RBI Amends Large Exposure Framework For Banks

The Reserve Bank of India tweaked the guidelines on how banks will treat large exposures to better capture concentration risk and align the framework with international norms.

The regulator introduced three amendments to the guidelines that came into effect from April 1. The changes are:

• Exclude entities connected with the sovereign from definition of group of connected counterparties.
• Introduce economic interdependence criteria in the definition of connected counterparties.
• Make look-through approach mandatory in determining relevant counterparties in case of collective investment undertakings, securitisation vehicles and other structures.

The RBI had first introduced the large-exposure framework in December 2016 to reduce the bad loan risks faced by Indian banks. The guidelines also gain prominence in light of defaults by the IL&FS and Videocon groups.

Most of the amended guidelines will be effective April 1, the RBI said. The norms on economic interdependence criteria and non-centrally cleared derivatives exposures would be applicable from the new financial year.

The RBI has exempt:

• Large exposures to central and state governments which are eligible for zero percent risk weight.
• Exposures to the RBI.
• Cases where the principal and interest are fully guaranteed by the government.
• Exposures are secured by financial instruments issued by the government.
• Intraday inter-bank exposures.
• Intra group exposures.

Borrowers to whom limits are authorised under food credit exposures to qualifying central counterparties in case of bank clearing activities and deposits maintained with Nabard.

Two or more companies which are outside the scope of sovereign exemption but are dependent or owned by a borrower with such an exemption will not be deemed to constitute a group of connected counterparties, the regulator said.

But a bank’s exposure to an exempt entity which is hedged by a credit derivative for that specific credit exposure, notwithstanding the original exemption, will be assessed under the framework.

The RBI introduced the economic interdependence criteria for banks to better assess connected-party risk. The regulator defines it as a situation where if one of the counterparties were to experience financial problems, in particular funding or repayment difficulties, the others would also be likely to encounter similar problems.

The criteria must be looked at in conjunction with the control relationship that they might share, the regulator said. To establish economic interdependence, banks must consider at a minimum that:

• 50 percent or more of one counterparty’s gross receipts or gross expenditure is derived from the other counterparty
• Where the exposure to one counterparty is guaranteed by another which will likely default if a claim is made
• Where both counterparties are dependent on the same revenue source to repay loans
• Situations where both counterparties are likely to be linked in the event of an insolvency proceeding.

The regulator said banks are expected to identify possible connected counterparties when the sum of all exposures to one individual counterparty exceeds 5 percent.