Available-for-Sale (AFS) Portfolio

In modern banking and financial systems, investment classification plays a critical role in balance sheet management, risk assessment, and regulatory compliance. One such important classification is the Available-for-Sale (AFS) portfolio, which occupies a middle position between trading securities and long-term held investments. In the Indian context, the AFS portfolio has particular significance due to the structure of the banking sector, the dominance of government securities, and the regulatory framework prescribed by the Reserve Bank of India (RBI).
The AFS portfolio refers to a category of financial assets that banks and financial institutions do not intend to actively trade in the short term, nor hold until maturity. These securities are primarily maintained to manage liquidity, earn stable returns, and respond flexibly to changing interest rate and market conditions.

Concept and Definition of Available-for-Sale Portfolio

The Available-for-Sale portfolio consists of investments that are neither classified as Held-to-Maturity (HTM) nor Held-for-Trading (HFT). These securities may be sold in response to liquidity needs, changes in interest rates, or shifts in asset–liability management strategies.
In accounting terms, AFS securities are typically carried at fair value, with unrealised gains or losses recognised differently from trading securities. In India, regulatory accounting treatment is largely guided by RBI norms, which align partially with international standards while retaining prudential safeguards.
AFS investments commonly include:

• Government securities
• State Development Loans (SDLs)
• Corporate bonds and debentures
• Shares and units of mutual funds (where permitted)

Regulatory Framework in India

The RBI governs the classification, valuation, and income recognition of investment portfolios of banks in India. Banks are required to classify their investments into three categories:

• Held-to-Maturity (HTM)
• Available-for-Sale (AFS)
• Held-for-Trading (HFT)

The AFS portfolio is subject to stricter valuation norms than HTM but less frequent marking than HFT. Key regulatory features include:

• Mark-to-market valuation: AFS securities must be marked to market at least quarterly.
• Depreciation and appreciation treatment: Net depreciation is charged to the Profit and Loss Account, while net appreciation is generally ignored.
• Transfer restrictions: Shifting securities between HTM, AFS, and HFT categories is restricted and regulated to prevent income smoothing.

These norms aim to ensure transparency, financial discipline, and prudent risk management within the banking system.

Role of AFS Portfolio in Banking Operations

The AFS portfolio serves several strategic functions in banking operations.
One major role is liquidity management. Unlike HTM securities, AFS investments can be sold without regulatory penalties, making them a reliable source of funds during liquidity stress. This is particularly important in India, where banks often face seasonal liquidity pressures.
Another critical role is interest rate risk management. By maintaining a diversified AFS portfolio, banks can adjust their exposure to changing interest rates. For example, during periods of rising interest rates, banks may reduce their AFS holdings to limit valuation losses.
The AFS portfolio also contributes to income generation. Interest income from bonds and securities provides stable returns, while occasional sale of securities may generate capital gains, subject to market conditions.

Valuation and Accounting Treatment

Valuation of AFS securities in India is conservative in nature. The portfolio is valued at market prices or prices declared by authorised valuation agencies.
Important aspects of valuation include:

• Securities are valued individually or category-wise as prescribed.
• Net depreciation within the AFS category must be recognised in the Profit and Loss Account.
• Net appreciation is ignored and not recognised as income.
• Provisions once created cannot be reversed even if market prices recover, except on sale or maturity.

This asymmetric treatment reflects prudential regulation, ensuring that banks do not overstate profits during favourable market movements.

AFS Portfolio and the Indian Government Securities Market

The Indian banking system is a major investor in government securities due to statutory requirements such as the Statutory Liquidity Ratio (SLR). Although a significant portion of SLR investments is held under HTM, a sizeable share is maintained under AFS to retain flexibility.
AFS holdings of government securities play an important role in:

• Supporting the government borrowing programme
• Enhancing liquidity in the bond market
• Transmitting monetary policy signals through yield movements

Changes in repo rates, open market operations, and inflation expectations directly affect the valuation of AFS government securities, making this portfolio highly sensitive to monetary policy actions.

Impact on Profitability and Capital Adequacy

The AFS portfolio has a direct influence on bank profitability and capital adequacy.
During periods of falling interest rates, bond prices rise, leading to potential gains on AFS securities. Although unrealised gains are not fully recognised, realised gains on sale can boost profits.
Conversely, during periods of rising interest rates, banks may face mark-to-market losses, increasing provisions and reducing net profits. This was evident during phases of monetary tightening in India, when banks experienced pressure on earnings due to AFS depreciation.
Large valuation losses can also indirectly affect capital adequacy, as reduced profits limit internal capital generation, which is crucial for meeting Basel III norms.

Significance in Asset–Liability Management (ALM)

Asset–Liability Management is central to banking stability, and the AFS portfolio is a key ALM tool. By adjusting the duration and composition of AFS securities, banks manage mismatches between assets and liabilities.
AFS securities allow banks to:

• Rebalance portfolios in response to changing deposit profiles
• Manage duration gaps
• Respond quickly to market signals without long-term commitment

In India, where deposit maturities are often short-term, the flexibility of the AFS portfolio is especially valuable.

Risks Associated with AFS Portfolio

Despite its advantages, the AFS portfolio carries several risks.
The most prominent risk is interest rate risk, as bond prices are inversely related to interest rates. Sudden policy changes can lead to sharp valuation losses.
There is also market liquidity risk, particularly in corporate bonds and lower-rated securities, where selling large volumes may be difficult without price concessions.
Additionally, regulatory risk exists, as changes in RBI norms regarding valuation or classification can significantly affect banks’ investment strategies and reported earnings.

Criticism and Challenges in the Indian Context

The AFS framework in India has faced criticism for its conservative accounting treatment, especially the non-recognition of unrealised gains while mandating full recognition of losses. Critics argue that this leads to income volatility and discourages active portfolio management.
Another challenge is the high concentration of government securities, which increases systemic exposure to interest rate cycles. Smaller banks, in particular, may struggle to absorb AFS valuation losses during tightening phases.
The gradual transition towards Indian Accounting Standards (Ind AS) has also posed challenges, as fair value accounting introduces greater earnings volatility, requiring banks to strengthen risk management and capital buffers.

Importance for the Indian Economy

The AFS portfolio is significant not only for banks but also for the broader Indian economy. By enabling banks to actively participate in the government securities market, it supports public borrowing and infrastructure financing.
The portfolio also enhances financial stability by providing liquidity buffers and improving transmission of monetary policy. Well-managed AFS portfolios help banks absorb shocks, maintain confidence, and continue credit flow to productive sectors.