HomeCirculars › RBI/2010-11/219

RBI curbs bank investments in zero coupon bonds

No longer current — withdrawn, no replacement on file yet
Source: Reserve Bank of India · RBI/2010-11/219 · issued 29 Sep 2010 · ~2 min read
Quick answerRBI has barred banks from investing in zero coupon bonds unless issuers create a sinking fund for accrued interest, invested in liquid securities like government bonds. Banks must also set conservative limits on such investments to mitigate unrecognized credit risk.
The rule, in the simplest words
How it plays out — a real example

A forex & trade-finance officer in Indore, Priya, is reviewing her bank's investment options. She sees a long-term zero coupon bond from a company. Remembering the new RBI rule, she tells her team they can only buy it if the company creates a sinking fund for all the interest that will pile up, and invests that fund in government bonds. She also sets a small limit on how much the bank can put into such bonds, keeping the risk low.

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.

Historical instruction — do not use for current compliance. This is what was required at the time; it no longer reflects current RBI requirements. If no replacement rule is linked above, that only means none is recorded on our register yet — it does not prove no later applicable rule exists. Confirm on the official RBI source below.

What banks were required to do at the time

Who it affects

All commercial banks (excluding Regional Rural Banks), Treasury departments, Risk management teams, Credit and investment committees

❓ Common questions

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).

📜 Read the original circular — full text as issued by RBI
The guidelines have been repealed. Please refer to the Reserve Bank of India (Classification, Valuation and Operation of Investment Portfolio of Commercial Banks) Directions, 2021 . RBI/2010-11/219 DBOD No. BP.BC. 44 / 21.04.141/ 2010-11 September 29, 2010 The Chairmen and Managing Directors/ Chief Executive Officers of All Commercial Banks (excluding Regional Rural Banks) Dear Sir, Prudential norms on Investment in Zero Coupon Bonds It has come to our notice that banks are investing in long term Zero Coupon Bonds (ZCBs) issued by corporates including those issued by Non-Banking Financial Companies (NBFCs). In the case of ZCBs the issuers are not required to pay any interest or installments till the maturity of bonds. As a result, the credit risk in such investments would go unrecognized till the maturity of bonds and this risk could especially be significant in the case of long term ZCBs. Such issuances and investments if done on a large scale could pose systemic problems. 2. In view of the foregoing, it has been decided that: • Banks should henceforth not invest in ZCBs unless the issuer builds up sinking fund for all accrued interest and keeps it invested in liquid investments/securities (Government bonds), and • Banks should put in place conservative limits for their investments in ZCBs. 3. Banks are advised to take immediate action to adhere to the above instructions. Yours faithfully (B. Mahapatra) Chief General Manager-in-Charge
Reproduced for reference with acknowledgment — Source: Reserve Bank of India · RBI/2010-11/219 · issued 29 Sep 2010. The plain-English explanation above is BankPulse’s own independent summary.
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Official RBI source: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=6019&Mode=0 — Plain-English summary by BankPulse (bankpulse.ai), reviewed by our expert reviewer, CA Amit Jain. Independent platform, not affiliated with the Reserve Bank of India; is our own plain-English paraphrase, not RBI’s original wording.
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