to ensure that the banks and DFIs do not classify the loss-yielding securities or bonds as Held to Maturity, when their prices start falling, just to avoid showing losses. The circular also requires banks and DFIs to classify their existing investments into the above categories.

Senior bankers well-versed with the issue told Dawn that some banks wanted the State Bank to allow as a policy matter shifting of the category of investment after the investment has been made but the central bank refused to do this. Instead, it promised to provide relief to specific banks or DFIs that do this for a genuine reason.

The circular says the SBP would allow shifting to and from Held to Maturity category once a year only in cases where the board of directors of the bank or DFI has approved of it within two months of the commencement of the account year.

In case of branches of the foreign banks, the approval of the country head is necessary. "Any further shifting to/from this category will not be allowed during the remaining part of that accounting year."

The circular further says that shifting to and from Available for Sale category will be allowed with the approval of the ALCO (Assets and Liabilities Committee) of the banks or DFIs but they will record the reasons for the shifting in writing.

It says that shifting of investment from 'Held for Trading' category to 'Available for Sale' or 'Held to Maturity' categories would generally not be allowed.

"It would be permitted under exceptional circumstances... and the justification for such exceptional shifting...shall be recorded in the minutes of the ALCO meeting, which shall be reviewed by the SBP inspectors during the on-site inspection."

The circular further says that shifting of securities from one category to another shall be done "at the lower of the market value or the acquisition cost/book value, and the diminution in value if any, on such transfer shall be fully provided for."

Cleared of jargons, it means that if a bank has purchased a bond for Rs120 and its current price is Rs110, its shifting from one to another category will take place at Rs110.

On the other hand if the bond has been bought at Rs120 and its current market price is Rs130, its shifting from one to another category will take place at Rs120. The purpose of this condition is to make investment portfolio management rather more market-based.

The circular says that the banks and DFIs will have to take the surplus/deficit arising as a result of revaluation of 'Held for Trading' securities into their Profit & Loss Account. They will have to take to Surplus/Deficit Account the surplus or deficit on revaluation of 'Available for Sale' and 'Held to maturity' securities.

"However, any permanent diminution in the value of 'Available for sale' or 'Held to Maturity' securities will be provided for by charging it to the Profit & Loss Account. The measurement of surplus/deficit shall be done on portfolio basis for each of the above three categories separately."

Senior bankers say this requirement means that the banks or DFIs will not be able to take the advantage of short term interest rate movements and make it next to impossible for them to avoid showing losses on investment.