Credit/Investment Concentration Norms – Credit Risk Transfer

Introduction

Reserve Bank of India (RBI) issued new guidelines for Non-Banking Financial Companies (NBFCs) and Housing Finance Companies (HFCs) dated January 15, 2024 with Circular bearing no.  RBI/2023-24/112.

This circular’s purpose is to ensure uniformity and consistency in the computation of concentration norms among NBFCs. The guidelines on the Large Exposures Framework (LEF) will apply to the NBFC-Upper Layer (NBFC-UL) however the NBFC-Base Layer (NBFC-BL) and NBFC-Middle Layer (NBFC-ML) are governed by the credit/investment concentration norms. To maintain the stability of the concentration norms among NBFCs, a review of the existing concentration norms has been undertaken and the decision is as follows[1]:

A. Regulations for NBFC-ML

• Computation of exposure – Credit Risk Transfer Instruments

The circular presents new regulations for the NBFC-Middle Layer (NBFC-ML), with emphasis on the computation of exposure through Credit Risk Transfer Instruments. The credit risk transfer instruments listed below can be used to offset the exposures of NBFC-ML:

1. Availability of right to set off cash margin/caution money/security deposit on the borrower’s behalf which are maintained as collateral;
2. Claims guaranteed by the Central Government which attract 0 percent risk weight for capital computation;
3. Claims guaranteed by the State Government which attract 20 percent risk weight for capital computation;
4. Guarantees issued under the Credit Guarantee Schemes of Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), Credit Risk Guarantee Fund Trust for Low Income Housing (CRGFTLIH) and individual schemes under National Credit Guarantee Trustee Company Ltd (NCGTC) subject to meeting the conditions of circular on ‘Review of Prudential Norms – Risk Weights for Exposures guaranteed by Credit Guarantee Schemes (CGS)’ dated September 07, 2022, as amended from time to time.

• Exemptions from credit/investment concentration norms

Apart from the exposures already exempted from credit/investment concentration norms, the following exposures shall also be exempt from credit/investment concentration norms:

1. Exposure to the Government of India and State Governments that qualify for zero percent risk weight as per the capital regulations applicable to NBFC.
2. Exposure where the principal and interest are entirely guaranteed by the Government of India.
3. Disclosure

During the year any NBFCs that exceed the prudential exposure limit are required to be disclosed in the Notes to Accounts in the annual financial statements. The computation of the exposure limit of the disclosure amount is also mentioned in the circular. 

B. Regulations for NBFC-BL

NBFC- BL is required to adopt an internal board-approved policy for credit/investment concentration limits for both single borrowers and a single group of borrower/ party. The computation of exposure should be in line with the NBFC-ML given in the circular.

C. Regulations for NBFC-UL

Clarification is given on the eligibility of credit risk transfer agreements and that it must be direct, explicit, irrevocable, and unconditional.

All the instructions will come into force from the date of issuance and all the other instructions of LEF and credit/investment concentration will follow the existing instructions.

Conclusion

In conclusion, the Reserve Bank of India's new guidelines for Non-Banking Financial Companies (NBFCs) and Housing Finance Companies (HFC) mark a significant step towards standardizing and strengthening the financial stability of these institutions. The detailed regulations for different layers of NBFCs specifically the NBFC-Upper Layer, NBFC-Middle Layer, and NBFC-Base Layer—demonstrate a focused approach to managing credit risk and exposure.

For the NBFC-ML, the circular introduces precise measures for computing exposure through Credit Risk Transfer Instruments, providing clarity on what can be considered as collateral, and which guarantees can be factored into the risk weight for capital computation.

The exemptions added to the credit or investment concentration norms aim to encourage prudent exposure to government securities and guaranteed obligations, thereby reducing systemic risk.

The disclosure requirement serves to enhance transparency for stakeholders, ensuring that any NBFC exceeding prudential exposure limits is promptly identified in the annual financial statements. Lastly, the regulations for the NBFC-BL and NBFC-UL, including the requirement for internal board-approved policies and clarifications on credit risk transfer agreements, reflect the RBI's commitment to maintaining a robust regulatory environment for financial entities.

All these instructions are effective immediately from the date of issuance and are intended to integrate with the existing instructions under the LEF and credit/investment concentration norms. This comprehensive framework is expected to not only safeguard the financial system but also to harmonize regulatory practices across NBFCs of different scales and complexities.

[1] Reserve Bank of India – notifications https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12598&Mode=0#FN2