The RBI Report on Trend and Progress of Banking (2024-25) has stated that “A comprehensive review of the existing instructions on IFR is underway to address certain operational constraints faced by banks in maintaining the IFR.”
Thus, some modifications in the Investment Fluctuation Reserve (IFR) provision were expected sooner or later, but not its outright abolition, which the RBI announced on April 8, 2026.
The genesis
The interest rate acts as a double-edged sword on banks’ profitability. A rising interest rates regime favours net interest income of banks in the near term via faster increase in lending rates vis-à-vis deposit rates. However, it disfavours non-interest income because rising yields on government securities impose ‘Mark-to-Market (MTM)’ losses thereon.
It is noteworthy here that government securities are the mainstay of treasury investments of the Indian banks. Thus, erosion of banks’ profitability is likely.
A significant uptrend in the yield of 10-year government security during 2017-18 (except Q1) resulting in MTM losses for banks provided the backdrop for the IFR introduction in 2018.
The RBI advised banks to create and maintain an IFR with effect from FY2019 subject to profit availability after statutory appropriations.
Amount transferred to IFR was to be lower of the following (a) net profit on sale of investments during the year or (b) net profit for the year less mandatory appropriations, until the amount of IFR is at least 2 per cent of the ‘Available for Sale (AFS)’ and ‘Held for Trading (HFT)’ portfolio on a continuing basis, to be achieved preferably within three years from 2018-19.
In March 2020, the RBI permitted banks to count IFR balances as part of the Tier-II capital.
Thus, when yields on government securities increase, IFR acts as a ‘shock absorber’ for banks against MTM losses, besides fostering adequate reserves. As a macroprudential policy measure, it mitigates the macroeconomic impact of sharp increases in yields thereby enhancing systemic resilience.
IFR status
The Table presents the IFR position, bank group-wise, at March-end 2025.
* At March-end 2025, the 33 banks had an average closing IFR balance of almost ₹1,400 crore, posting a Compound Annual Growth Rate of a little over 26 per cent during 2021-25: PSBs the highest (34 per cent), followed by OPBs (22 per cent) and NPBs (19 per cent).
* All banks maintained the stipulated minimum ‘ratio’ of 2 per cent. However, in a few years, a handful of banks fell short of the benchmark.
* The ‘ratio’ was the highest in respect of OPBs followed, in succession, by NPBs and PSBs, reflecting their investment policies and risk appetite.
* During 2024-25, banks transferred 0.5 per cent of their profit available for appropriation (PAP) to IFR with OPBs at the highest (1.2 per cent) followed by PSBs (0.8 per cent) and NPBs (0.3 percent).
* At March-end 2025, the closing IFR balances constituted 14.6 per cent of the Tier-II capital: OPBs the highest (21.6 per cent) followed by NPBs (15.6 per cent) and PSBs (13.5 per cent).
* During 2021-25, the utilisation of IFR remained very limited as indicated by the ‘drawdown’ instances, and the total drawdown was below ₹2,400 crore.
Discontinuation
The RBI provides two reasons for discontinuing IFR: (a) “the operational challenges faced by banks in maintaining IFR above the regulatory threshold on a continuous basis” and (b) with the revised norms on classification, valuation and operation of investment portfolio announced by the RBI in November 2025, banks were better placed to mitigate the market risk.
The RBI requires banks to treat the outstanding IFR balance as Tier-I capital by transferring it to Statutory Reserve, General Reserve or Balance of Profit & Loss Account.
Although the gains will be reflected in banks’ books in 2026-27, a simulation exercise of its impact on the capital adequacy ratios of the 33 banks at March-end 2025 showed the Tier-II ratio to decrease by 28 bps to 1.6 per cent and the Tier-I ratio to increase correspondingly to 15.6 per cent. More Tier-I capital would mean more lendable resources.
However, doubts arise as to the ‘timing’ of the discontinuance due to the prevailing volatile conditions in general and rising yields of government papers in particular. For instance, yields on the benchmark 10-year government security increased to 7.04 per cent at March-end 2026 from 6.59 per cent at December-end 2025.
It is also viewed that the abolition could have been ‘gradual.’
In sum, to the extent the abolition minimises the operational complexities for banks and does not erode their profitability, it would be good.
The writer is a former Assistant General Manager (Economist), SBI. Views expressed are personal
Published on May 26, 2026