In the backdrop of the liquidity issues being faced by non-banking finance companies, the Reserve Bank of India (RBI) on Friday issued a draft circular on ‘Liquidity Risk Management Framework’.

This will require them to ensure maintenance of sufficient liquidity, including a cushion of unencumbered, high-quality liquid assets to withstand a range of stress events; establish diversified funding strategy; and monitor the risk of intra-group transfers.

The draft guidelines, which have to be adopted by all deposit taking NBFCs, non-deposit taking NBFCs with an asset size of ₹100 crore and above, and all CICs, among others, cover application of generic ALM (asset-liability management) principles.

They will bifurcate the 1-30 day time bucket in the statement of structural liquidity into granular maturity buckets and tolerance limits, liquidity risk monitoring tool, and adoption of the “stock” approach to liquidity.

In addition, the draft proposes to introduce Liquidity Coverage Ratio (LCR) for all deposit taking NBFCs; and non-deposit taking NBFCs with an asset size of ₹5,000 crore and above.

With a view to ensuring a smooth transition to the LCR regime, the proposal is to implement it in a calibrated manner through a glide path over a period of four years commencing from April 2020 and going up to April 2024.

Market experts say all the measures outlined in the draft circular could increase the cost of funding for NBFCs.

The draft circular requires the NBFCs to actively manage their collateral positions, differentiating between encumbered and unencumbered assets.

They should have sufficient collateral to meet expected and unexpected borrowing needs and potential increases in margin requirements over different time frames. The NBFCs have to formulate a contingency funding plan for responding to severe disruptions, which might affect their ability to fund some or all of their activities in a timely manner and at a reasonable cost.

The RBI said the net cumulative negative mismatches (fund outflows exceeding inflows) in the maturity buckets of 1-7 days, 8-14 days, and 15-30 days should not exceed 10 per cent, 10 per cent and 20 per cent of the cumulative cash outflows respectively.

The NBFCs, however, are expected to monitor their cumulative mismatches (running total) across all other time buckets up to one year by establishing internal prudential limits with the Board’s approval.

The NBFCs are required to adopt liquidity risk monitoring tools/metrics in order to capture strains in liquidity position, if any. Such monitoring tools should cover concentration of funding by counterparty/instrument/currency, availability of unencumbered assets that can be used as collateral for raising funds, and certain early warning market-based indicators such as price-to-book ratio, coupon on debts raised, breaches, and regulatory penalties.

In addition to the measurement of structural and dynamic liquidity, NBFCs have also been mandated to monitor liquidity risk based on a “stock” approach to liquidity. The monitoring will be by way of predefined internal limits as decided by the Board for various critical ratios pertaining to liquidity risk.

Introduction of LCR

All non-deposit taking NBFCs with asset size of ₹5,000 and above, and all deposit taking NBFCs irrespective of their asset size, need to maintain a liquidity buffer in terms of a Liquidity Coverage Ratio (LCR).

This will promote the resilience of NBFCs to potential liquidity disruptions by ensuring that they have sufficient High Quality Liquid Asset (HQLA) to survive any acute liquidity stress scenario lasting for 30 days.

The stock of HQLA to be maintained by the NBFCs will be minimum of 100 per cent of total net cash outflows over the next 30 calendar days. The LCR requirement will be binding on NBFCs from April 1, 2020 with the minimum HQLAs to be held being 60 per cent of the LCR, progressively increasing reaching up to 100 per cent by April 1, 2024.

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