Improving Financial Stability: RBI Guidelines on Credit Risk Transfer for NBFCs

Vanshika Jaiswal

17 Jan, 2024

The guideline framed by the Reserve Bank of India in the context of the existing regulatory framework by referring to the Master Direction on NBFCs and HFCs issued on October 19, 2023, and February 17, 2021, and aligns with the Large Exposure Framework applicable to different layers of NBFCs. The amendments outlined in the circular come into force from the date of its issuance, and especially for the NBFC-Middle Layer category are required to follow the guidelines immediately. The circular is issued to enhance the effectiveness of credit risk transfer instruments, make more clarity in the instruments, and streamline exemptions from credit and investment concentration norms for certain exposures so that the changes made to help in improving risk management practices within the NBFC sector and ensure a strong framework for handling credit risk.

Guideline Addresses Credit Risk

The circular focuses on addressing credit risk through credit risk transfer instruments, so the guidelines provide a structured approach to calculating exposures, particularly those related to credit risk. The credit risk outlined in the provided guidelines from the Reserve Bank of India involves implementing a structured approach to mitigate the potential impact of default on loans or credit obligations within the NBFC Sector, and the guidelines emphasize the importance of Credit Risk Transfer (CRT) instrument in the NBFC-Middle layer (NBFC-ML). It also states the additional CRT instruments, such as Cash Margins, government-guaranteed claims and guarantees under specific credit guarantee schemes to offset exposures successfully. The guidelines aim to strengthen risk management practices among NBFCs by strengthening the risk management practices among NBFCs. This approach is made to align with regulatory efforts to maintain consistency and transparency in managing credit risk in various layers of NBFCs.

Focus on Large Exposures Framework (LEF)

The circular focused on the application of LEF to the NBFC-Upper Layer (NBFC-UL) and outlined specific regulations for the NBFC-Base Layer (NBFC-BL) and NBFC-Middle Layer (NBFC-ML). The guidelines aim to mitigate the risk related to large exposures by providing a standardized approach to exposure calculation of aggregate exposures to a counterparty. The LEF contributes to improving risk management practices to foster stability within the NBFC sector by avoiding overexposure to individual counterparts and promoting a stable approach to risk mitigation.

Regulations for the Layers of NBFCs

The regulations for the different layers of NBFCs in the guidelines are as:

NBFC-Middle Layer (NBFC-ML)

The guidelines have been provided for NBFC-ML regarding the computation of exposure and managing credit risk. As per the circular, the exposure calculation for NBFC-ML involves a meticulous approach by considering both on and off-balance sheet exposures because the outstanding amount is utilized for reckoning the on-balance sheet exposures, and the off-balance sheet exposures are converted into credit risk using the prescribed credit conversion method. The circular expands the array of credit risk transfer instruments available to NBFC-ML by encompassing cash margins held as collateral on behalf of the borrower and central government-guaranteed claims at 0% weight risk, the Credit Guarantee Fund Trust for Micro and Small enterprises guarantee issues under credit guarantee schemes and individual scheme under National Credit Guarantee Trustee Company Limited. A detailed explanation of these guidelines for NBFC-ML by the RBI is to ensure uniformity and consistency in the computation of concentration norms among NBFCs.

NBFC-Base Layer (NBFC-BL)

The NBFC-BL is subject to specific regulations related to credit or investment concentration limits by making it align with the guidelines set for NBFC-ML and establishing an internal board-approved policy for determining these limits for both single and group borrowers. It needs to be aligned with the guidelines provided for NBFC-ML in paragraphs 3 and 4 of the circular related to the computation of exposure and incorporation of Credit Risk Transfer Instruments.

NBFC-Upper Layer (NBFC-UL)

As per paragraph 110.1.2 of the Master Direction, NBFC-UL is guided by the Large Exposure Framework for managing and controlling. It is designed to prevent excessive concentration of risk by stating the exposure limits to the individual or group of connected counterparties. The framework focuses on the approach toward risk management and promotes stability within the upper layer of the NBFC sectors to ensure financial stability.

Exemptions from Credit and Investment Concentration Norms

The guideline issued by the RBI gives clear insights into exemptions from credit and investment concentration norms for the NBFCs by stating the scenarios for not applying these norms as stated by the Master Direction on NBFC and Master Direction on HFC, such as:

1. The Central and State Governments of India are eligible for exposure at zero per cent risk weight under the regulation of capital, which applies to NBFCs and are exempted from credit and investment concentration norms to maintain creditworthiness related to government exposures.
2. If the Government offers the guarantee in principal and interest in exposures, then it is also exempted. NBFCS needs to adhere to these exemptions and consider them in their risk management strategies for credit and investment concentration norms.

Requirements of Disclosures

If the NBFCs exceed exposure limits in the annual financial statement, then it should be presented in the Notes to Accounts, and its main aim is to enhance transparency and disclosure practices.

Conclusion

The RBI circular focuses on all the terms related to the Large Exposure Framework and credit and investment concentration norms as per the issued guidelines. The guidelines aim to bring uniformity and consistency in the computation of concentration norms in the NBFCs in the aspects of Credit risk transfer instruments and provide a framework for the large exposure to ensure financial stability by mitigating the risk in the NBFC sector.