What changed
RBI issued a new restriction on UCB investments in Zero Coupon Bonds (ZCBs). Banks can no longer invest in ZCBs unless the issuer sets up a sinking fund for all accrued interest and keeps it invested in liquid investments/securities (Government bonds). This supplements earlier instructions from January 2009 on non-SLR securities.
What it means for you
UCBs must now assess ZCB issuers' compliance with the sinking fund requirement before investing. This rule aims to prevent hidden credit risk buildup, especially in long-term ZCBs, which could pose systemic issues if large-scale investments go unrecognized until maturity. Banks should ensure new investments meet the condition.
What you must do
- Stop new ZCB investments unless the issuer provides a sinking fund for accrued interest invested in liquid investments/securities (Government bonds).
- Review existing ZCB holdings to identify any that lack a sinking fund and assess compliance with the circular.
- Update internal investment policies and credit risk frameworks to incorporate this new condition for ZCBs.
- Train treasury and credit teams on the revised prudential norms for ZCB investments.
Who it affects
Primary (Urban) Co-operative Banks, Treasury departments of UCBs, Credit risk management teams in UCBs, Issuers of Zero Coupon Bonds, including corporates and NBFCs
What is a sinking fund in this context?
A sinking fund is a separate pool of money set aside by the ZCB issuer to cover all accrued interest over the bond's life. It must be invested in liquid investments/securities (Government bonds) to ensure funds are available at maturity.
Does this circular apply to all cooperative banks?
It specifically applies to Primary (Urban) Co-operative Banks, as addressed in the circular. Other types of cooperative banks may need to check separate RBI instructions.
What happens if a UCB already holds ZCBs without a sinking fund?
The circular does not explicitly address existing holdings, but banks should review their portfolios for compliance and consider the heightened credit risk. RBI may expect proactive risk management.