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RBI Asks NBFCs To Maintain Liquidity Coverage Ratio

The RBI introduced a framework for NBFCs, which aims to bring liquidity coverage ratio of 100 percent for them in a phases.

The Reserve Bank of India (RBI) seal on a gate outside the RBI headquarters in Mumbai.
The Reserve Bank of India (RBI) seal on a gate outside the RBI headquarters in Mumbai.

The Reserve Bank of India today introduced a liquidity management framework for non-banking financiers, which seeks to bring in a liquidity coverage ratio of 100 percent for them in a phased manner.

“All non-deposit taking NBFCs with asset size of Rs 10,000 crore and above, and all deposit taking NBFCs irrespective of their asset size, shall maintain a liquidity buffer in terms of LCR which will promote resilience of NBFCs to potential liquidity disruptions by ensuring that they have sufficient High Quality Liquid Asset to survive any acute liquidity stress scenario lasting for 30 days,” the central bank said in its framework.

The liquidity coverage ratio requirement shall be binding on NBFCs from Dec. 1, 2020, with the minimum high quality liquid asset to be held being 50 percent of the ratio. This would be gradually brought up to 100 percent by December 2024, the RBI said.

For non-deposit taking NBFCs with an asset size between Rs 5,000-10,000 crore, that shall start at a lower threshold of 30 percent by December 2020 and build up to 100 percent over four years. Core investment companies, small non-deposit taking NBFCs, non-operating financial holding companies and standalone primary dealers are exempt from the liquidity coverage ratio requirements.

In May, when the regulator had first released its draft guidelines on liquidity management framework, the RBI had sought to start the liquidity coverage ratio regime implementation with 60 percent high quality liquid asset requirement from December 2020.

How Will NBFCs Use The LCR?

During a period of severe financial stress, NBFCs that have high quality liquid assets will be allowed to use them to meet their liquidity needs, provided they inform the regulator about the reason behind it and detail steps taken to address the problem.

The RBI also specified the events that can be classified as severe financial stress. These include, among others:

  • Run-off of a proportion of deposits.
  • Partial loss of unsecured wholesale funding capacity.
  • Partial loss of secured short-term financing.
  • Additional contractual outflows that would arise out from a downgrade of the NBFC.

To be considered a high quality liquid asset without any haircut, the asset could be in the form of cash, government securities, marketable securities which aren’t issued by banks, a financial institution, the NBFC or any of its affiliates. Other types of liquid assets can be considered under high quality liquid asset with haircuts ranging from 15-50 percent.

“NBFCs should periodically monetize a proportion of assets through repo or outright sale to test the saleability of these assets and to minimize the risk of negative signalling during period of stress,” the central bank said.

These companies will also be required to periodically disclose their liquidity coverage ratio every quarter.

Liquidity Risk Management Framework

To ensure a sound and robust liquidity risk management system, the board of the non-bank lender shall frame a liquidity risk management framework which ensures it maintains sufficient liquidity, including a cushion of unencumbered, high quality liquid assets to withstand a range of stress events, including those involving the loss or impairment of both unsecured and secured funding sources.

This would be applicable on all non-deposit taking NBFCs with an asset size of over Rs 100 crore, core investment companies and all deposit-taking NBFCs. Implementation of the framework would be the responsibility of the non-bank lender’s board and it would be subject to supervisory review. Other non-bank lenders are expected to adhere to such a framework on a voluntary basis, the RBI said.

Such monitoring tools shall cover:

  • Concentration of funding by counterparty/ instrument/ currency.
  • Availability of unencumbered assets that can be used as collateral for raising funds.
  • Certain early warning market-based indicators, such as book-to-equity ratio, coupon on debts raised, breaches and regulatory penalties for breaches in regulatory liquidity requirements.

Asset-Liability Mismatches

To ensure that asset-liability mismatches don’t get out of hand, RBI has set limits for the extent of ‘negative’ mismatch permitted in shorter maturity buckets. An asset-liability mismatch occurs when the tenor of an institution’s assets and liabilities don’t match. The 1-30 day time bucket in the statement of structural liquidity is segregated into granular buckets of 1-7 days, 8-14 days, and 15-30 days.

The net cumulative negative mismatches in the statement of structural liquidity in the maturity buckets 1-7 days, 8-14 days, and 15-30 days shall not exceed 10 percent, 10 percent and 20 percent of the cumulative cash outflows in the respective time buckets.
RBI liquidity framework for NBFCs

NBFCs, the central bank said, shall adopt a “stock” approach to liquidity risk measurement and monitor certain critical ratios in this regard by putting in place internally defined limits as approved by their board. The ratios and the internal limits shall be based on an NBFC’s liquidity risk management capabilities, experience and profile.

Besides, NBFCs must make extensive disclosures from here on. These disclosures include:

  • Funding concentration based on significant counter-parties.
  • Top 20 large deposits.
  • Top 10 borrowings.
  • Funding concentration based on significant instrument/products.
  • Exposure to CPs, NCDs and other short term liabilities.

The need for an extensive liquidity management framework came up after the Infrastructure Leasing & Financial Services Group collapsed last year, leading to a freeze in available credit among non-bank lenders and housing financiers. As a direct consequence of this, companies like Dewan Housing Finance Corporation Ltd., Altico Capital India Pvt. Ltd., Reliance Home Finance Ltd. and Reliance Commercial Finance Ltd. are facing a severe funding crunch and are undergoing restructuring by their respective lenders.

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