Large exposure norms for banks were on Monday amended by the Reserve Bank of

India (RBI). The move will make lending to non-banking financial companies (NBFC) more
streamlined and invite scrutiny on the structure of these entities.

The new framework, however, also makes it possible for government entities to borrow
more, as they will not be considered part of a group of connected entities.

The central bank introduced economic interdependence criteria in the definition of

connected counterparties and said banks must check how the different parties in a group
were invested in each other's assets.

The RBI also excluded entities connected with the sovereign from the definition of group of
connected parties. This means that government-backed entities can expect to get higher
loans from banks, without inviting objections of the RBI. All banks, however, have board-
approved policies on lending to various entities and don’t breach those

levels.

The RBI said banks must apply a look-through approach in cases where a bank invested in

structures that themselves had exposures to assets underlying the structures. Such
structures include funds, securitisations and those with underlying assets.

the central bank said that it has excluded all entities connected with the sovereign
from the definition of group of connected companies. For instance, exposures where
the principal and interest are fully guaranteed by the government or exposures to
central and state governments will be excluded from counter-party exposure.
RBI also introduced the concept of “economic interdependence" criteria in definition
of connected counterparties. According to the regulator, if one of the firms were to
experience financial difficulties, then related parties are also likely to encounter
funding or repayment difficulties.
Hence, it has asked banks to ensure that the sum of all exposures to one counterparty
does not exceed 5% of the Tier 1 capital. “Banks are expected to identify possible
connected counterparties on the basis of economic interdependence in all cases where
the sum of all exposures to one individual counterparty exceeds 5% of the eligible
capital base, and not in other cases," RBI said.
The central bank also said that banks need to take into account their direct and indirect
exposure to an underlying asset while calculating total exposure. For instance, if
banks have invested in structures such as funds, securitizations and other structures,
which have exposure to an underlying asset, then banks need to include this exposure
along with the direct exposure while calculating total exposure (termed as look-
through approach), provided it is above 0.25% of the Tier 1 capital.
These structures can include mutual funds, venture capital funds, alternative
investment funds, investment in security receipts, real estate investment trusts or
infrastructure investment trusts. “A bank must look through the structure to identify
those underlying assets for which the underlying exposure value is equal to or above
0.25% of its eligible capital base. In this case, the counterparty corresponding to each
of the underlying assets must be identified so that these underlying exposures can be
added to any other direct or indirect exposure to the same counterparty," it said.

The Reserve Bank of India Monday modified the guidelines on large exposures
for banks with a view to reduce concentration of risk and align them with the global norms.

The modified 'Large Exposures Framework' (LEF) provides exclusion of entities connected
with the sovereign from definition of group of connected counter-parties.

It also introduces economic interdependence criteria in definition of connected counter-

parties.

The amendment, the RBI said, is being done in order to "capture exposures and

concentration risk more accurately" and to align the above instructions with international
norms.

As per the revised norms, the sum of all the exposure values of a bank to a single counter-
party must not be higher than 20 per cent of the bank's available eligible capital base at all
times.

In exceptional cases, board of banks may allow an additional 5 per cent exposure of the
bank's available eligible capital base.
In case of groups of connected counter-parties, the sum of all the exposure values of a
bank to a group of connected counter-parties must not be higher than 25 per cent of the
bank's available eligible capital base at all times, the revised LEF said.

Under the LE Framework, an exposure to a counter-party will constitute both on and off-
balance sheet exposures included in either the banking or trading book and instruments
with counter-party credit risk.

On exposures to NBFCs, the banks' exposures to a single NBFC should be restricted to 15

per cent of their eligible capital base.

Also, banks' exposures to a group of connected NBFCs or group of connected counter-

parties having NBFCs in the group should be restricted to 25 percent of their Tier I Capital.

Applicability
The LEF shall be applicable on all scheduled commercial banks in India, with respect to their
counterparties only.

The LEF has become applicable with effect from April 1, 2019. The revised guidelines on LEF shall also
become applicable from the same date with retrospective effect except for the provisions of economic
interdependence and non-centrally cleared derivative exposures.

What sort of borrowers are affected?

The revised guidelines have an impact on the borrowers who used to take advantage of different entities
and hide behind the corporate veil to avail funding. The introduction of economic interdependence as a
criteria for determining connected counterparties ensures that no same persons, whether promoters or
management avail facilities through other entity.

Further, borrowers who operate as special purposes vehicles, securitisation structures or other structures
having investments in underlying assets would also be affected as the banks will now look-through the
structure to identify the counterparty corresponding the underlying asset.

However, the LEF does not address issues relating to lending to any specific sector or such other
exposures.

What happens to affected borrowers?

The borrowers taking advantage of corporate veil will no more be able to avail funds in the covers of veil.
The entities having same or related parties in their management shall not be able to avail funds
exceeding the exposure limit. This would result in shrinkage of the availability of borrowed funds that
would have otherwise been available to the entities. Also, entities operating as aforementioned structures,
are likely to face contraction of borrowed fund availability.
 IV    Risk Mitigation

4.1       With increase in reach, size and significance of payment systems the Bank is committed to
assuring their safe and efficient functioning by identifying various risks, addressing risk-reduction by
putting in place risk-mitigation measures and mandating appropriate risk-management practices.

4.2   The risks in payment systems viz. concentration risk, counter-party risk, credit risk, legal risk, liquidity
risk, operational risk, regulatory risk, settlement risk and systemic risk will continue to be addressed by
the Bank.

4.3   Towards this end, emphasis will be on advocating –

 Mitigating concentration risk in both large value as also retail payment systems by way of limiting
operations of multiple payment systems by a single entity as also one bank acting as settlement bank for
multiple payment systems or alternatively putting in place measures for risk mitigation wherever
necessary.  Important large value payment systems are now being operated by Clearing Corporation of
India Limited (CCIL), which also acts as a central counterparty for systemically important payment
systems. This calls for very close monitoring of the activities and functioning of CCIL and continuously
reviewing the need for an additional / alternate central counterparty operating some of the payment
systems with each capable of taking over the operations of the other in case of eventuality. The risk of
concentration of settlement in the form of a single central counterparty needs to be carefully looked into.
The retail payment systems are operated by various entities, and the focus would be to ensure that there
is no concentration of a single bank acting as settlement bank for multiple payment systems. The other
issue that needs to be addressed as part of concentration risk is in the outsourcing arrangements entered
into by system participants with service providers. Reliance on a single or few service providers gives rise
to concentration risk and could emerge as a significant single-point-of-failure. Proper risk mitigation
measures in this regard would be pursued in consultation and co-ordination with all the regulatory
departments.