Banks’ large exposure to counterparties to be capped at 25% of Tier 1 capital

The Reserve Bank of India is planning to cap banks’ large exposure (LE) to each counterparty, including a group of connected counterparties, at 25 per cent of their Tier 1 capital.

The current single and borrower group exposure (loan) limits are placed at 15 per cent and 40 per cent respectively of the banks’ Capital Funds (Tier I + Tier II capital).

In a discussion paper on ‘Large Exposures Framework and Enhancing Credit Supply through Market Mechanism’, which was released late last evening, the RBI said the proposed LE Framework exposure limit will be 25 per cent of Tier I Capital for single as well as groups of connected counterparties.

The central bank said the Large Exposures (LE) framework will be fully applicable from January 1, 2019.

As banks’ large exposures will be capped, the RBI said it will encourage large borrowers to raise a certain portion of their financing needs through the market mechanism.

Hence, it wants large borrowers to meet a portion of both their short-term and long-term funding needs through market mechanisms such as commercial papers (CPs) and corporate bonds.

The IMF, in its Financial Sector Assessment Program for India, has observed that the prudential framework in India is characterised by concentration limits that are significantly higher than international best practice and a too-general definition of connected counterparties.

“The default of a borrower or a group of connected borrowers can cause a serious loss to a banking group. The current large exposure limit is a maximum of 55 per cent of a banking group’s capital,” said the IMF.

The RBI said, currently, the average Tier I and Tier II capital of banks in India is in the ratio of 70:30.

“Thus, even at current levels of capital, banks in India will get additional buffer for their exposures to single counterparties under the LE Framework vis-à-vis the current exposure norms of RBI. However, their group exposure limits will be reduced to some extent,” it said.

The RBI pointed out that in the BCBS standards, counterparties connected through specific relationships or dependencies are referred to as a group of connected counterparties and must be treated as a single counterparty. These relationships and dependencies arise from two criteria — control relationship and economic interdependence.

While the control relationship criterion of the BCBS Standard is similar to the RBI’s current norms on identification of ‘group’ borrowers, the criterion of ‘economic interdependence’ is an additional requirement.

Practical difficulties are envisaged in implementing the economic interdependence criterion in India in terms of information availability and also in view of the current stage of development of financial markets and economy, the RBI said.

Accordingly, the adoption of the proposal to include ‘economic interdependence’ as a criterion merits wider discussion with all stakeholders. The central bank has invited comments on the discussion paper by April 30.