The Reserve Bank of India (RBI) today tightened the prudential norms for the non-banking financial companies (NBFCs) under which they will have to account for risks towards off-balance sheet items while computing capital adequacy requirement.
These off-balance sheet items, against which NBFCs will have to make provisions, will include interest rate contracts, foreign exchange contracts, credit default swaps and other market related contracts permitted by the RBI.
"Off-balance sheet exposures of NBFCs have increased with the increased participation in...Currency options and futures and interest rate futures...It is therefore necessary that NBFCs move over to modern techniques of risk measurement to strengthen their capital framework," the RBI said in a notification.
The decision to expected to improve solvency of the NBFCs though it might put additional financial burden on them.
NBFCs will have to assign adequate weights to both on and off-balance sheets items while maintaining the mandatory CRAR (Capital to Risk Asset Ratio).
The central bank said that henceforth the NBFCs "will need to calculate the total risk weighted off-balance sheet credit exposure as the sum of the risk-weighted amount of the market related and non-market related off-balance sheet items."
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Giving justification for its move, the RBI said that with liberalisation in Indian financial markets over the last few years and growing integration of domestic markets with external markets and greater use of derivatives products, asset liability management of for NBFCs have become complex and large, "requiring strategic management."
The new norms, the RBI said, will be effective from April 1, 2012, for off-balance sheet items already contracted. For the new contracts, it said, the norms will apply with immediate effect.
The risk weight to each off-balance sheet items which will include interest rate contracts, foreign exchange contracts, credit default swaps and other permissible contracts will be assigned according to a pre-specified formula.