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RBI recently issued a new notification on 10th October 2022 vide RBI/2022-23/, 125. which deals with the Review of Prudential Norms – Risk Weights for Exposures to Corporates and NBFCs, which would come into effect from 31 March 2023. The article discusses the various aspects discussed in the notification to clarify the same.
Table of Contents
Risk-weighted assets are used to ascertain the minimum amount of capital that should be held by the NBFCs, banks and other financial institutions for the purpose of reducing the risks of insolvency. The capital requirements are determined on the basis of the assessment of risk for each type of bank asset.
Basel III provides international banking regulations that prescribe certain guidelines to avoid problems related to risk-weighted assets. The regulators insist that each bank must pool its assets on the basis of the risk category to ensure that the amount of required capital is matched with each asset type. Basel III makes use of credit ratings of certain assets to derive their risk coefficients to prevent the banks from losing huge amounts of capital in case the value of a particular asset class falls sharply.
ECAI stands for External Credit Assessment Institution, which is a credit rating agency whose credit assessment ratings are eligible to be used by the regulated banks for the purpose of calculating the credit risk exposure to check capital adequacy. This agency plays a significant role in providing a standardised approach as well as a securitization framework for prudent regulations through mapping each credit assessment to the corresponding risk weights.
The new notification released on 10 October 2022 was regarding the Review of Prudential Norms – Risk Weights for Exposures to Corporates and NBFCs, wherein it was stated that RBI has observed that the press release issued by the ECAI often doesn’t contain the details of the lenders, the absence of which might result in banks applying the derived risk weights for unrated exposures, without being satisfied with the adherence to the prescribed condition which would eventually lead to the lower provision of capital and under-pricing of the risks.
Therefore, in order to deal with the same, RBI has advised the ECAI through a letter dated 04.06.21 about disclosing the name of the banks along with the corresponding credit facilities as rated by them in the press release on rating actions upon receiving the consent by the borrowers.
Further, it was observed that the disclosures aren’t available in large numbers of press releases issued by the ECAI due to the absence of the prior consent of the borrowers. Hence the loan ratings devoid of such disclosures won’t be eligible for being reckoned for the computation of capital by the banks. The banks must consider such exposures as unrated, followed by assigning applicable risks as per the risk weights prescribed in the master circular ibid r/w amendments carried out from time to time.
As an Illustration, a scenario might be assumed wherein a borrower has availed credit facilities from Banks 3 banks, namely A, B and C and an external rating from an ECAI is obtained only regarding the credit facility extended by Bank A. If there has been a disclosure of the name of bank A by the ECAI along with the corresponding credit facility rated by it, then Bank A can reckon the said rating for the purpose of risk weighting
However, Banks B and C are allowed to derive risk weights for their respective unrated credit facilities as per the conditions specified in paragraph 6.8.1 (i) of Master Circular ibid, as permitted hitherto.
In cases where ECAI have not made the above disclosure, none of the banks should reckon s rating and, therefore, shall apply risk weights of 100 % or 150 % as applicable in terms of extant instructions.
The risk weights can be categorized into Long term Claims on Corporates and NBFCs excluding CICs and Short term Claims on Corporates and NBFCs excluding CICs, which are provided in the table mentioned below –
The following pointers must be noted –
The notification regarding Risk Weights for Exposures to Corporates and NBFCs can help in NBFCs and corporates to clear the confusion regarding the risk weights for better computation of the capital requirements as well as ensure adherence to the prescribed norms. Additionally, it can encourage the ECAI to disclose the name of the banks along with the corresponding credit facilities.
Read our Article: Capital Adequacy Ratio [CAR] – Definition, Calculation and Importance
Shubhangi has completed her B. A.LLB (H) with specialization in Business Laws from Amity University. She is particularly interested in legal research and writing and wishes to utilize her knowledge to create informative legal content. She has prior experience in corporate and criminal litigation and has great drafting skills. She has also published various research papers in reputed journals.
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