NBFC

Guidelines on Liquidity Risk Management Framework for NBFCs 

Income recognition norms for NPAs

The set of liquidity risk management criteria listed below must be followed by all non-deposit-taking NBFCs with assets of ₹100 crore or more, systemically important Core Investment Companies, and all deposit-taking NBFCs regardless of asset size. However, these regulations will not cover Type NBFC-NDs, Non-Operating Financial Holding Companies, and Standalone Primary Dealers.

The Board of each NBFC will be in charge of making sure that the rules are followed. The internal controls NBFCs must implement by these standards must pass supervisory inspection. Additionally, all other NBFCs are urged to voluntarily follow similar liquidity risk management principles as a matter of caution.

Although parts of the current regulatory requirements that apply to NBFCs regarding the ALM framework have been rewritten, certain new features, such as disclosure criteria, have also been included, and the detailed rules are provided in Annex A.

Introduction of Liquidity Coverage Ratio (LCR)

All non-deposit-taking NBFCs with asset sizes of at least 10,000 crore and all deposit-taking NBFCs, regardless of asset size, shall maintain a liquidity buffer in terms of LCR. This will help NBFCs be more resilient to potential liquidity disruptions by ensuring they have enough High-Quality Liquid Asset (HQLA) to last through any acute liquidity stress scenario lasting 30 days. The LCR requirement will be mandatory for NBFCs starting on December 1, 2020, with the minimum amount of HQLAs to be held being 50% of the LCR. According to the timeline below, this amount will rise to 100% by December 1, 2024.

FromDecember 1, 2020December 1, 2021December 1, 2022December 1, 2023December 1, 2024
Minimum LCR50%60%70%85%100%

Non-deposit-taking NBFCs with asset sizes of ₹ 5000 crore and above but less than ₹10,000 crore shall maintain the required level of LCR starting on December 1, 2020, as per the timeline.

FromDecember 1, 2020December 1, 2021December 1, 2022December 1, 2023December 1, 2024
Minimum LCR30%50%60%85%100%

Guidelines on Liquidity Management Framework

All deposit-taking NBFCs except NBFC-NDs, Non-Operating Financial Holding Companies, and Standalone Primary Dealers and non-deposit-taking NBFCs with asset sizes of ₹100 crore and above, as well as systemically important Core Investment Companies, must abide by the rules outlined below. The Board will be in charge of making sure that the rules are followed.

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The internal controls that NBFCs are required to implement in accordance with these standards must pass supervisory inspection. Additionally, all other NBFCs are urged to voluntarily follow similar liquidity risk management principles as a matter of caution. The guidelines cover the following elements of the framework for liquidity risk management.

  • Liquidity Risk Management Policy Strategies and Practices
  • Management Information System (MIS)
  • Internal Controls
  • Maturity Profiling
  • Liquidity Risk Measurement – Stock Approach
  • Currency Risk
  • Managing Interest Rate Risk
  • Liquidity Risk Monitoring Tools

Policy, Strategies, and Practices for Liquidity Risk Management

The Board of the NBFC shall establish a liquidity risk management framework to ensure that it maintains adequate liquidity3, including a cushion of unencumbered, high-quality liquid assets to withstand a variety of stress events, including those involving the loss or impairment of both unsecured and secured funding sources. The entity-level liquidity risk tolerance, funding strategies, prudential limits, a system for measuring, stress testing framework, assessing, and reporting/reviewing liquidity, liquidity planning under alternative scenarios/formal contingent funding plan, nature and frequency of management reporting, periodic review of assumptions used in liquidity projection, etc., must all be spelt out in this document.

The following are important components of the framework for managing liquidity risk:

  • Liquidity Risk Management Governance

The NBFC’s senior management must successfully implement any risk management strategy, which must show a strong commitment to integrating risk management into fundamental operations and strategic decision-making. The Chief Risk Officer nominated by the NBFC shall be involved in identifying, measuring, and mitigating liquidity risks. A good organisational structure for managing liquidity risk should be as follows:

  1. Board of Directors
  2. Asset-Liability Management Committee (ALCO)
  3. Risk Management Committee
  4. Asset Liability Management (ALM) Support Group
  • Liquidity Risk Tolerance – An NBFC must have a reliable procedure in place for recognising, quantifying, monitoring, and managing liquidity risk. It must express its liquidity risk tolerance in an acceptable manner for its business strategy and its position within the financial system.
  • Liquidity Costs, Benefits, and Risks in Internal Pricing – NBFCs should make an effort to develop a process to quantify liquidity costs and benefits to incorporate the same into the internal product pricing, performance measurement, and new product approval process for all significant business lines, products, and activities.
  • Off-balance Sheet Exposures and Contingent Liabilities – A strong framework for comprehensively projecting cash flows arising from assets, liabilities, and off-balance sheet items over an appropriate set of time horizons should be part of the process of identifying, measuring, monitoring, and controlling liquidity risk. 
  • Funding Strategy – An NBFC must have a funding strategy that effectively diversifies the sources and duration of finance. To effectively encourage funding source diversity, it should have a persistent presence in its chosen funding markets and solid connections with fund providers.
  • Management of Collateral holdings: An NBFC is required to actively monitor its collateral holdings, identifying encumbered and unencumbered assets. It should keep an eye on the legal structure, geographical location, and potential prompt mobilisation of collateral.
  • Stress Testing – Stress testing must be a fundamental component of NBFCs’ overall governance and liquidity risk management culture.
  • Contingency Funding Plan – An NBFC is required to create a CFP in the event of major disruptions that could make it difficult for the NBFC to fund some or all of its operations.
  • Public disclosure – The NBFC is required to publicly disclose information (Appendix I) every quarter on the company’s official website and in the annual financial statement as notes to an account to allow market participants to assess the validity of its liquidity risk management framework and liquidity position.
  • Intra-Group transfers – The Group Chief Financial Officer (CFO) is expected to develop and maintain liquidity management processes and funding programmes that are compatible with the complexity, risk profile, and scope of operations of the Group’s companies to recognise the likely increased risk arising from Intra-Group transactions and exposures (ITEs).
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Management Information System (MIS)

An NBFC must have a dependable MIS built to give the Board and ALCO accurate information about the liquidity position of the NBFC and the Group in both regular and emergency circumstances. It should be able to provide more precise and timely information during stressful situations, and it should be able to capture all sources of liquidity risk, including contingent risks and those resulting from new activities.

Internal Controls 

An NBFC must have the proper internal controls, systems, and procedures in place to ensure adherence to liquidity risk management policies and processes. According to management, the various parts of the NBFC’s liquidity risk management process should be reviewed and assessed regularly by an impartial party.

Maturity Profiling

The use of a maturity ladder and the computation of the cumulative surplus or deficit of funds at chosen maturity dates is used as a standard instrument for assessing and managing net funding requirements. The future cash flows of NBFCs should be estimated using the Maturity Profile throughout various periods.

  • NBFCs would have securities in their investment portfolio that may be roughly categorised as either “mandatory securities” (those required by law) or other “non-mandatory securities.” 
  • All cash inflows and outflows may be arranged in the maturity ladder in accordance with the anticipated timing of cash flows to create the Statement of Structural Liquidity. A maturing asset will result in a financial inflow, whereas a maturing liability will result in a cash outflow.
  • The NBFCs shall estimate their short-term liquidity profiles based on business predictions and other obligations for planning reasons, allowing them to monitor their short-term liquidity on a dynamic basis across a time horizon ranging from one day to six months.
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Stock Approach to Liquidity Risk Measurement

To measure and monitor certain crucial ratios for liquidity risk, NBFCs must use a “stock” method, with internal restrictions that their Board has authorized. The ratios and internal restrictions must take into account an NBFC’s expertise, track record, and profile in managing liquidity risk.

Financial Risk

The risk profile of an NBFC’s balance sheets with foreign assets or liabilities takes on a new dimension as a result of exchange rate volatility. The NBFCs‘ Board should be aware of the liquidity risk posed by such exposures and make appropriate preparations for controlling the risk.

Interest Rate Risk Management (IRR)

NBFCs must manage interest rate risk in accordance with current regulatory requirements.

Tools for Monitoring Liquidity Risk

One of the methods for required monitoring is now the Statement of Structural Liquidity. Additionally, the Board of the NBFC shall implement the following instruments for internal monitoring of liquidity requirements:

  • Concentration of Funding – This indicator is designed to pinpoint the key financing sources whose withdrawal could result in liquidity issues. As a result, the metric promotes diversification of funding sources and monitoring of each important counterparty, significant product and instrument, and significant currency.
  • Assets that are currently unencumbered – The accessible, unencumbered assets that could be utilised as collateral to achieve additional secured borrowing in secondary markets are key information that is provided by this indicator. It will include information on the quantity, variety, and location of unencumbered assets that are readily available and could be used as collateral for secured borrowing on secondary markets.
  • Tools for Monitoring the Market – They are high-frequency market data that can be used as early warning signs to track potential liquidity issues at NBFCs.

The Board or committee established for the purpose shall keep track regularly of changes to listed NBFCs’ book-to-equity ratios and the interest rates at which they issue long- and short-term debt. This also offers details on any possible regulatory liquidity requirement breaches or penalties.

Conclusion

The guidelines on the Liquidity Risk Management Framework for Non-Banking Financial Companies and Core Investment Companies are framed to enhance the liquidity risk management of NBFCs. Also, to ensure the proper governmental rules are proactively implemented to maintain the interest of their stakeholders.

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