Saturday, August 1, 2015

Exposure Norms for Financial Institutions

Credit exposure norms are prescribed by RBI for term lending institutions to limit their exposures to an individual borrower and group borrowers. These norms are to be considered as a part of prudent credit management system and not as a substitute for efficient credit appraisal, monitoring and other safeguards.

Scope and Applicability
The refinance portfolio of refinancing institutions is not subject to exposure norms. However, they are advised to evolve their own credit exposure limits, even in respect of their refinancing portfolio.

Principal and interest fully guaranteed by the Government of India may be excluded While computing the extent of exposures.

These norms deal with individual/group exposures but not sector / industry exposures. The Financial Institutions (FIs) may, therefore, consider fixing internal limits for aggregate commitments to specific sectors, so that the exposures are evenly spread.

These stipulations shall apply to all borrowers. However, in case of public sector undertakings, only single borrower exposure limit would be applicable.

Various aspects of credit exposure norms are detailed in the following paragraphs.

         'Capital Funds'
The total regulatory capital (i.e., Tier 1 + Tier 2 capital), would constitute the 'capital funds' for the purpose of exposure norms.

'Infrastructure Projects' / 'Infrastructure Lending'
Infrastructure lending includes credit facility provided to a company engaged developing, operating and maintaining any infrastructure facility that is a project in any of the following sectors :

i)  a road, including toll road, a bridge or a rail system;

ii)   a highway project;

iii)  a port, airport, inland waterway or inland port;

iv)     a water supply project, irrigation project, water treatment system, sanitation and sewerage system or solid waste management system;

v)    telecommunication services, radio paging, domestic satellite service, network of trunking, broadband network and internet services;

vi)  an industrial park or special economic zone;

vii)  generation or generation and distribution of power;

viii)     transmission or distribution of power;

ix) Any other infrastructure facility of similar nature.

'Group' Borrowers

The group to which a particular borrowing unit belongs should be decided by the FIs on the basis of the relevant information available with them, the guiding principle in this regard being commonality of management and effective control.

Net Owned Funds in respect of NBFCs

Net owned Funds will consist of
(paid up equity capital+ free reserves+ balance in share premium account + capital reserves from surplus arising out of sale of assets but not its revaluation)
minus (accumulated loss balance + book value of intangible assets ).
Investments in shares of other NBFCs and in shares, debentures of subsidiaries and group companies in excess of ten percent of the owned fund mentioned above will be deducted to arrive at the Net Owned Funds. The NOF should be computed on the basis of last audited Balance Sheet.

Exposure Ceilings

For Single / Individual Borrowers
The credit exposure to single borrowers shall not exceed 15 per cent of capital funds of the FI. It may exceed by additional five percent in case of infrastructure projects. FIs may, in exceptional circumstances, consider 25 per cent of capital funds for infrastructure projects and 20 percent for other projects.

For Group Borrowers
The credit exposure to a group shall not exceed 40 per cent of capital funds of the FI. It may exceed by additional ten percentage points in case of infrastructure projects 55 percent of capital funds for infrastructure projects and 45 percent for other projects.

    For Bridge Loans / Interim Finance
FIs may grant bridge loan / interim finance to companies other than NBFCs against public issue of equity in India or abroad but not against Rights issue.

FIs may sanction bridge loans only against their own commitment and not against loan commitment of any other FIs / Banks except in cases where the lending institution faces temporary liquidity constraint.

These restrictions are also applicable to the subsidiaries of FIs for which FIs are required to issue suitable instructions to their subsidiaries.

Working Capital Finance
FIs may extend working capital finance to borrowers enjoying credit limits with banks, when the banks are not in a position to meet the credit requirements of the borrowers on account of temporary liquidity constraints. In case of borrowers whose working capital is financed under a multiple banking arrangement, the FI should obtain an auditor's certificate indicating the extent of funds already borrowed, before considering the borrower for further working capital finance.

Revolving Underwriting Facility
FIs should not extend Revolving Underwriting Facility to Short Term Floating Rate Notes / Bonds or Debentures issued by corporate entities.

      Lending to Non Banking Financial Companies (NBFCs)
There are no limits in respect of lending by FIs to Equipment Leasing & Hire Purchase Companies, equipment and hire purchase NBFCs and Loan & Investment Companies which have complied with RBI's requirement of registration, credit rating and prudential norms and have been certified as such by RBI. However such lending would be subject to compliance with single and group borrower exposure norms.

For NBFCs which have not complied with the above requirements and the Residuary Non Banking Companies (RNBCs), overall limit of aggregate credit from all FIs taken together can be obtained from the master circular.

Fls are also advised not to provide finance to NBFCs for the following activities:

a) Bills discounted / rediscounted except those arising from sale of commercial vehicles including light commercial vehicles;

b)    Investments made in shares, debentures etc., of a current nature;

c)   Investments/ advances to subsidiaries, group companies or other entities;

d)   Investments / inter-corporate loans & deposits in other companies.

Fls should not sanction bridge loans to NBFCs (Including RNBCs).

Investment in Debt Securities
The total investment in the unlisted debt securities should not exceed 10 per cent of the FIs' total investment in debt securities as on March 31 (June 30 in case of NHB), of the previous year. However, the investment in the following instruments will not be reckoned as 'unlisted debt securities':

(i) Security Receipts (SRs) issued by Securitisation Companies / Reconstruction Companies registered with RBI under SARFAESI Act; and

(ii)   Asset Backed Securities (ABS) and Mortgage Backed Securities (MBS) which are rated at or above the minimum investment grade.

Investment in Venture Capital Funds (VCF)
FIs are advised to comply with the prudential requirements relating to financing of venture capital funds.

Cross Holding of Capital among Banks / Financial Institutions
(i)  Investment in the following instruments, which are issued by other banks / FIs and are eligible for capital status for the investee, should not exceed 10% of the investing FI's capital funds (Tier I plus Tier II) :

a.  Equity shares;
b.  Preference shares eligible for capital status;
c.  Subordinated debt instruments;
d.  Hybrid debt capital instruments;
e.  Any other instrument approved as in the nature of capital.
FIs should not acquire any fresh stake, if by such acquisition, the investing FI's holding exceeds 5 percent of the investee bank's / FI's equity capital.

(ii) FIs' investments in the equity capital of subsidiaries are at present deducted from their Tier I capital for capital adequacy purposes. Investments in the instruments listed above, which are not deducted from Tier I capital, will attract 100 percent risk weight for credit risk for capital adequacy purposes.

Level of Exposure
The sanctioned limit or outstanding, whichever is higher, shall be reckoned for arriving at the level of credit exposure which shall include funded and non-funded credit limits, underwriting and other similar commitments. The exposure on account of derivative products should also be reckoned for the purpose.

In case of term loans, exposure should be the actual outstanding plus undisbursed or undrawn commitments. However, where disbursements are yet to commence, the level of exposure should be the sanctioned limit or the extent of the FI’s commitment with the borrowing companies.

For the purpose of determining the level of exposure, the following instruments should also be reckoned :

(i) Bonds and Debentures in the Nature of Advance :
- where it is issued as part of the proposal for project finance and the tenor is for three years and above
-  The FI has a significant stake (i.e., 10% or more) in the issue and
-   The issue is a part of private placement.

(ii)   Preference Shares in the Nature of Advance : The preference shares, other than convertible preference shares, acquired as part of project financing and meeting the criteria as above.

(iii)   Deposits : The deposits placed by the FIs with the corporate sector.

For computing the level of exposure in respect of the NBFCs, the FI's investment in the privately placed debentures should be included while those acquired in the secondary market should be excluded.

Prudential Norms for Off-balance Sheet Exposures of FIs
FIs are advised to comply with the prudential requirements relating to Off-balance Sheet Exposures of FIs.

Measurement of Exposure in Derivative Products
There are two methods for measuring the credit risk exposure inherent in derivatives, as described below.

A. The Original Exposure Method

The credit risk exposure of a derivative product is calculated by multiplying the notional principal amount with the prescribed credit conversion factors. FI should apply the following credit conversion factors to the notional principal amounts of each instrument as under:

Original Maturity
Credit Conversion Factor to be applied to

Notional Principal Amount

Interest Rate Contract

Exchange Rate Contract

Less than one year

One year and less

5.0% (2% + 3%)
than two years

For each additional


B. The Current Exposure Method
The credit risk exposure / credit equivalent amount of the derivative products is computed periodically on the basis of the market value of the product. The credit equivalent of the off-balance sheet interest rate and exchange rate instruments would be the sum of the following two components:

(a)    the total 'replacement cost' - obtained by "marking-to-market" of all the contracts with positive value (i.e. when the FI has to receive money from the counterparty); and

(b)   an amount for 'potential future exposure' - calculated by multiplying the total notional principal amount of the contract by the following credit conversion factors:

Residual Maturity
Conversion Factor to be

applied on Notional Principal


Interest Rate
Exchange Rate


Less than one year
One year and over

FIs should follow their internal methods and mark to market the derivative products at least on a monthly basis. However, the FIs would not be required to calculate potential credit exposure for single currency floating / floating interest rate swaps.

The FIs are encouraged to follow the Current Exposure Method for determining individual / group borrower exposures. In case an FI is not in a position to adopt the Current Exposure Method, it may follow the Original Exposure Method but should subsequently move over to Current Exposure Method in course of time.

Exposure in respect of bonds guaranteed by Public Financial Institutions (PFIs)
·         The investments made in the bonds and debentures of corporates which are guaranteed by FI, will be treated as an exposure of the bank / FI on the FI and not on the corporate.
·         Guarantees issued by FI to the bonds of the corporates will be treated as an exposure of the FI to the corporate.
·        the exposure of the bank / FI on the FI guaranteeing the corporate bond will be to the extent of 100 per cent of the bank's investment.

The FIs should consider the overall exposure of the guaranteed unit to the financial system before guaranteeing the bonds / debentures.

Treatment of Loans granted by the FIs against the Guarantee of Banks / FIs
The banks / FIs may extend guarantees in favour of other lending institutions in respect of infrastructure projects. The bank should however take a funded share of at least five per cent of the project cost. It should also undertake normal credit appraisal, monitoring and follow up of the project. The entire loan transaction should be reckoned as an exposure on the borrowing entity and not on the bank guaranteeing the loan. In case the funded facility is a term loan, the level of exposure should be reckoned as:

-   Before commencement of disbursement, the exposure would be the sanctioned limit or the extent of commitment, as the case may be;

-   After commencement of disbursement, it would be the aggregate of the outstanding amount plus the undisbursed or undrawn commitment.

Reporting System
An annual review of the implementation of exposure management measures should be placed before the Board of Directors before the end of June every year. A copy of the review should be furnished to the RBI.

Consolidated Financial System
In addition to prudential limits on exposure of the solo entities, the FIs at the group-wide level should also adhere to the following prudential limits:

Single borrower
15% of capital funds of the Group.
exposures at the
Up to 20% of capital funds of the Group
group level
provided the additional exposure of up to five

percentage points is for the purpose of

financing infrastructure projects.
Group borrower
40% of capital funds of the Group.
exposures at the
Up to 50% of capital funds of the Group
group level
provided the additional exposure of up to 10

percentage points is for the purpose of

financing infrastructure projects.

The 'capital funds' of the Group would be the same as reckoned for the purpose of group-wide capital adequacy. The measurement of credit exposure at the group level should be done in the same manner as prescribed for the FIs on a solo basis.

The FI should make appropriate disclosures in the 'Notes on account' to the annual financial statements in respect of the exposures where the FI had exceeded the prudential exposure limits during the year.

Based on the Master Circular of 1/7/15. Please visit if required……………  Poppy