Large Exposure Framework for NBFC-UL

Prabhat Nigam

21 Apr, 2022

The central bank has released four separate circulars viz. Large exposures framework for NBFCs- Upper Layer (NBFC-UL), scale based regulations for capital requirements-Upper layer, disclosures in their financial statements and Regulatory restrictions on their loans and advances. These improvements have been made on the October 22, 2021 circulars.

These norms have been brought to address the credit risk concentration in Non-Banking Finance Companies (NBFCs). The changes have been made to the previously released circular titled “Scale Based Regulations: A Revised Regulatory Framework” for which a Large Exposure Framework (LEF^[1]) has been prescribed for NBFCs in the Upper Layer.

What is “Tier I Capital”?

According to RBI, the meaning of “Tier I Capital” for the purpose of the guidelines has the same meaning which has been defined in the October 21 circular. The RBI also made clear that all the profits accrued during a year shall be reckoned as Tier I capital for the purpose of Large Exposure Framework after making the required adjustments according to the guidelines applicable to NBFCs- Upper Layer.

NBFCs-UL have been directed to obtain a certificate from an external auditor once the augmentation of capital has taken place and the certificate shall be submitted to RBI (Department of Supervision) before the reckoning the additions to capital funds.

What is meaning of the term ‘control’?

In these new guidelines, RBI has tried to explain the meaning of the term ‘control’ which according to RBI means the right to appoint the majority of directors or to control the management or policy decisions which are taken by a person individually or persons acting individually or in agreement, either directly or indirectly by virtue of their management rights or their shareholding or shareholder’s agreements or voting agreements or in any other manner.

What is meaning of the term “Group of connected counterparties”?

Clarity was also given by RBI about the meaning of “Group of connected counterparties”. It means that two or more (both natural and legal) who satisfy at least one of the conditions- control relationship and economic interdependence.

The criteria of control relationship automatically get satisfied if one of the parties own more than 50 per cent of the voting rights of the other entity.

Criteria of economic interdependence

In cases where connectedness has to be shown on the basis of economic interdependence, NBFC-UL should consider, at least, the following criteria as suggested by RBI:

1. Where 50 percent or more than 50 percent of one counterparty’s gross receipts or gross expenditure (on an annual basis) is derived from the transactions with the other counterparty;
2. Where one of the counterparty has partly or fully guaranteed the exposure of other counterparty or is liable by some other means and the exposure is so substantial that the guarantor is likely to default if a claim occurs;
3. In case a substantial portion of one counterparty’s output/ production is sold to the another counterparty, which cannot be replaced with other customers;
4. Where the expected source of funds to repay loans for both the parties is same and neither of the two counterparties has another independent source of income  from which the loan may serviced or fully paid;
5. Where a possibility lies that financial difficulties faced by one counterparty would cause difficulties for other counterparties in terms of timely and full repayment of liabilities;
6. In cases where default or insolvency of one of the counterparties is likely to be associated with the default or insolvency of the others;
7. In case where both the counterparties rely on the same source for majority of their funding and in the event of common provider’s default, an alternative provider cannot be found. In these cases, funding problems of one of the counterparties is likely to spread to another due to one-way or two-way dependence on the same main funding source.
8. To avoid a situation where a thorough investigation of economic interdependencies will not be proportionate to the size of the exposures, NBFC-UL should identify possible connected enterprise on the basis of economic interdependence in every case where the amount of all the exposure to one individual counterparty exceeds 5% of the eligible capital base and not in other cases.

How has RBI defined the term “large exposure”?

RBI explains the term ‘large exposure’ which means sum of all the exposure values of an NBFC-UL to a counterparty and/or a group of connected counterparties, if it is equal to or above 10% of the NBFC-UL’s eligible capital base.

These guidelines are applicable to NBFC-UL both at solo level and at the consolidated (group) level. The exposure in this case will comprise both on and off-balance sheet exposures by the NBFC-UL.

The sum of all the exposure values of an NBFC-UL to a single counterparty should not be higher than 20 percent of the NBFC-UL’s available eligible capital base at all times. RBI allows the board of the NBFC-UL an additional 5% exposure above 20 percent but not in any case beyond 25% of the NBFC-UL’s eligible capital base, subject to conditions.  A special allowance is given by RBI to Infrastructure Finance Company (IFC) to further exceed the exposure limit of 5% of Tier I capital for exposure to a single counterparty. In case of groups of connected counterparties, RBI states that all the exposure values of an NBFC-UL to a group of connected counterparties will not be higher than 25 per cent of NBFC-UL’s available eligible capital base at all the times. On the other hand, IFC has been allowed to exceed its exposure limit by 10% of its Tier I capital for exposure to a group of connected counterparties.