The Reserve Bank of India's (RBI) annual monetary policy for 2009-10 has outlined several prudential measures for strengthening the health of banks in troubled times.
RBI, at its policy review on Tuesday, has proposed to fine tune the already existing guidelines for banks to maintain floating rate provisions.
This follows the recent recommendations of the G-20 Working Group on Enhancing Sound Regulation and Strengthening Transparency on maintenance of capital above minimum requirements and loan loss provisions by banks in good times, which could act as buffers to withstand large shocks.
In June 2006, RBI had directed banks to build floating provisions as a buffer for the possible stress on asset quality as part of the ‘prudential norms on Income recognition, asset classification and provisioning pertaining to advances’ as a desirable practice. According to this, banks would voluntarily set apart provisions much above the minimum prescribed level.
These guidelines will be thus modified later this financial year after Financial Stability Board of G-20 countries and the committee on Global Financial System (CGFS) finalise their recommendations in this regard.
Similarly, in order to capture the liquidity risks arising from international operations of banks, RBI has outlined that lenders will be required to integrate their various foreign currency assets and liabilities positions from their branch operations overseas with the rupee asset liability position in India. Otherwise referred to as "global liquidity planning", RBI will prepare a draft circular detailing the modalities for adopting the integrated liquidity risk management system based on Basel Committee’s ‘Principles for Sound Liquidity Risk Management and Supervision’ brought out in September 2008 as well as other international best practices for public comments by June 15, 2009.
Liquidity risk arises from difficulty in selling an asset or, in other words, difficulty in finding an exit route from the asset.
Currently, for asset liability management, liquidity of banks in India is tracked through traditional maturity or cash flow mismatches. This renders difficulty in managing risk in dealing in assets and liabilities of banks overseas when the country's risk or the overall business risk increases as is the case at present following the global slowdown.
It could be mentioned that some of the derivative instruments such as credit-linked notes or credit default swaps floated by Indian banks and companies are difficult to get traded overseas due to tight dollar liquidity conditions. While banks manage domestic assets and liabilities, the risks arising from overseas instruments have not been incorporated and thus most of the banks had to make higher provisioning to make up for these losses in 2008-09. .
In the light of the recent volatility in markets, banks have faced a severe erosion in value of collateral and deposits maintained against various loans and other exposures, either through outright default or fall in prices of the assets. Towards this, RBI has prescribed risk weights for exposure of banks to central counterparties (CCPs).
A central counterparty is an entity that interposes itself between counterparties to contracts traded within one or more financial markets, thus becoming the legal counterparty such that it is the buyer to every seller and the seller to every buyer.
The Clearing Corporation of India (CCIL) has been acting as a CCP for banks in various segments of the financial market. Similarly, contracts such as interest rate futures and currency futures, which are traded on the stock exchanges, are also settled through the clearing houses attached to these exchanges
For exposure of banks on account of derivatives/securities financing transactions trades outstanding against all CCPs, the risk weight will be assigned zero exposure value as it is presumed that CCPs’ exposures to their counterparties are fully collateralised on a daily basis, thereby providing protection for the central counterparty’s credit risk exposures.
The margin amounts/collateral maintained with the CCPs will attract risk weights appropriate to the nature of CCP. For CCIL, the risk weight will be 20 per cent and for other CCPs it will be according to the ratings assigned to these entities as per the New Capital Adequacy Framework.
RBI is of the view that banks settling trades through CCIL/stock exchanges have two types of exposures to these CCPs; first, on account of the on-balance sheet and off-balance sheet transactions undertaken through CCP and second, the exposure on account of deposits/collateral kept with CCPs to meet the margin requirements.
