What changed
RBI issued a circular prohibiting banks from investing in zero coupon bonds unless the issuer builds a sinking fund for all accrued interest and keeps it in liquid investments or government securities. Banks are also required to set conservative limits on their ZCB investments.
What it means for you
This move addresses the risk of credit exposure going unrecognized until maturity, especially for long-term ZCBs, which could pose systemic issues if large-scale. Banks must now ensure that the credit risk is mitigated through a sinking fund mechanism, reducing the potential for sudden defaults. Lenders will need to reassess their investment strategies and limit exposure to such instruments.
What you must do
- Immediately stop new investments in zero coupon bonds unless the issuer provides a sinking fund for accrued interest, invested in liquid securities or government bonds.
- Review and set conservative internal limits for existing and future ZCB investments.
- Ensure compliance with the sinking fund requirement for any ZCBs already held or planned.
- Monitor and report adherence to these prudential norms to the board and risk management committees.
Who it affects
All commercial banks (excluding Regional Rural Banks), Treasury departments, Risk management teams, Credit and investment committees
Why did RBI ban investments in zero coupon bonds without a sinking fund?
RBI noted that ZCBs allow credit risk to go unrecognized until maturity, which can be significant for long-term bonds and pose systemic risks if done on a large scale. The sinking fund requirement ensures that accrued interest is set aside in liquid assets, mitigating this risk.
What are the key conditions for banks to invest in ZCBs now?
Banks can only invest if the issuer creates a sinking fund for all accrued interest and keeps it invested in liquid investments or government securities. Additionally, banks must set conservative limits on their total ZCB exposure.
Does this circular apply to all banks?
It applies to all commercial banks except Regional Rural Banks (RRBs).