RBI New LCR Guidelines for NBFC

Liquidity coverage ratio (LCR) norms for non-banking financial companies (NBFCs) will take effect on 1 December 2020. According to the central bank’s final guidelines on liquidity risk management framework for NBFCs and core investment companies, LCR, which refers to the share of high quality liquid assets to be set aside to meet short-term obligations, will be introduced in stages.

In its final guidelines, RBI said NBFCs with assets of Rs 100 billion and above will have to maintain a minimum of 50% of LCR as high quality liquid assets (HQLA), while those with assets of Rs 50-100 billion will have to maintain 30% LCR. In both cases, LCR will be progressively increased to 100% by December 2024.

The RBI also asked NBFCs to adopt liquidity risk monitoring tools to capture any possible liquidity stress. This will include concentration of funding by counterparty/ instrument/ currency, availability of unencumbered assets that can be used as collateral for raising funds, certain early warning market-based indicators, such as price-to-book ratio, coupon on debts raised, breaches and regulatory penalties for breaches in regulatory liquidity requirements

Liquidity Coverage Ratio (LCR) – RBI Notifications – April 2020

As part of post Global Financial Crisis (GFC) reforms, Basel Committee on Banking Supervision (BCBS) had introduced Liquidity Coverage Ratio (LCR), which requires banks to maintain High Quality Liquid Assets (HQLAs) to meet 30 days net outgo under stressed conditions. Further, as per Banking Regulation Act, 1949, the banks in India are required to hold liquid assets to maintain Statutory Liquidity Ratio (SLR).

In view of the fact that liquid assets under SLR and HQLAs under LCR are largely the same, RBI is allowing banks to use a progressively increasing proportion of the SLR securities for being considered as HQLAs for LCR so that the need to maintain liquid assets for both the requirements is optimized.

At present the assets allowed as Level 1 High Quality Liquid Assets (HQLAs), inter alia, includes among others within the mandatory SLR requirement, Government securities to the extent allowed by RBI under (I) Marginal Standing Facility (MSF) and (ii) Facility to Avail Liquidity for Liquidity Coverage Ratio (FALLCR) [15% of the bank's NDTL with effect from April 1, 2020]. Given that SLR has now been reduced to 18% of NDTL from April 11, 2020, and with increase in MSF from 2%nto 3% of the banks’ NDTL (with effect from March 27, 2020 and applicable up to June 30, 2020), entire SLR-eligible assets held by banks are now permitted to be reckoned as HQLAs for meeting LCR.

Liquidity Coverage Ratio (LCR)

In the backdrop of the global financial crisis that started in 2007, the Basel Committee on Banking Supervision (BCBS) proposed certain reforms to strengthen global capital and liquidity regulations with the objective of promoting a more resilient banking sector.

For funding liquidity Basel Committee prescribed minimum standards as Liquidity Coverage Ratio (LCR). The LCR standard aims to ensure that a bank maintains an adequate level of high quality liquid assets that can be converted into cash to meet its liquidity needs for a 30 calendar day time horizon under a significantly severe liquidity stress scenario.

Definition of LCR

Stock of high quality liquid assets (HQLAs) ≥ 100% (the stock of high quality liquid assets should at least equal total net cash outflows), (Stock of high quality liquid assets (HQLAs)/ total net cash outflows over the next 30 days). The LCR requirement would be binding on banks from January 1, 2015 with a view to provide a transition time for banks, the requirement would be minimum 60% for the calendar year 2015 i.e. with effect from January 1, 2015, and rise in equal steps of 10% to reach the minimum required level of 100% on January 1, 2019.However RBI expects Banks should strive to achieve a higher ratio than the minimum prescribed above as an effort towards better liquidity risk management.

Stock of HQLA (of high quality liquid assets) = Level 1 Assets + Level 2A Assets + Level 2B Assets – Adjustment for 15% cap – Adjustment for 40% cap

Where:

Adjustment for 15% cap = Max [{Level 2B – 15/85*(Adjusted Level 1 + Adjusted Level 2A)}, {Level 2B – 15/60*Adjusted Level 1}, 0]

Adjustment for 40% cap = Max {(Adjusted Level 2A + Level 2B – Adjustment for 15% cap – 2/3*Adjusted Level 1 assets), 0}

Level 1 assets includes Cash including cash reserves in excess of required CRR, Government securities in excess of the minimum SLR requirement, within the mandatory SLR requirement, banks can include 7% of their SLR Government securities to the extent allowed by RBI1 under Marginal Standing Facility (MSF),Marketable securities issued or guaranteed by foreign sovereigns.

The portfolio of Level 2 assets held by the bank should be well diversified in terms of type of assets, type of issuers and specific counterparty or issuer as per guidelines given by RBI.

Level 2A Assets

Level 2A assets include Marketable securities representing claims on or claims guaranteed by sovereigns, Public Sector Entities (PSEs) or multilateral development banks that are assigned a 20% risk weight under the Basel II Standardised Approach for credit risk and provided that they are not issued by a bank/financial institution/NBFC or any of its affiliated entities. Corporate bonds, not issued by a bank/financial institution/NBFC or any of its affiliated entities, which have been rated AA-.Commercial Papers not issued by a bank/PD/financial institution or any of its affiliated entities, which have a short-term rating equivalent to the long-term rating of AA- or above.

A minimum 15% haircut should be applied to the current market value of each Level 2A asset held in the stock

Level 2B Assets

Level 2B assets include Marketable securities representing claims on or claims guaranteed by sovereigns having risk weights higher than 20% but not higher than 50%, i.e., they should have a credit rating between A+ to BBB- as RBI Master Circular on ‘Basel III – Capital Regulations’.

Common Equity Shares which are not issued by a bank/financial institution/NBFC or any of its affiliated entities. Also included in NSE CNX Nifty index and/or S&P BSE Sensex index.

A minimum 50% haircut will applied to the current market value of each Level 2B asset held in the stock. Further, Level 2B assets should comprise no more than 15% of the total stock of HQLA. They must also be included within the overall Level 2 assets.

Calculation of Total net cash outflows

The total net cash outflows is defined as the total expected cash outflows minus total expected cash inflows for the subsequent 30 calendar days. Total expected cash outflows are calculated by multiplying the outstanding balances of various categories or types of liabilities and off-balance sheet commitments by the rates at which they are expected to run off or be drawn down. Total expected cash inflows are calculated by multiplying the outstanding balances of various categories of contractual receivables by the rates at which they are expected to flow in up to an aggregate cap of 75% of total expected cash outflows.