RBI tweaks large exposure framework for banks; NBFCs to come under scrutiny

According to the RBI’s guidelines, a bank has to make sure its exposure to each underlying asset is lower than 0.25 per cent of the structure’s capital base
Large exposure norms for banks were on Monday amended by the Reserve Bank of India (RBI). The move will make lending to non-banking financial companies (NBFC) more streamlined and invite scrutiny on the structure of these entities.

The new framework, however, also makes it possible for government entities to borrow more, as they will not be considered part of a group of connected entities.

The central bank introduced economic interdependence criteria in the definition of connected counterparties and said banks must check how the different parties in a group were invested in each other's assets.

The RBI also excluded entities connected with the sovereign from the definition of group of connected parties. This means that government-backed entities can expect to get higher loans from banks, without inviting objections of the RBI. All banks, however, have board-approved policies on lending to various entities and don’t breach those 

The RBI said banks must apply a look-through approach in cases where a bank invested in structures that themselves had exposures to assets underlying the structures. Such structures include funds, securitisations and those with underlying assets.

According to Ashvin Parekh, managing partner of Ashvin Parekh Advisory Services, these changes were more relevant for regulating NBFCs, as the relationship between different balance sheets of NBFCs had to be established.

“On back-to-back, when funds are moved to NBFCs where details are not disclosed or financial strength is not known to the banking system and markets, some control has to be established,” Parekh said.

The direction is established. The message is liquidity will be provided only to those finance companies who qualify on the certain parameters (fleshed out in amended circular), he said.

“Banks must assign such exposure amount, i.e., the amount invested in a particular structure, to specific counterparties of the underlying assets,” the revised large assets framework said.

This will basically increase the scrutiny on such large NBFCs that have various arms invested in each other’s business.

For example, at least one large NBFC was recently accused of creating shell companies to route the promoters’ assets. The banks will now have to compulsorily check the matter in detail before extending loans to this firm.

According to the RBI’s guidelines, a bank has ensure that its exposure to each underlying asset is lower than 0.25 per cent of the structure’s capital base. Only in that case, the bank can go ahead and not have a look-through approach.

If a bank is not able to identify the underlying assets of the structure, it must assign the total exposure amount to the structure itself, as a distinct counterparty, the RBI said.

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