Harmonising computation for concentration limits across NBFCs

– Kaushal Shah, finserv@vinodkothari.com 

Reserve Bank of India (RBI) has recently announced amendments to the Credit and Investment concentration norms, specifically targeting Base and Middle Layer Non-Banking Financial Companies (NBFCs). The circular, dated January 15, 2024, brings about notable changes aimed at ensuring uniformity and consistency across NBFCs while computing the concentration norms. 

What has RBI done?

For Middle Layer NBFCs (NBFC-MLs) :

1. In addition to the use of Credit Default Swaps (‘CDS’), RBI has now allowed NBFC MLs to offset the aggregate exposure with the following additional Credit Risk Transfer (CRT) instruments: 

• Cash margin/caution money/security deposit held as collateral on behalf of the borrower against the advances for which right to set off is available;

It is pertinent to note that, as per para 84 of the SBR Directions, already requires the NBFC for the purpose of assignment of risk weight to net off the amount of cash margin/ caution money/security deposits held as collateral against the advances out of the total outstanding exposure of the borrower. 

• Central Government guaranteed claims which attract 0 per cent risk weight for capital computation;

• State Government guaranteed claims which attract 20 per cent risk weight for capital computation; and 

• Guarantees issued under Credit guarantee Schemes of Credit Guarantee Fund Trust for Micro and Small Enterprises, Credit Risk Guarantee Fund Trust for Low Income Housing and individual schemes under National Credit Guarantee Trustee Company Ltd

Given the fact that the guarantees are issued to micro and small enterprises where the scale are, it is safe to say that the exposures on such micro or small enterprise may not be big enough in comparison to the scale of operation of the NBFC MLs. Thus, the exposure will not be big enough to be considered under the concentration norms. 

2. In addition to the existing credit/investment concentration norms as per the SBR Master Directions and HFC Master Directions, the following shall be excluded from the credit/investment concentration norms: 

• Exposures to Central and State Government which carry zero per cent risk weight; and 
• Such exposure where the principal and interest are fully guaranteed by the Government of India. (Those to state government shall not be excluded) 

3. to disclose in their Notes to Accounts (NTA) when they breach the exposure limit. However, moving forward the said disclosure shall be made after considering the above-mentioned changes.

It may be noted that the breach of concentration limits are viewed as a breach of the RBI regulations and the regulator has the right to take necessary action and impose penalty on the defaulting NBFC.

For Base Layer NBFCs (NBFC-BLs) :

• NBFC BLs now required to put in place an internal board-approved policy for credit/investment concentration limits for both single borrower/party and single group of borrowers/parties, where the computation shall be made as per the requirements applicable to NBFC MLs. 

What is the intent?

• The changes are aimed at ensuring uniformity and consistency across NBFCs while computing the concentration norms.

What will be the impact of the Circular?

• NBFC MLs will now have additional instruments to offset the aggregate exposure and will be able to exclude the abovementioned exposures from the credit/investment concentration norms.
  • It is also clarified that to be eligible as a credit risk transfer instrument, guarantees shall be direct, explicit, irrevocable and unconditional. (applicable to NBFC ULs as well)  
• NBFC BLs will be required to put in place a board approved internal policy for credit/investment concentration limits as state in above in the article.

Concern Areas 

As this novel requirement emerges, it is important to note that NBFC BLs currently operate outside the scope of concentration limits. Henceforth, even the base layer NBFCs will be required to ensured the following:

1. Frame an internal policy fixing internal limits for the concentration of exposures
2. Compute exposures in accordance with the regulations applicable to NBFC MLs.

The aforesaid requirement raises concerns regarding the intent of the SBR Framework, introduced to impart a scalar approach to NBFC regulation. Requiring NBFC BLs to adhere to NBFC MLs requirements appears counterintuitive and potentially undermines the original intent behind the SBR Framework.

---

Resources on Scale Based Regulations