Accounting By Asterisk

Recent reports that banks have approached the Reserve Bank of India seeking permission to spread out losses on their bond portfolios amidst rise in yields could well be dismissed as routine lobbying, were it not for what they reveal about our increasingly elastic relationship with financial discipline. The trigger, as always, is a sharp rise in yields, which mechanically translates into mark-to-market losses on government securities. The request, equally predictably, is to soften the blow by amortising these losses over time.

Unlike credit losses, which, once recognised, tend to linger on bank balance sheets due to regulatory norms, MTM losses are not necessarily permanent. Interest rates may well reverse course; yields could fall; and what appears as a loss today could morph into a gain tomorrow. In that sense, MTM volatility can feel transient, even unfair.

MTM accounting is not designed to judge permanence; it is designed to reflect reality — immediate, observable, and market-determined. A tradable asset, by definition, carries a price that changes with market conditions. Recognising that change is not a punitive exercise; it is a prudential necessity. It ensures that balance sheets remain anchored to current valuations rather than to optimistic assumptions about future reversals.

The comparison with credit risk is instructive, and often misunderstood. Loans are not continuously tradable instruments; their valuation does not fluctuate in real time with a liquid market price. Instead, the regulatory framework imposes provisioning norms to account for expected losses which is an altogether different mechanism aimed at capturing deterioration in credit quality over time. MTM, by contrast, is the discipline applied to assets that can be sold, priced, and re-priced daily.

More importantly, the asymmetry in the banks’ argument is hard to miss. If MTM losses can be deferred on the expectation that interest rates might fall, what happens if rates rise further in the next quarter? Do we then extend the deferral? Stretch the amortisation window? Or quietly accumulate a larger stock of unrecognised losses? Markets, after all, are under no obligation to cooperate with accounting preferences.

This is the inconvenient truth. MTM cuts both ways. In a falling yield environment, banks sit and juice profit and, occasionally, bonuses. There is rarely a call then to smooth or defer these gains in the interest of prudence. Yet when the cycle turns, the same volatility is recast as an aberration, something to be managed away through regulatory indulgence.

Such selective comfort with market discipline is where the sanctity of rules begins to erode.

The analogy to news channels censoring expletives is not entirely misplaced. Replace a few letters with asterisks, and the word remains perfectly intelligible. The viewer is spared the appearance of vulgarity, but not its substance. Similarly, spreading MTM losses over time does not eliminate them; it merely masks their immediacy. The balance sheet appears cleaner, profits less volatile, but the underlying economic reality is unchanged, only deferred. Don’t valuation metrics take care of this while valuing bank stocks?

There is, of course, a case for regulatory flexibility in periods of extreme stress. Financial systems are not academic constructs; they are living organisms, prone to panic and contagion. A rigid insistence on MTM in the midst of disorderly market conditions can amplify instability. But flexibility, to retain credibility, must remain the exception and not the default response to every bout of volatility.

Frequent relaxations carry a subtler, more corrosive risk. They recalibrate expectations. Banks begin to operate on the assumption that adverse outcomes will be cushioned, that rules are negotiable, and that discipline is, at best, conditional. Over time, this weakens incentives for prudent risk management…be it in managing duration, hedging interest rate exposure, or calibrating investment books.

The broader question, then, is not whether banks deserve relief in a difficult quarter. It is whether the system can afford the gradual dilution of the very norms that are meant to safeguard it. MTM is not an accounting inconvenience; it is a transparency tool.

Blur these distinctions, and we risk creating a framework that is neither transparent nor prudent; only convenient.

In finance, as in broadcasting, asterisks may make things look better. But they do little to change what is actually being said.