To enhance the risk management system of banks, Reserve Bank of India (RBI) has proposed tweaking the norms for capital adequacy, with regard to their exposure in derivative instruments. Under the new framework, banks’ exposure to central counterparty (CCP), a clearing house, arising from OTC derivatives, exchange traded derivatives and Securities Financing Transactions (SFTs), will be subjected to capital requirements for counterparty credit risk, RBI said in draft guidelines.
The central bank has invited feedback from the banks on the draft on ‘Capital requirements for bank exposures to central counterparties’ by end of this month. A CCP is a clearing house that interposes itself between counterparties to contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer and thereby ensuring the future performance of open contracts.
For the purpose of regulatory capital calculation, CCPs will be considered a financial institution.
The draft norms noted that one of the lessons learnt from the recent crisis has been that OTC derivatives market may be one of the channels for contagion during the crisis. It was, therefore, decided by the G20 leaders that standardised OTC derivative contracts should be settled through CCPs. Central clearing will reduce systemic risk by reducing the contagion risk as problems at one institution will not be transmitted to other institutions through OTC derivatives market. However, requirement of central clearing also concentrates too much risk within the CCPs and any failure of a CCP may be catastrophic for the entire financial system, it said.
The draft norms proposes amendments in the Guidelines on Implementation of Basel III Capital Regulations issued in May last year. The effective date of implementation of Basel III guidelines has been deferred to April 1, 2013.