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RBI curbs UCB investments in Zero Coupon Bonds without sinking fund

Current · Source: Reserve Bank of India · RBI/2010-11/409 · issued 18 Feb 2011 · ~2 min read
Quick answerRBI has barred Primary Urban Co-operative Banks from investing in Zero Coupon Bonds unless the issuer creates a sinking fund for accrued interest, invested in liquid investments/securities (Government bonds), 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 is reviewing a new investment offer from a company selling long-term Zero Coupon Bonds. Before approving the purchase, she checks that the company has created a sinking fund for all the interest that will pile up over the years and that the fund is invested only in Government bonds. Only then does she give the green light, knowing the bank's money is safer.

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

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

❓ Common questions

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.

📜 Read the original circular — full text as issued by RBI
RBI/2010-11/409 UCB (PCB) BPD Cir.No. 36/16.20.000/2010-11 February 18, 2011 The Chief Executive Officers of All Primary (Urban) Co-operative Banks Dear Sir / Madam, Prudential norms on investment in Zero Coupon Bonds Please refer to paragraph 2 (iii) (c) of circular UBD(PCB) BPD Cir No.46/16.20.000/2008-09 dated January 30, 2009 on investments in Non-SLR securities by Primary (Urban) Co-operative Banks. 2. It is observed that banks are investing in long term Zero Coupon Bonds (ZCBs) issued by corporates including those issued by Non-Banking Financial Companies (NBFCs). As the issuers of ZCBs are not required to pay any interest or installments till the maturity of bonds, 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. 3. In view of the above, it has been decided that banks should not, henceforth invest in ZCBs unless the issuer builds up a sinking fund for all accrued interest and keeps it invested in liquid investments/securities (Government bonds). The other instructions contained in paragraph 2 (iii)(c) of circular dated January 30, 2009 remain unchanged. Yours faithfully, (Uma Shankar) Chief General Manager
Reproduced for reference with acknowledgment — Source: Reserve Bank of India · RBI/2010-11/409 · issued 18 Feb 2011. The plain-English explanation above is BankPulse’s own independent summary.
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Who does what — compliance checklist
💻 IT / Systems
  • Train treasury and credit teams on the revised prudential norms for ZCB investments.
📜 Compliance
  • 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.
Grouped from the action items above — a single circular may involve more than one team.
Worked example & action-note template

Example: if you are a Compliance officer at a bank this circular applies to (Primary (Urban) Co-operative Banks, Treasury departments of UCBs, Credit risk management teams in UCBs, Issuers of Zero Coupon Bonds, including corporates and NBFCs), your first concrete step on “RBI curbs UCB investments in Zero Coupon Bonds without sinking fund” is: “Stop new ZCB investments unless the issuer provides a sinking fund for accrued interest invested in liquid investments/securities (Government bonds).” (RBI issued this 18 Feb 2011).

  1. Circular: RBI/2010-11/409 -- RBI curbs UCB investments in Zero Coupon Bonds without sinking fund
  2. Issued: 18 Feb 2011
  3. Action required: Stop new ZCB investments unless the issuer provides a sinking fund for accrued interest invested in liquid investments/securities (Government bonds).
  4. Action required: Review existing ZCB holdings to identify any that lack a sinking fund and assess compliance with the circular.
  5. Action required: Update internal investment policies and credit risk frameworks to incorporate this new condition for ZCBs.
  6. Action required: Train treasury and credit teams on the revised prudential norms for ZCB investments.
  7. Owner: ____________ Target date: ____________
  8. Board/committee approval needed? Y / N
  9. Evidence filed in compliance register on: ____________
Built only from this circular’s own published fields — not legal advice; always confirm against the official RBI source.

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Official RBI source: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=6268&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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