The State Bank of Pakistan (SBP) has issued the
circular regarding amendments in the revaluation of banks' investment
portfolios. The amendments that have been made relate to the held to
maturity investments where a) unrealized losses on securities would be
carried at amortized cost and shall not be required to be revalued and
losses do not have to be booked on their balance sheets and b)
reclassification within classes for held to maturity investments would
be disallowed once a security has been classified as held to maturity.
The circular BSD-14 is a follow up to an earlier
circular BSD-10 on the classification of investment portfolios of banks.
According to BSD-14 banks no longer need to revalue their holdings of
the government securities and bonds that have been categorized as 'held
to maturity'. In order to bring the investment portfolios under
International Accounting Standards, banks were supposed to classify
their securities in three categories: 1) held for trading, 2) available
for sale and 3) held for maturity.
According to Ali Farid of AKD Securities, "The
SBP has stepped in as a savior to bring the banks out of the bond market
blood bath. As interest rates climbed up, bonds prices fell and banks,
which has previously made huge gains from the rising bond prices, were
caught on the wrong foot. The combined impact on falling bond prices,
along with thin spread, placed the banking sector's profitability in
peril. Although, the rise in interest rates is expected to improve the
spread, the impact would still be marginal, as high competition in the
sector would be a constraint. "
These amendments are expected to bode well for banks
as it would prevent them from reporting losses on their balance sheets.
However, banks would have to make a strategic decision regarding which
investments would have to be classified under held to maturity before
30th September. Although, most banks have disposed off part of their PIB
holdings during the current year, PIB holdings are still a matter of
The amendments in the circular focus on held to
maturity investments. According to the previous circular, unrealized
gains and losses on securities under this category would be charged to
equity and could be transferred to the other two classes, namely held
for trading and available for sale within two months of a new accounting
year. Both of these points have been modified where now unrealized gains
and losses on securities held to maturity would be carried at amortized
cost and shall not be required to be revalued. In addition,
reclassification within classes for held to maturity investments cannot
be made and once a security has been classified as held to maturity it
cannot be reclassified.
The amendments should bode well for banks as they
would not have to book unrealized losses on their equity with respect to
bond investments. During the recent past, banks have been facing a major
threat as increasing PIB rates have resulted in huge unrealized losses
on their investment portfolios. Since these investments do not have to
be revalued and can be carried at cost, a major hit on bank's balance
sheet is avoided. However, banks would have to re-examine and finalize
their investment categories by 30th September 2004 after which
reclassification of investments amongst the three categories would be
difficult to make. Therefore, banks would have to make a strategic
decision on how much investments would be classified as "held to
maturity". It is expected that banks would transfer majority of
their PIB holdings depending on their ability to maintain a large PIB
With respect to specific banks, larger banks are
expected to benefit the most as they have the capacity to transfer most
of their PIB holdings as held to maturity and carry their large
portfolio for a long period of time.
THE KEY CATEGORIES
Held for Trading investments are valued at fair
market value and listed on current assets on the balance sheet. Any
unrealized and realized gains or losses on these securities are reported
in the income statement.
Available for Sale securities are valued at market
value and carried on the balance sheet. The unrealized gains and losses
on this category are not included in income statement and reported as a
separate component of shareholders' equity.
Held to Maturity securities are valued at amortized
costs and are not revalued. However, according to the new circular, once
the banks have made the classification, they cannot reclassify the
securities form one category to another. This would help the banks with
high proportion of government securities and bonds, whose value is below
market value. Also once the banks have classified their holdings of
government securities as held to maturity, they would be saved from the
fall in bond prices due to any hike in interest rates. This would
provide the banks an incentive to invest in government securities
especially since the yields are also increasing.