A call for timely action

After the IL&FS crisis, the RBI feels that the oversight framework related to the financial corporations need to be geared for timely measures

The Reserve Bank of India in its Financial Stability Report has pointed out the reasons why the existing oversight structures related to financial conglomerates  may not be enough to monitor systemic risks such large entities can pose for the financial markets. Jash Kriplani explains.

Why has the Reserve Bank of India called for an improvement of the oversight structure of financial conglomerates?

Over the years, FCs have become a key constituent of the financial markets. Such conglomerates have presence across various segments of the financial market — including banks, insurance and mutual funds. Due to their deep engagement in the financial markets, the stability of these conglomerates is also important for the stability of the financial market. After the Infrastructure Leasing and Financial Services (IL&FS) crisis, the RBI feels that the oversight framework related to the FCs need to be geared for timely measures. Timely intervention can help in containing the contagion risks when such FCs face challenges in keeping their own balance sheet in sound health. 

How are FCs monitored under the existing framework?

FCs submit Financial Conglomerate Returns (FINCON) on a quarterly basis. These submissions capture information related to intra-group transactions covering short-term lending, placement of deposits, investments in bonds/debentures, commercial papers, certificate of deposits, units of mutual funds etc. within the group entities. These filings help the banking regulator in understanding the movement of funds within the group entities. 

The FINCON returns format itself is likely to be changed soon to enhance the information flow. A revised FINCON returns format will capture additional detailed information related to borrowings made by each group entity in an FC. Further, the bifurcation in terms of short-term borrowings (up to one year) and long-term borrowings (more than one year) will also be obtained. According to the regulator, this will help in ascertaining the dependence of the FC’s group entities on banks and short-term borrowings. The oversight of financial conglomerates is being carried out by an Inter Regulatory Forum for monitoring Financial Conglomerates, which is one of the four working groups set up under the aegis of the FSDC Sub-Committee. 

What are the gaps in the existing oversight regime?

The RBI’s report said the current definition for identifying an FC itself might be missing some key elements. A group which has significant cross-sectoral activities but do not have a significant presence in at least two sectors is not covered in the existing definition. While significant presence in activities is a major contributor to an entity’s systemic risk, it is not the only contributor. As per the definition adopted by the Inter Regulatory Forum, “a group would be identified as an FC on the basis of its significant presence in two or more market segments (banking, insurance, securities, non-banking finance and pension fund).” The report observed that complex and camouflaged inter-group linkages through credit support and potency of spillover effects in times of turmoil (through banking sector linkages) are becoming important considerations for identifying FCs in the Indian context. It is also important to have an oversight of groups that are engaged in financial intermediation with significant spillover potential and yet have a significant part of their group revenue coming from non-financial businesses.

What are some of the changes being mooted?

The FSR says the information the FCs are presently being asked to furnish is fairly exhaustive, but also notes that it is backward looking and so it may not be able to capture emerging risks and vulnerabilities adequately. The report proposes some changes that can be considered to improve the oversight framework so that risks can be flagged early. The report calls for a risk sensitive oversight regime for FCs where the intensity of the oversight takes into account the size of the entity and the likelihood of an adverse event (say, over a one-year horizon). This may make it possible for regulators and other related agencies to take timely remedial measures. Some of the trigger events for conducting an FC’s assessment may be adverse rating action, unutilised credit lines falling below a certain threshold and bunching of maturing liabilities.