December 26, 2011
All NBFCs (excluding RNBCs)
Revised Capital Adequacy Framework for Off-Balance Sheet Items for NBFCs
In the normal course of their business, NBFCs are exposed to credit and market risks in view of the asset-liability transformation. With liberalisation in Indian financial markets over the last few years and growing integration of domestic markets with external markets and greater use of derivatives products, asset liability management for NBFCs have become complex and large, requiring strategic management. Off balance sheet exposures of NBFCs have increased with the increased participation in the designated currency options and futures and interest rate futures as clients for the purpose of hedging their underlying exposures. It is therefore necessary that NBFCs move over to modern techniques of risk measurement to strengthen their capital framework.
3. The Non-Banking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 and The Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 require the NBFCs to maintain a minimum CRAR based on risk weights assigned to both on and off balance sheet items. Explanation (2) to para 16 of the afore-mentioned Regulations, however, recognizes only 6 items as off balance sheet items which have linkages to NBFI activities. There is therefore a need to recognize instruments which would find use in balance sheet management/ hedging, in liquidity management or which provide alternate forms of resources, other than the traditional ones.
4. It is therefore considered necessary to expand the off-balance sheet regulatory framework to introduce greater granularity in the risk weights and credit conversion factors for different types of off balance sheet items. For this purpose, NBFCs will need to calculate the total risk weighted off-balance sheet credit exposure as the sum of the risk-weighted amount of the market related and non-market related off-balance sheet items. The risk-weighted amount of an off-balance sheet item that gives rise to credit exposure will be calculated by means of a two-step process :
- the notional amount of the transaction is converted into a credit equivalent amount, by multiplying the amount by the specified credit conversion factor or by applying the current exposure method; and
- the resulting credit equivalent amount is multiplied by the applicable risk weight.
5. For the off-balance sheet items already contracted by NBFCs, the risk weights shall be applicable with effect from the Financial Year beginning April 01, 2012. For all new contracts undertaken including CDS, the new risk weights shall be applicable from the date of the circular.
6. The amending Notifications DNBS.PD.No.237/ CGM (US) 2011 and DNBS.PD.No. 238/CGM (US) 2011 both dated December 26, 2011 amending the Non-Banking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) directions, 2007 and the Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 respectively are enclosed for meticulous compliance.
Chief General Manager in Charge