Annex I

Review of Regulatory Framework for the All India Financial Institutions (AIFIs)

I. Capital to Risk Weighted Assets Ratio (CRAR)

Existing regulation

1. The AIFIs are currently governed by Basel I capital requirements. Under the Basel I

framework the AIFIs are required to maintain a minimum Total capital of 9% of risk weighted assets

and minimum Tier I capital of 4.5%, and Tier II capital not exceeding 50% of total capital.

Revised regulation

2. Basel III Capital Framework as applicable to banks (Master Circular

DBR.No.BP.BC.1/21.06.201/2015-16 dated July 1, 2015) with modifications indicated in paragraph 1

of Part A of Annex II shall apply to the AIFIs. Please see Appendix 1 for summary of the main

elements.

Rationale

3. Currently, there is no alternative capital measurement standard for financial entities other than

the Basel standards. While there is no requirement for non-banking financial institutions to follow

Basel standards, almost in all countries, such institutions are being subject to exactly or broadly

similar requirements. While definition of capital under Basel III is neutral to the risk profiles of the

institutions, the risk weight measurement approaches are exposure and risk profile specific.

Therefore, under Basel III framework, individual institutions can choose the risk measurement

approaches according to their risk profiles and need to capitalise only those risks to which they are

exposed. For example, an institution that does not have trading book exposures including derivatives

or re-securitisation exposures, need not worry about the heavy capital requirements under Basel III to

which these exposures are subjected.

4. Over the last 25 years, many development banks have migrated from Basel II to Basel III

standards along with the commercial banks in their respective countries. While Basel I was obviously

very crude in terms of risk sensitivity, during the 2008 global financial crisis Basel II was found

deficient in many respects including inadequate coverage of financial risks. Internationally, the

development banks have chosen to adopt Basel III because the micro-prudential elements of Basel

standards generally measure and capitalise financial risks regardless of the entities that undertake

them. Basel III strengthens the institution-level i.e. micro prudential regulation, with the intention to

raise the resilience of individual financial institutions in periods of stress. Besides, the reforms have a

macro prudential focus also, addressing system wide risks, which can build up across the banking/

financial sector, as well as the pro-cyclical amplification of these risks over time. These new global

regulatory and supervisory standards mainly seek to raise the quality and level of capital to ensure

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that financial entities are better able to absorb losses on both a going concern and a gone concern

basis, increase the risk coverage of the capital framework, introduce leverage ratio to serve as a

backstop to the risk-based capital measure, raise the standards for the supervisory review process

(Pillar 2) and public disclosures (Pillar 3) etc.

Why to leapfrog to Basel III?

5. Basel II was very sophisticated, much more risk sensitive, and resource intensive as

compared with Basel I. It marked a completely new approach to measurement of capital adequacy

with revised market risk framework and inclusion of operational risk. On the other hand, Basel III

capital framework has two dimensions – (i) Micro-prudential and (ii) Macro-prudential. Micro-

prudential elements are essentially similar to Basel II, but completely revised (or under revision) to

address the shortcomings observed during the crisis. Most of these revisions have been introduced in

supersession of particular paragraphs of Basel II such that those provisions of Basel II remain no

longer valid as an international standard. Implementing Basel II in such a situation would mean

implementing a superseded international standard with known weaknesses, which is not likely to be

seen as a positive move by the market.

6. The macro-prudential elements of Basel capital framework are considered an integral part of

the capital framework for financial entities to protect them from the harmful effects of the systemic

crises. Not extending this framework to the AIFIs would expose them to the macro-prudential shocks.

II. Leverage Ratio

Existing regulation

7. Under the current Resource Raising Norms (Master Circular

DBR.No.FID.FIC.1/01.02.00/2015-16 dated July 1, 2015), the AIFIs can borrow up to 10 times of their

Net Owned Funds (NOF).

Revised regulation

8. Minimum Basel III Leverage Ratio equal to 6% computed as ratio of Tier I capital to Total

Exposure. The rules governing the computation of the exposure measure shall be the same as for

banks (Master Circular DBR.No.BP.BC.1/21.06.201/2015-16 dated July 1, 2015) with modifications

indicated in paragraph 2 of Part A of Annex II. Consequently, the Master Circular

DBR.No.FID.FIC.1/01.02.00/2015-16 dated July 1, 2015 stands withdrawn.1

9. The fall in the leverage ratio of the AIFIs from their current levels shall be constrained by not

more than 2% each year until it declines to 6%.

1 This circular deals with limit on borrowings linked to the Net Owned Funds of the AIFIs, Umbrella Limit and related matters. Umbrella Limit also stands withdrawn as indicated in paragraph 38 of this circular.

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Rationale

10. The extant limit on the borrowings of the AIFIs linked to their Net Owned Funds suffers from the

following limitations:

(i) It fails to capture the contingent liabilities and off balance sheet exposures of the

AIFIs exposing them to the risk of breaching the limit as the contingent liabilities devolve and

are funded by the on-balance sheet liabilities.

(ii) It has no scientific basis and has been found to be constraining the asset growth of

some of the AIFIs apart from compelling them to maintain a high level of capital despite their

low risk profile.

(iii) Basel III Leverage Ratio serves two objectives: (i) Constraining the build-up of

leverage in the banking sector, helping avoid destabilising deleveraging processes which can

damage the broader financial system and the economy; and (ii) To reinforce the risk based

requirements with a simple, non-risk based “backstop” measure. Unlike this, the existing limit

on borrowings only controls the leverage. Besides, since it is not calibrated in relation to the risk

weighted assets density, it is not capable of acting as an effective counter-cyclical measure.

III. Liquidity risk framework

Existing Regulation 11. There is no liquidity risk standard for the AIFIs at present. However, RBI has issued

instructions to AIFIs on asset liability management through structured liquidity statements vide circular

Asset-Liability Management (ALM) System (Circular DBS.FID.No.C.11/ 01.02.00/ 99-2000 dated

December 31, 1999). This is mostly in the nature of guidance rather than a regulatory requirement.

Revised regulation

12. The revised new liquidity risk framework - Liquidity Risk Coverage (LRC) - for the AIFIs is

primarily based on regulatory prescriptions for minimum positive cumulative cash flow gaps upto 90

days. The framework is outlined in paragraph 1 of Part B of Annex II. The main elements of the LRC

are as follows:

(i) Cash Flow Gap limits 13. The AIFIs shall monitor the cumulative cash flow mismatches over different maturity buckets

regularly and observe the following gap limits.

(a) Regulatory limits

Period Cumulative gaps

0-14 days Minimum positive gap equal to 25% of cash outflows

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0-28 days Minimum positive gap equal to 20% of cash outflows

0-90 days No negative gap

(b) Internal limits 14. The AIFIs shall prescribe internal gap limits with the approval of their boards for cumulative

cash flow mismatches beyond 90 days upto one year.

(ii) Treatment of Lines of Credit (LOCs) 15. Under Basel III- Liquidity Coverage Ratio (LCR) framework for banks, the LOCs availed by

banks are deemed non-available for the purpose of computing cash inflows, as it is assumed that

when a financial system is under stress, other institutions may fail to honour their commitments under

LOC. However, as explained above, the liquidity risk framework for AIFIs is not intended to be

calibrated for the same stress levels as applicable to banks. Therefore it is considered appropriate to

treat the LOCs sanctioned by banks or any other financial institution available to the AIFI albeit, with a

haircut. The Board of Directors of individual AIFIs shall determine the haircuts to be applied to the

LOC taking into account various factors that might suggest the non-availability of LOC, full or partial,

when required.

(iii) Funding the required minimum positive gap 16. The AIFIs can fund the required minimum positive gap by a combination of excess of normal

cash inflows over the cash outflows, Government securities and LOCs, subject to the conditions set

out below:

a. Stock of Central Government Securities 17. In cases where the normal cash inflows (i.e. cash flows excluding LOCs) are not sufficient to

meet the minimum requirement of positive gaps as given in paragraph 6.4(i)(a) [Please see paragraph

1 of Part B of Annex II], the AIFI shall maintain a stock of liquid Central Government securities upto

5% of cash outflows (other than that maturing within 28 days). The procedure to calculate the

requirement of maintaining the central government security is explained in Appendix A.

b. LOC

18. If the normal cash flow excluding the LOCs is zero or positive, there shall be no minimum

requirement of LOC or stock of government securities. However, as the normal cash flow turns

negative, the minimum funding requirement in terms of government securities arises. However, it is

capped to 5% of cash outflows and the remaining gap can be met with LOCs. The AIFIs shall also be

free to hold stock of government securities of more than 5%.

Rationale

19. Prior to the global financial crisis, no regulatory standard existed on the liquidity risk

management by banks and other financial institutions. In India also we did not have any regulatory

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requirement for banks and financial institutions with regard to liquidity risk management. However,

RBI has issued instructions to both banks and AIFIs on asset liability management through structured

and dynamic liquidity statements. This is mostly in the nature of guidance rather than a regulatory

requirement.

20. The financial crisis underscored the need for the sound management of liquidity risk by banks

and other financial entities. BCBS has formulated two liquidity standards for banks namely, Liquidity

Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). Of these, LCR has already been

applied to banks with effect from January 1, 2015. The objective of the LCR is to ensure minimum

amount of High Quality Liquid Assets (HQLA) in relation to the net cash outflows of a bank measured

over a period of 30 days under stress situation.

21. RBI has implemented the LCR standards for banks with effect from January 1, 2015.

However this has not been extended to the AIFIs. It is proposed not to extend the LCR standard to

the AIFIs as a study undertaken by RBI showed that given very different business models of the four

AIFIs, significant variations of the net cash outflows over a financial year, mandating a bank-like LCR

standard for AIFIs maybe onerous for them. Further, in view of greater predictability and stability of

the cash flows of the AIFIs as compared with those in case of banks, the cash outflows and inflows

need not be measured at the same stress level as in the case of the banks. Nevertheless, the AIFIs,

would still have some amount of liquidity risk associated with the secured and unsecured wholesale

funding which is available and the possible draw down of the committed lines of credit over a target

horizon. In addition, unlike banks, the AIFIs also do not maintain liquidity reserves in the form of SLR

securities. Therefore, it would be necessary to have a regulatory framework to take care of the

liquidity risks faced by the AIFIs.

IV. Prudential limits

a) Exposure Norms

Existing regulation

22. The AIFIs’ exposures to a single borrower and a group of borrowers are limited to 15% and

40% of capital funds, respectively on par with banks (Master Circular

DBR.FID.FIC.No.4/01.02.00/2015-16 dated July 1, 2015). However, the refinance portfolio, which

forms a major chunk of the operations of AIFIs, has been exempted from these limits while advising

them to set their Board-approved limits for the same. In addition, there are limits on exposure to

NBFCs on individual and aggregate basis.

Revised regulation

23. The instructions on exposure to NBFC have been aligned with those applicable to banks. The

mentioned circular is applicable with modifications as outlined in paragraph 2 of Part B of Annex II.

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Rationale

24. Exposure limits are one of the fundamental tools to manage credit concentration risk. From

the perspective of risk management, the AIFIs should attract lower exposure limits as compared with

banks due to high sectoral concentration of their credit portfolios. However, this issue shall be dealt

under Pillar 2 of capital framework rather than through lower exposure limits.

b) Significant investment in non-financial/commercial enterprises2

Existing regulation

25. No regulation is in place regarding the AIFI’s significant equity investments in commercial

enterprises. However, by practice, AIFIs have been discouraged to make significant equity investment

in commercial enterprises unless these are mandated by their statutes.

Revised regulation

26. The Exposure Norms for the AIFIs (Master Circular DBR.FID.FIC.No.4/01.02.00/2015-16

dated July 1, 2015) shall be modified as outlined in paragraph 2.3 of Part B of Annex II.

27. Under Basel III, significant investments in commercial enterprises (exceeding 10% of the

investee company’s equity) are subject to 100% capital charge. This shall be applicable to the AIFIs

as well, except where the investment is mandated by the statute.

Rationale

28. Though the limit placed by RBI is not a Basel requirement, it has served a useful purpose.

Under Basel III, such investments in excess of 10% of an investing bank’s equity shall be deducted

from its equity. In general, therefore, as in the case of banks, it is not desirable for the AIFIs to invest

in the commercial enterprises due to high possibility of conflict of interest, their high illiquidity and high

risk. However, when the equity investments are mandated in the statute in accordance with the

objectives of the institutions, higher limits can be allowed.

c) Significant equity investments in the financial entities

Existing regulation

29. There is no regulation in place for equity investment by the AIFIs in their subsidiaries, joint

ventures, associates and other financial services entities. By practice, the limits as applicable to banks

have been applied. In the case of banks, these investments are restricted to 10% of the bank’s paid

up capital and reserves in a single entity and upto 20% of its paid up capital and reserves in all

2 For the purpose of this Circular, investment exceeding 10% of equity of the investee company shall be treated as ‘significant investment’.

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financial entities including subsidiaries (Master Direction on Financial Services provided by Banks

DBR.FSD.No.101/24.01.041/2015-16 dated May 26, 2016).

Revised regulation

30. The AIFIs’ strategic investments shall not be subject to any regulatory limit and the AIFIs may

formulate their own Board-approved policies in this regard. The Master Direction on Financial

Services for Banks (DBR.FSD.No.101/24.01.041/2015-16 dated May 26, 2016) shall be modified as

outlined in paragraph 3 of Part A of Annex II.

Rationale

31. The intent of this regulation is to ensure that banking continues to be a bank’s predominant

activity. While limited diversification into other financial activities may be useful to manage volatility in

the earnings of the group, substantial engagement in non-core areas could potentially distract the

bank’s board and management from banking business, affecting the safety and soundness of the

bank. However, these concerns are not significant in the case of the AIFIs and so long as the investee

entities are operating in the areas permissible under the AIFIs’ governing Act, there is no need for a

regulatory limit, although RBI’s prior permission for making such investments above a cut-off would be

necessary.

d) Capital Market Exposure (CME)

Existing regulation

32. The aggregate exposure of an AIFI to capital market in all forms (both fund based and non-

fund based) should not exceed 40 per cent of its net worth as on March 31 of the previous year

(Master Circular DBR.No.FID.FIC.3/01.02.00/2015-16 dated July 1, 2015). Within this overall ceiling,

the AIFI’s direct investment in shares, convertible bonds / debentures, units of equity-oriented mutual

funds and all exposures to Venture Capital Funds (VCFs) [both registered and unregistered] should

not exceed 20 per cent of its net worth. Given SIDBI’s special mandate, its direct investment in

shares, convertible bonds / debentures, units of equity-oriented mutual funds and all exposures to

Venture Capital Funds (VCFs) [both registered and unregistered] has been permitted upto 40 per cent

of its net worth within the overall ceiling.

Revised regulation

33. Direct CME (treasury investments) should not exceed 10% of net worth of the AIFIs. This limit

shall not include significant investments and other non-significant strategic investments made as part

of equity financing for which there is no limit. Prudential Norms for Classification, Valuation and

Operation of Investment Portfolio by FIs- (Master Circular DBR.No.FID.FIC.3/01.02.00/2015-16 dated

July 1, 2015) would be applicable with modifications proposed in paragraph 2.3 of Part B of Annex II.

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Rationale

34. Generally, the AIFIs, unlike banks, need not invest in equity as part of their treasury

operations. However, they may like to do so as part of diversification strategy. So a small limit of 10%

of Net Worth may be appropriate for such investments.

(e) Investments in liquid/ short term debt schemes of mutual funds

Existing regulation

35. The limit for investment by AIFIs in Non-Government Debt Securities, viz. 10 per cent of the

AIFIs' total investment in debt securities, did not apply to money market mutual funds.(Master Circular

DBR.No.FID.FIC.3/01.02.00/2015-16 dated July 1, 2015)

Revised regulation

36. With effect from April 1, 2023, the total investment by AIFIs in liquid/short term debt schemes

(by whatever name called) of mutual funds with weighted average maturity of not more than one year,

shall be subject to a prudential cap of 10 per cent of their Net Worth as on March 31 of the previous

year. Also, the AIFI’s investments in unlisted non-Government debt Securities, including in the liquid/

short term debt schemes of mutual funds, shall not exceed 10% of its total investment in non-

Government debt securities.

Rationale

37. The limit for banks in respect of the investments in liquid/ short term debt schemes of mutual

funds was imposed from the perspective of systemic risk issues that arise from investments made by

banks for short term liquidity management. In particular, sudden withdrawal by banks from the mutual

funds during periods of liquidity stress in the market could lead to liquidity drying up for these mutual

funds. The same concerns exist even for the AIFIs. However, given that some AIFIs actively use

mutual funds for short term liquidity management, it has been decided to allow a five years’ period for

AIFIs to reach the 10 per cent limit.

f) Borrowings through specified instruments ( Umbrella Limit)

Existing regulation

38. Currently, under the ‘Umbrella Limit’, the AIFIs can borrow upto 100 per cent of their Net

Owned Funds (NOF) through five instruments viz., term deposits, term money borrowings, certificates

of deposits (CDs), commercial papers (CPs) and inter-corporate deposits (ICDs).

Revised regulation

39. No limit on borrowings through specified instruments.

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Rationale

40. There shall be no limit on the AIFIs’ short-term borrowings in view of the revised LRC

framework (Please see paragraph 12 above). The gap-based limits shall provide a better alternative

to the existing framework.

V. Risk Management Guidelines

a) Credit risk management

Existing regulations

41. No specific guidelines have been issued to the AIFIs on credit risk management as yet.

Revised regulations

42. It is proposed to issue the same guidelines on credit risk management systems as applicable

to Scheduled Commercial Banks (Circular DBOD.No.BP.520/21.04.103/2002-03 dated October 12,

2002) with suitable modifications as indicated in paragraph 4.1 of Part A of Annex II to take care of

the additional risks in the AIFIs’ balance sheets and excluding the portions which are not relevant to

them.

Rationale

43. A peculiarity of the credit portfolios of AIFIs is that unlike in the case of banks, the exposures

tend to be large. A significant part of the portfolio consists of institutional borrowers, such as credit

institutions, state governments, government agencies etc. It is felt that the risk management

guidelines prescribed for banks shall work well for AIFIs as well, however emphasis should be on

risks associated with lending to credit institutions, state governments, government agencies and risks

associated with project finance.

b) Market risk management and Asset Liability Management

Existing regulations

44. No specific guidelines have been issued to the AIFIs on market risk management and Asset

Liability Management (interest rate risk) as yet.

Revised regulations

45. The guidelines as applicable to Scheduled Commercial Banks shall apply to the AIFIs for

market risk management (Circular DBOD.No.BP.520/21.04.103/2002-03 dated October 12, 2002)

(paragraph 4.2 of Part A of Annex II) and for Asset Liability Management (interest rate risk) (Circular

DBOD. No. BP. BC. 59 / 21.04.098/ 2010-11 dated November 4, 2010) (paragraph 4.3 of Part A of

Annex II).

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Rationale

46. The market risk and interest rate risk management practices are exposure-specific and

applicable to any institution which has these exposures. As the AIFIs also have market risk and

interest rate risk in the banking book, the guidelines which already exist for banks can apply to the

AIFIs.

c) Operational Risk Management

Existing regulations

47. No specific guidelines have been issued to the AIFIs on operational risk management as yet.

Revised regulations

48. It is proposed to issue the same guidelines as applicable to Scheduled Commercial Banks for

operational risk management (Circular DBOD.No.BP.BC.39/21.04.118/2004-05 dated October 14,

2005) (paragraph 4.4 of Part A of Annex II).

Rationale

49. Like any other financial institution, AIFIs also have operational risk. We are also issuing

guidelines on capital charge for operational risk as mentioned in paragraph 2 above. Therefore, it is

appropriate to issue guidelines to AIFIs on operational risk management with suitable modifications.

d) Stress Testing

Existing regulation

50. Currently, no guidelines exist for stress testing for the AIFIs.

Proposed regulation

51. Guidelines based on similar guidelines on stress testing applicable to banks (Circular

DBOD.BP.BC.No.75/ 21.04.103/ 2013-14 December 2, 2013) shall be applicable to the AIFIs with

modifications as mentioned in paragraph 4.5 of Part A of Annex II. The guidelines would, inter alia,

cover appropriate methodologies for stress testing the risk factors that are most relevant for the

individual AIFIs taking into account their sector-specific portfolios.

Rationale

52. Stress testing is an integral part of risk management for any financial institution. Apart from

getting a sense of the right amount of capital needed in a stress situation, it also helps the institutions

to rebalance their portfolios and introduce appropriate risk management controls to survive in a stress

scenario. Therefore, stress testing guidelines are considered necessary for the AIFIs.

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e) Liquidity risk management

Existing regulation

53. Existing guidelines on liquidity risk management (Circular DBS.FID.No.C.11/01.02.00/99-

2000 dated December 31, 1999) were issued to the AIFIs as part of the ALM guidelines.

Proposed regulation

54. Liquidity risk management guidelines based on those applicable to banks (Circular

DBOD.BP.No.56/21.04.098/2012-13 dated November 7, 2012) shall apply to the AIFIs, with

modifications as indicated in para 4.6 of Part A of Annex II. However, the same shall be fine-tuned to

account for business profile of each of these institutions which differ from commercial banks as well

as within the AIFI group. Also, since Basel III Liquidity Coverage Ratio is not being extended to AIFIs,

the revised regulation prescribes certain gap limits. RBI’s instructions dated November 07, 2012 on

detailed liquidity risk management for banks cover principles for the management and supervision of

liquidity risk, governance structure, measurement and management of liquidity risk, including

disclosure. These guidelines are shall be made applicable to the AIFIs with suitable modifications as

indicated in paragraph 4.6 of Part A of Annex II.

Rationale

55. AIFIs being financial entities also face liquidity risk. Therefore, it is appropriate to issue

guidelines to AIFIs on liquidity risk management with suitable modifications.

f) Strategic and reputational risk management

Existing regulation

56. At present no specific regulation exists for management of strategic and reputational risk.

Revised regulation

57. The guidance for banks on these topics is contained in Pillar II of the capital adequacy

framework (Master Circular DBR.No.BP.BC.4./21.06.001/2015-16 dated July 1, 2015). These

guidelines shall be extended to AIFIs with modifications as mentioned in paragraph 4.7 of Part A of

Annex II.

Rationale

58. AIFIs are important financial institutions which are expected to play an important role in

furthering the economic development of the country through various initiatives, most of which involve

frequent introduction of new products, new strategies and implementation of new projects. Some of

the programmes are implemented as part of Government’s initiatives. Considering these aspects, it is

necessary that the AIFIs are conscious about the resultant strategic and reputational risks.

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VI. Impact study

59. RBI has carried out a quick impact study. It shows that the present level of capital of most of

the AIFIs shall be adequate to support the Basel III capital requirement. In fact, the capital ratios for

three AIFIs shall improve if Basel III risk weights are applied.

60. In case an AIFI’s capital is insufficient to meet the minimum requirement on the date of

introduction of the Basel III framework, it shall be allowed time upto 2 years to achieve the minimum

requirement.

VII. Other regulations

61. The review of the remaining regulations will be undertaken as part of the issuance of Master

Directions which largely involves consolidation of the existing instructions. We do not expect any

significant changes in those directions. However, in case some changes in those instructions become

necessary, the AIFIs will be given an opportunity to provide feedback before finalisation thereof. The

AIFIs have already been consulted on the Master Directions on Disclosure Norms, Exposure Norms,

Prudential Norms for Classification, Valuation and Operation of Investment Portfolio and Prudential

norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances.

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Appendix 1

Prudential requirements -

Capital

Existing RBI directions Parameters of proposed revised directions

Basel I Basel III

Pillar 1 Minimum Capital Requirement

9% Total capital 9%

Minimum 4.5% Tier 1 7%

No minimum requirement Common Equity Tier 1

5.5%

Additional Tier 1 1.5%

Not more than 50% of total capital

Tier 2 2%

Definition of capital

Same as for banks

Eligibility criteria for instruments

Same as for banks

Point of Non-Viability criteria

Same as for banks

Capital conservation buffer

No requirement under Basel I

2.5%

Countercyclical capital buffer

No requirement under Basel I

0-2.5% ( as and when put in place)

Pillar 2 No requirement under Basel I

Same as for banks

Pillar 3 No requirement under Basel I

Same as for banks

Capital Measurement Approaches

Credit Risk A simplified approach with three risk weights – Exposure to sovereigns-0%, Exposure to banks - 20%, All other assets – 100%

Basel II Standardised Approach for credit risk which shall be replaced by Basel III Standardised Approach for credit risk along with commercial banks in due course. Additional risk weights would be considered for foreign assets with risk mitigations based on their expected performance.

Market Risk The 1996 amendment of Basel I introducing capital requirements for market risk has been not made applicable to the AIFIs.

Basel II Standardised Approach for market risk shall be implemented until April 1, 2019 at which time it would be replaced by Basel III version of the market risk approach as for banks.

Operational risk No operational risk capital requirements under Basel I

Basel II Standardised Approach for operational risk which shall be replaced by Basel III Standardised Approach for operational risk along with commercial banks in due course

Annex II

Part A: Bank circulars extended to the AIFIs subject to specific instructions

Sl. No.

Specific instructions for the AIFIs

1. Capital to Risk Weighted Assets Ratio (CRAR) Basel III Capital Regulations- Master Circular DBR.No.BP.BC.1/21.06.201/2015-16 dated July 1, 2015 will apply with the following modifications.

1.1 The following instructions may be read after paragraph 4.5.6 of the circular Capital instruments already issued by the AIFIs which no longer qualify under Basel III will be allowed to be counted as Tier 1 or Tier 2, as the case may be, as per the existing rules until their maturity or the first call date. In the case of any perpetual instruments without call option, these will cease to be counted towards capital after April 1, 2028. All capital instruments issued by AIFIs after the date of this circular (circular Reference dated December , 2016) shall comply with the requirements set out in Master Circular DBR.No.BP.BC.1/21.06.201/2015-16 dated July 1, 2015.

1.2 Paragraph 5.1.3.6 to be read as under All investments made by the AIFIs in the paid-up equity of non-financial entities (other than subsidiaries) made under their statutory mandate which exceed 49% of the issued common share capital of the issuing entity or where the entity is an unconsolidated affiliate as defined in paragraph 4.4.9.2(C)(i) shall receive a risk weight of 1250%1. Equity investments equal to or below 49% paid-up equity of such investee companies shall be assigned a 125% risk weight or the risk weight as warranted by rating or lack of it, whichever higher. An AIFI can hold up to 49% of equity of a company as a pledgee. However, if the AIFI ends up acquiring this in satisfaction of its claims, it shall be brought down below 10% limit within 3 years. In the event of failure to comply with this requirement, the entire exposure shall receive a risk weight of 1250%.

1.3 The following instructions may be read after paragraph 5.2.6 of the circular Foreign assets of the AIFIs guaranteed by Central Government may be appropriately risk weighted taking into account the risks

1 Equity investments in non-financial subsidiaries will be deducted from the consolidated / solo bank/ AIFI capital as indicated in paragraphs 3.3.2 / 3.4.1.

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inherent in such exposures. AIFIs may formulate a policy with the approval of their Board in this regard.

1.4 The following instructions may be read after paragraph 8.3.10 of the circular At their discretion, the AIFIs not having complex derivatives or options in their trading book, can calculate the market risk capital charge on their trading book exposures using a MS-Excel based calculator which can be obtained from the RBI on request.

1.5 Paragraph 9.2.2 to be read as under The AIFIs shall adopt the Basic Indicator Approach (BIA) for calculating the Operational Risk capital charge.

1.6 The following instructions may be read after paragraph 13.6 of the circular Typically, the AIFIs are sector-specific institutions and have a relatively limited scope for diversifying their assets portfolio. As a result, as compared with banks these institutions have higher credit concentration risk. The ICAAPs prepared by these institutions must address this risk. One way to reduce overall credit concentration risk faced by the AIFIs is to limit their single name concentration by choosing to adopt lower large exposure limits. In addition, the AIFIs could consider diversifying their credit portfolios along the following dimensions: (i) Geographical spread within the country (ii) Domestic/ International/ across countries (e.g. in case of EXIM Bank) (iii) Industry segment (iv) Direct Lending/ Refinance (v) Production Credit/ Marketing Credit/ Investment Credit (e.g. in case of NABARD) (vi) Microfinance/ SMEs/ Mid-corporate/ Large Corporates (vii) Public Sector/ Private Sector Borrowers (viii) Financial sector entities- Public Sector Banks/ Private Sector Banks/ RRBs/ Cooperative Banks, etc. (ix) Residential/ Commercial Real Estate (e.g. in case of NHB) The sectoral concentration risk and the risk arising from the above mentioned dimensions of credit concentration of the individual AIFI will be specifically evaluated under SREP and the AIFI may be required to hold additional capital to mitigate this risk.

1.7 Footnote to paragraph 13.13 Paragraph 13.13 will not be applicable to the AIFIs considering their statutory nature.

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2. Leverage Ratio Basel III Capital Regulations- Master Circular DBR.No.BP.BC.1/21.06.201/2015-16 dated July 1, 2015 will apply with the following modifications

Paragraph 16.2.2 to be read as under In the case of AIFIs, the leverage ratio will be 6% from April 1, 2018 and will be reviewed after the final rules for banks are finalized by the Basel Committee by end-2017. Considering its current capital level, EXIM Bank shall comply with the requirement of leverage ratio of 6% not later than April 1, 2020.

3. Significant equity investments in the financial entities Reserve Bank of India (Financial Services provided by Banks) Directions, 2016- Master Direction/DBR.FSD.No.101/24.01.041/2015-16 dated May 26, 2016 will apply with the following modifications.

Paragraph 5 to be read as under Prudential Regulation for Investments AIFIs shall formulate policies, with the approval of their Board of Directors, covering the following aspects of investments in financial entities to the extent these are not covered under the cross holding limits prescribed by RBI vide circular DBR.FID.FIC.No.4 /01.02.00/2015-16 dated July 1, 2015:

(i) Limits in terms of percentage of the paid up capital and reserves of the AIFI

a. Investment in equity of a single financial services entity which is not an affiliate of the AIFI

b. Aggregate investment in equity of all financial services entities which are not affiliate of the AIFI

c. Aggregate investment in equity of all financial services entities including the affiliates of the AIFI

d. The aggregate of equity investment in factoring subsidiaries and factoring companies

e. Investment in equity of a single deposit taking NBFC

f. Equity/Units of a venture capital fund (VCF)/Category I Alternate Investment Fund (AIF-I).

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(ii) Requirement for approval of Reserve Bank of India No AIFI shall, without the prior approval of RBI, make: (i) Investment in a subsidiary and a financial services company that is not a subsidiary. Provided that such prior approval shall not be necessary in the following circumstances:

a. The investment is in a company engaged in financial services; and b. The AIFI has CRAR of 10 per cent or more as at the close of the immediate preceding financial year and has also made a

net profit in that immediate preceding financial year; and c. The shareholding of the AIFI including the proposed investment is less than 10 per cent of the investee company’s paid

up capital; and d. The aggregate shareholding of the bank along with shareholdings, if any, by its subsidiaries or joint ventures or other

entities is less than 20 per cent of the investee company’s paid up capital. (ii) Investment in a non-financial services company in excess of 10 percent of such investee company’s paid up share capital.

4. Risk Management Guidelines

4.1 Guidance Note on Credit Risk Management- Circular DBOD.No.BP.520/21.04.103/2002-03 dated October 12, 2002 will apply with the following modifications.

4.1.1 Title of paragraph 5 to be read as under Para 5 - Managing credit risk in exposure to banks

4.1.2 Para 9 and 10.3 No applicable.

4.1.3 The following instructions may be read after Chapter 10 of the circular: Please see Appendix F

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4.2 Guidance Note on Market Risk Management- Circular DBOD.No.BP.520/ 21.04.103/2002-03 dated October 12, 2002 will apply with the following modifications.

4.2.1 Chapter 1: Policy Framework –Fully applicable

4.2.2 Chapter 2: Organizational setup – Fully applicable

4.2.3 Chapter 3: Liquidity Risk Management- Not applicable

4.2.4 Chapter 4: Interest Rate Risk Management: Not applicable

4.2.5 Chapter 5: Foreign Exchange Risk Management– Fully applicable

4.2.6 Chapter 6: The Treatment of Market Risk in the Proposed Basel Capital Accord- Not applicable

4.2.7 Annex I: BCBS Principles for the Assessment of Liquidity Management in Banks- Not applicable

4.2.8 Annex II: BCBS Principles for Interest Rate Risk Management– Fully applicable

4.2.9 Annex III: Sources, effects and measurement of interest rate risk- Not applicable

4.2.10 Annex IV: Value at Risk- Not applicable

4.2.11 Annex V: Stress Testing- Not applicable

4.3 Guidelines on Banks’ Asset Liability Management Framework – Interest Rate Risk - (DBOD. No. BP. BC. 59 / 21.04.098/ 2010-11 dated November 4, 2010).

Fully applicable

4.4 Guidance Note on Management of Operational Risk- Circular DBOD.No.BP.BC.39/21.04.118/2004-05 dated October 14, 2005 will apply with the following modifications.

Fully applicable except the guidance that is relevant for Advanced Measurement Approaches (model based approaches) for operational risk.

4.5 Guidelines on Stress Testing- Circular DBOD.BP.BC.No.75/ 21.04.103/ 2013-14 December 2, 2013 will apply with the following modifications.

4.5.1 The following instructions may be read after paragraph 1.2.3 of the circular. Stress testing is equally important for banks and AIFIs which may not be using Value at Risk or Economic Capital models for risk measurement. Though these institutions may not be able to use sophisticated, quantitative stress testing techniques, it may still be possible for them to use simpler sensitivity and scenario analysis effectively using normal methods.

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4.5.2 The following instructions may be read after paragraph 3.1 of the circular. Additional shocks relevant for the AIFIs i. NABARD

Shock 10: Impact on direct and indirect exposure (through refinanced banks) to agriculture sector, of drought (less than or equal to 25% deficit in the rainfall), moderate drought (26 to 50% deficit in rainfall) and severe drought (more than 50% deficit in rainfall). This may be further refined by dividing the refinanced banks into three categories, namely:

Banks with net income marginally sensitive to performance of agriculture sector.

Banks with net income moderately sensitive to performance of agriculture sector.

Banks with net income substantially sensitive to performance of agriculture sector.

Shock 11: Impact on the resource base of NABARD of fall in the contributions to various funds arising from the banks meeting the Priority Sector Lending targets by financing such loans themselves. Following scenarios can be considered:

Contribution to Funds falls by 5% of the total resources.

Contribution to Funds falls by 10% of the total resources.

Contribution to Funds falls by 15% of the total resources.

The impact of the above scenarios on business growth and profitability of NABARD may be assessed.

Shock 12: Impact on the liquidity and profitability of NABARD due to a banking crisis.

Failure of a major co-operative bank.

A major financial crisis in co-operative banking sector that results in simultaneous failure of five or more co-operative banks.

Failure of a major private sector bank

Failure of a major public sector bank with a bailout from government.

Failure of a major public sector bank without bailout from government.

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ii. SIDBI

Shock 13: Impact on the resource base of SIDBI of fall in the contributions to various funds arising from the banks meeting the Priority Sector Lending targets by financing such loans themselves. Following scenarios can be considered:

Contribution to Funds falls by 5% of the total resources.

Contribution to Funds falls by 10% of the total resources.

Contribution to Funds falls by 15% of the total resources. The impact of the above scenarios on business growth and profitability of SIDBI may be assessed. iii. EXIM Bank

Shock 14: Impact on the profitability of EXIM Bank due to appreciation/depreciation of Indian Rupee of 25% on an annual basis. Shock 15: Sovereign crisis or materialization of political risky events, including imposition of unexpected capital control, in the counterparties nation;

Forming 10% of the portfolio of EXIM Bank

Forming 15% of the portfolio of EXIM Bank

Forming 25% of the portfolio of EXIM Bank. Shock 16: National or international changes in the trade and cross border investment policies including sanctions on India impacting the existing exposures and business projections over next year. Following three scenarios maybe considered:

Total volume of trade and cross border investment falls by 10%

Total volume of trade and cross border investment falls by 25%

Total volume of trade and cross border investment falls by 50% iv. NHB

Shock 17: Impact on the resource base of NHB of fall in the contributions to various funds arising from the banks meeting the Priority Sector Lending targets by financing such loans themselves. Following scenarios can be considered:

Contribution to Funds falls by 5% of the total resources.

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Contribution to Funds falls by 10% of the total resources.

Contribution to Funds falls by 15% of the total resources. The impact of the above scenarios on business growth and profitability of NHB may be assessed. Shock 18: Impact on the profitability of NHB due to fall in housing prices and commercial real estate prices under three scenarios for each.

Total fall in prices by 10%

Total fall in prices by 20%

Total fall in prices by 30%

Shock 19: Impact on the liquidity and profitability of NHB due to a crisis in housing finance market.

Failure of a major HFC.

A major financial crisis in HFC sector that results in simultaneous failure of five or more HFCs.

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4.6 Guidelines on Liquidity Risk Management to banks-RBI No 2012-13/285/DBOD.BP.No.56/21.04.098/ 2012-13 will apply with the following modifications.

4.6.1 Paragraph 20 to be read as under

20. In the case of banks, tolerance levels/prudential limits for various maturities may be fixed by the bank’s Top Management depending on the bank’s asset - liability profile, extent of stable deposit base, the nature of cash flows, regulatory prescriptions, etc. In respect of mismatches in cash flows in the near term buckets, say up to 28 days, it should be the endeavour of the bank’s management to keep the cash flow mismatches at the minimum levels. The AIFIs are required to maintain minimum positive cumulative gaps equal to 25% for maturity upto 14 days, 20% for maturity upto 28 days and 0% for maturity upto 90 days. Depending upon the maturity profile of their assets and liabilities, the likelihood of drawdown of refinance facilities, the possibility of the banks not honouring their LOCs under stress scenarios, the AIFIs may consider maintaining higher positive gaps for period’s upto 28 days.

4.6.2 Paragraph 24 to be read as under

24. Certain critical ratios in respect of liquidity risk management and their significance for banks and AIFIs are given in the Table 1 and 2 below respectively2. AIFIs may monitor these ratios by putting in place an internally defined limit approved by the Board for these ratios. The industry averages for these ratios are given for information of banks. They may fix their own limits, based on their liquidity risk management capabilities, experience and profile. The stock ratios are meant for monitoring the liquidity risk at the solo bank level. Banks may also apply these ratios for monitoring liquidity risk in major currencies, viz. US Dollar, Pound Sterling, Euro and Japanese Yen at the solo bank level.

4.6.3 Paragraph 25 to be read as under

25. While the mismatches in the structural liquidity statement up to one year would be relevant since these provide early warning signals of impending liquidity problems, the main focus should be on the short-term mismatches viz. say, up to 28 days. AIFIs, however, are expected to monitor their cumulative mismatches (running total) across all time buckets by establishing internal prudential limits with the approval of the Board / Risk Management Committee. For banks, the net cumulative negative

2 Table 2 is given in Appendix G

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mismatches in the domestic and overseas structural liquidity statement (Refer Appendix II - Part A1 and Part B of Liquidity Return )3 during the next day, 2-7 days, 8-14 days and 15-28 days bucket should not exceed 5%, 10%, 15%, 20% of the cumulative cash outflows in the respective time buckets. For AIFIs, there must be minimum cumulative positive gaps equal to 25%, 20% and 0% for 0-14 days. 0-28 days and 0-90 days respectively. Banks may also adopt the above cumulative mismatch limits for their structural liquidity statement for consolidated operations (Appendix II – Part C)3. AIFIs shall also adopt the above cumulative mismatch limits for their structural liquidity statement for consolidated operations.

4.6.4 Paragraph 27 & 28, 55 & 58 and 67 & 68

Not applicable.

4.7 Strategic and reputational risk management- Prudential Guidelines on Capital Adequacy and Market Discipline-New Capital Adequacy Framework (NCAF) DBR.No.BP.BC.4./ 21.06.001/2015-16 dated July 1, 2015 will apply with the following modifications.

4.7.1 The following instructions may be read after paragraph 13.9 of the circular. Reputational risk management of by the AIFIs In general, the AIFIs do not engage in the structuring and sale of highly innovative financial products that may raise reputational risk concerns due to possible mis-selling to clients. However, the AIFIs that have subsidiaries may be called upon to provide unexpected capital or liquidity support to them in case the latter face financial/ liquidity stress. All the AIFIs are statutory organisations owned by government, RBI and public sector banks. Owing to such ownership structure, the AIFIs’ activities could potentially have implications for the reputation of the Government and RBI. The AIFIs need to take into account these factors while conducting their affairs.

4.7.2 The following instructions may be read after paragraph 13.16 of the circular Strategic risk management for the AIFIs

AIFIs may undertake new activities including the ones which are only indirectly related to their statutory mandates. Normally AIFIs would not have prior expertise in these areas. Due care needs to be taken to identify and manage the strategic risks arising from taking new initiatives for e.g. expanding the scope of their refinance activities to new set of institutions, and designing new refinance products, new investment/ financial products, entering into partnership with banks to introduce new products etc.

3 Relevant portion reproduced in Appendix H

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Part B: Amendments to existing AIFI Circulars

1. Asset-Liability Management ( Liquidity Risk) Asset-Liability Management (ALM) System- Circular DBS.FID.No.C.11/ 01.02.00/ 99-2000 dated December 31, 1999

Paragraph 6.4 to be modified as under 6.4 Liquidity Risk Coverage The global financial crisis underscored the need for the sound management of liquidity risk by banks and other financial institutions. BCBS has formulated two liquidity standards for banks namely Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). Of these, LCR has already been applied to banks with effect from January 1, 2015. The objective of the LCR is to ensure minimum amount of High Quality Liquid Assets (HQLA) in relation to the net cash outflows of a bank measured over a period of 30 days under stress situation. A study undertaken by RBI showed that given very different business models of the four AIFIs, significant variations of the net cash outflows over a financial year, mandating a bank like LCR standard for AIFIs maybe onerous for them. Further, in view of greater predictability and stability of the cash flows of the AIFIs as compared with that in case of banks, the cash outflows and inflows need not be measured at the same stress level as in the case of the banks. Nevertheless, the AIFIs, would still have some amount of liquidity risk associated with the secured and unsecured wholesale funding which is available and the possible draw down of the committed lines of credit over a target horizon. In addition, unlike banks, the AIFIs also do not maintain liquidity reserves in the form of SLR securities. Therefore, it would be necessary to have a regulatory framework to take care of the liquidity risks faced by the AIFIs. The liquidity framework for the AIFIs shall be as follows:

(i) Cash Flow Gap limits The AIFIs shall monitor the cumulative cash flow mismatches over different maturity buckets regularly and observe the following gap limits.

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(a) Regulatory limits

Period Cumulative gaps

0-14 days Minimum positive gap equal to 25% of cash outflows

0-28 days Minimum positive gap equal to 20% of cash outflows

0-90 days No negative gap

(b) Internal limits

The AIFIs shall prescribe internal gap limits with the approval of their boards for cumulative cash flow mismatches beyond 90 days upto one year.

(ii) Treatment of Lines of Credit (LOCs) Under Basel III- LCR framework for banks, the LOCs availed by banks are deemed non-available for the purpose of computing cash inflows, as it is assumed that when a financial system is under stress, other institutions may fail to honour their commitments under LOC. However, as explained above, the liquidity risk framework for AIFIs is not intended to be calibrated for the same stress levels as applicable to banks. Therefore it is considered appropriate to treat the LOCs sanctioned by banks or any other financial institution available to the AIFI albeit, with a haircut. The board of directors of individual AIFIs shall determine the haircuts to be applied to the LOC taking into account various factors that might suggest the non-availability of LOC, full or partial, when required.

(iii) Funding the required minimum positive gap

The AIFIs can fund the required minimum positive gap by a combination of excess of normal cash inflows over the cash outflows, Government securities and LOCs, subject to conditions set out below:

a. Stock of Central Government Securities

In cases where the normal cash inflows (i.e. cash flows excluding LOCs) are not sufficient to meet the minimum requirement of positive gaps as given in paragraph 6.4(i)(a), the AIFI shall maintain a stock of liquid Central Government securities upto 5% of cash outflows (other than that maturing within 28 days). The procedure to calculate the requirement of maintaining the central government security is explained in Appendix A.

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b. LOC

If the normal cash flow excluding the LOCs is zero or positive, there will be no minimum requirement of LOC or stock of government securities. However, as the normal cash flow turns negative, the minimum funding requirement in terms of government securities arises. However, it is capped to 5% of cash outflows and the remaining gap can be met with LOCs. The AIFIs will also be free to have stock of government securities of more than 5%. An illustration of LRC is given in Appendix A.

(iv) Liquidity Monitoring tools

(a) Concentration of Funding i. This metric is meant to identify those sources of funding that are of such significance, the withdrawal of which

could trigger liquidity problems. The metric thus encourages the diversification of funding sources. This metrics aims to address the funding concentration of AIFIs by monitoring their funding from each significant counterparty, each significant product / instrument and each significant currency. ii. AIFIs shall furnish to RBI a Statement of Funding Concentration from significant counterparties, significant instruments / products and details of funding through securitization on a monthly basis as per the format given in Appendix B.

ii. As regards addressing the currency concentration risk, the same is captured in the Statement of structural liquidity, foreign currency - Indian operations - Liquidity Return 1 - Part A 24 wherein AIFIs are required to furnish their assets and liabilities in major / significant currencies as well as information on Aggregate gap limit.

(b) LRC by Significant Currency

i While the LRC standard is required to be met in one single currency, in order to better capture potential currency mismatches, the LRC in each significant currency needs to be monitored.

ii. Accordingly, a statement on LRC by significant currency as given in Appendix D needs to be furnished on monthly

basis.

4 The relevant portion is reproduced in Appendix C

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(v) Disclosure requirement The AIFIs shall disclose the position of compliance with LRC requirement in their annual reports in the format given in Appendix E

2. Exposure Norms Exposure Norms for Financial Institutions- Master Circular DBR.FID.FIC.No.4/01.02.00/2015-16 dated July 1, 2015

2.1 The following instructions may be read after Paragraph 4.1 of the circular

With effect from May 29, 2008, the single borrower exposure limit has been raised to twenty five percent of the capital funds, only in respect of Oil Companies who have been issued Oil Bonds (which do not have SLR status) by Government of India. In addition to this, AIFIs may in exceptional circumstances, as hitherto, in terms of paragraph 4.1, consider enhancement of the exposure to the Oil Companies up to a further 5 percent of capital funds.

2.2 Paragraph 4.6 of the circular shall be modified as follows

4.6 Exposures to NBFCs

(i) NBFCs predominantly Engaged in lending against Gold Jewellery: The exposure (both lending and investment, including off balance sheet exposures) of a AIFI to a single NBFC which is predominantly engaged in lending against collateral of gold jewellery (i.e. such loans comprising 50 per cent or more of their financial assets), shall not exceed 7.5 per cent of AIFIs’ capital funds. However, this exposure ceiling may go up by 5 per cent, i.e., up to 12.5 per cent of AIFIs’ capital funds if the additional exposure is on account of funds on-lent by such NBFCs to the infrastructure sector.

(ii) Residuary NBFCs: In respect of Residuary Non-Banking Companies (RNBCs), which are also required to be mandatorily registered with Reserve Bank of India, AIFI finance shall be restricted to the extent of their Net Owned Fund (NOF).

(iii) Infrastructure Finance Companies: Exposure of a AIFI to Infrastructure Finance Companies (IFCs) shall not exceed 15% of its capital funds as per its last audited balance sheet, with a provision to increase it to 20% if the same is on account of funds on-lent by the IFCs to the infrastructure sector.

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(iv) Other NBFCs: The exposure (both lending and investment, including off balance sheet exposures) of a AIFI to a single NBFC shall not exceed 10% of the AIFI’s capital funds as per its last audited balance sheet. In case of NBFCs financing physical assets supporting productive/economic activity such as automobiles, tractors, lathe machines, generator sets, earth moving and material handling equipment, industrial machines, etc., the financing AIFI’s exposure limit may be exceeded upto a maximum of another 5% of bank’s capital funds, on a pro-rata basis, to the extent of NBFCs’ finance to physical assets supporting productive/economic activity.

(v) Other Provisions regarding AIFIs’ exposure to NBFCs

(a) AIFIs may assume exposures on a single NBFC up to another 5% of their capital funds over and above ceilings prescribed at sub-paras (iv) above, provided the excess exposure is on account of funds on-lent by the NBFC to the infrastructure sector.

(b) AIFIs should also fix internal limits for their aggregate exposure to all NBFCs put together. AIFIs should also have an internal sub-limit on their aggregate exposures to all NBFCs, having gold loans to the extent of 50 per cent or more of their total financial assets, taken together. This sub-limit should be within the internal limit fixed by the AIFIs for their aggregate exposure to all NBFCs put together.

(c) The AIFIs shall not hold more than 10% of the paid up equity capital of an NBFC – D. This restriction would, however, not apply to investment in housing finance companies.

2.3 Paragraph 4.8 of the circular shall be modified as follows

4.8 Exposure to capital markets

4.8.1 Computation of exposure

For computing the exposure to the capital markets, loans/advances sanctioned would be reckoned with reference to sanctioned limits or outstanding, whichever is higher. However, in the case of fully drawn term loans, where there is no scope for re-drawal of any portion of the sanctioned limit, banks may reckon the outstanding as the exposure. Further, banks’ direct investment in shares, convertible bonds, convertible debentures and units of equity-oriented mutual funds would be calculated at their cost price.

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4.8.2 Limit on investments in non-financial commercial enterprises and aggregate exposure to capital markets The aggregate exposure of an AIFI to the capital markets in all forms, on solo as well as consolidated basis shall not exceed 40 per cent of its net worth, as on March 31 of the previous year, provided that the AIFI’s direct exposure within this overall ceiling shall not exceed 10 per cent of its net worth.

A. Limits on equity investment in a single entity (i) Limits on significant equity investments in non-financial/ commercial enterprises An AIFI’s equity investment in a single company that is made in conformity with its statutory mandate shall not exceed 49% of the equity of the investee company. (ii) Limits on other equity investments in non-financial/ commercial enterprises a. An AIFI should not hold more than 10% of the equity of the investee company as direct investment. b. An AIFI can hold up to 49% of equity of a company as a pledgee. However, if the AIFI ends up acquiring this in satisfaction of its claims, it shall be brought down below 10% limit within 3 years. B. Limits on aggregate exposure to capital markets a. An AIFI’s aggregate investment in equity of non-financial commercial enterprises, other than that covered under para 4.8.1 (i) above, shall not exceed 10 per cent of the AIFI’s net worth as on March 31 of the previous year. b. The aggregate exposure of an AIFI to the capital markets in all forms (both fund based and non-fund based, direct and indirect) should not exceed 40 per cent of its net worth as on March 31 of the previous year. This regulation will be applicable both at solo and consolidated levels. Provided that Board of Directors of the AIFI shall have the freedom to adopt a lower ceiling for the AIFI, keeping in view its overall risk profile and corporate strategy. Provided further that acquisition of equity shares of listed companies consequent to a debt restructuring package in terms of RBI’s prudential norms resulting in exceeding the regulatory Capital Market Exposure (CME) limit mentioned at para 4.8.1(i) and 4.8.1(ii) shall not be treated as a breach of regulatory limit subject to the condition that such acquisition shall be reported to RBI and disclosure shall be made in the Notes to Accounts in Annual Financial Statements by the AIFIs. Provided further that AIFIs exceeding the regulatory ceiling of the capital market exposure mentioned in para 4.8.1(i) and 4.8.1(ii) due to financing acquisition of PSU shares under the Government of India disinvestment programmes shall approach RBI with a request for relaxation in the ceiling.

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2.4 A new paragraph 4.16 shall be added as indicated below.

4.16 Exemptions 4.16.1 Clearing Exposures to Q-CCPs 4.16.1.1 AIFIs’ clearing exposure to a Qualifying CCP (QCCP) shall be kept outside of the exposure ceiling of 15 per cent of its capital funds applicable to a single counterparty. Clearing exposure shall include trade exposure and default fund exposure. Other exposures to QCCPs such as loans, credit lines, investments in the capital of CCP, liquidity facilities, etc. shall continue to be within the existing exposure ceiling of 15 per cent of a AIFI’s capital funds to a single counterparty. However, all exposures of a AIFI to a non-QCCP shall be within the exposure ceiling of 15 per cent. The Reserve Bank will monitor AIFIs’ clearing exposures to QCCPs. In cases where a /AIFI’s exposures to QCCPs are considered high, the Reserve Bank may initiate suitable measures requiring the AIFI to initiate suitable risk mitigation plans such as either reducing the exposure within reasonable time or maintaining a higher level of capital on such exposure. 4.16.1.2 Presently, there are four CCPs viz. Clearing Corporation of India Ltd. (CCIL), National Securities Clearing Corporation Ltd. (NSCCL), Indian Clearing Corporation Ltd. (ICCL), and MCX-SX Clearing Corporation Ltd. (MCX-SXCCL) in India and are subject to rules and regulations consistent with CPSS-IOSCO Principles for Financial Market Infrastructures. The CCIL has been granted the status of a QCCP by the Reserve Bank and the other three CCPs have been granted the status of QCCP by SEBI vide press statements dated January 1, 2014 and January 3, 2014 respectively., If a regulator/supervisor of a CCP withdraws its QCCP status, the concerned CCP will be considered a non-QCCP and exposure norms as applicable to non-QCCPs would be applicable

4.16.2 Rehabilitation of Sick/Weak Industrial Units The ceilings on single/group exposure limits are not applicable to existing/additional credit facilities (including funding of interest and irregularities) granted to weak/sick industrial units under rehabilitation packages.

4.16.3 Guarantee by the Government of India The ceilings on single /group exposure limit shall not be applicable where principal and interest are fully guaranteed by the Government of India.

4.16.4 Exposure to banks and other AIFIs The ceiling on single/group borrower exposure limit will not be applicable to exposure assumed by AIFIs on other AIFIs. However, the individual AIFIs shall have in place a Board-approved policy to determine the size of the exposure to other AIFIs. However, AIFIs may note that there is no exemption from the prohibitions relating to investments in unrated non-SLR securities

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prescribed in terms of the Master Direction on Prudential Norms for Classification, Valuation and Operations of Investment Portfolio by AIFIs, as amended from time to time.

4.16.5 Disinvestment Programme of the Government of India On account of AIFIs’ financing of acquisition of PSU shares under the Government of India disinvestment programmes, if a AIFI, is likely to exceed the regulatory ceiling of single / group borrower limit, RBI may consider relaxation on specific requests from AIFIs in the single/group credit exposure norms on a case by case basis, provided that the AIFI’s total exposure to the borrower, net of its exposure due to acquisition of PSU shares under the Government of India disinvestment programme, should be within the prudential single/group borrower exposure ceiling prescribed by RBI.

4.16.6 Other Items excluded from Capital Market Exposure

The following items would be excluded from the aggregate exposure ceiling of 40 per cent of net worth and direct investment exposure ceiling of 20 per cent of net worth (wherever applicable):

AIFIs’ investments in own subsidiaries, joint ventures and investments in shares and convertible debentures, convertible bonds issued by institutions forming crucial financial infrastructure such as National Securities Depository Ltd. (NSDL), Central Depository Services (India) Ltd. (CDSL), National Securities Clearing Corporation Ltd. (NSCCL), National Stock Exchange (NSE), Clearing Corporation of India Ltd., (CCIL), a credit information company which has obtained Certificate of Registration from RBI and of which the bank is a member, Multi Commodity Exchange Ltd. (MCX), National Commodity and Derivatives Exchange Ltd. (NCDEX), National Multi-Commodity Exchange of India Ltd. (NMCEIL), National Collateral Management Services Ltd. (NCMSL), National Payments Corporation of India (NPCI) and United Stock Exchange of India Ltd. (USEIL) and other Public Finance Institutions as given in Annex 25. After listing, the exposures in excess of the original investment (i.e. prior to listing) would form part of the Capital Market Exposure.

ii. Tier I and Tier II debt instruments issued by other banks/ AIFIs;

iii. Investment in Certificate of Deposits (CDs) of other banks/ AIFIs;

iv. Preference Shares;

5 The list of Public Finance Institutions is reproduced in Appendix (I)

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v. Non-convertible debentures and non-convertible bonds;

vi. Units of Mutual Funds under schemes where the corpus is invested exclusively in debt instruments;

vii. Shares acquired by AIFIs as a result of conversion of debt/overdue interest into equity under Corporate Debt Restructuring (CDR) mechanism;

viii. Promoters shares in the SPV of an infrastructure project pledged to the lending AIFI for infrastructure project lending.

Ix AIFIs exposure to brokers under the currency derivatives segment

2.5 A new paragraph 4.17 shall be added as given below.

4.17.1 AIFIs shall report their exposures to Central Repository for Information on Large Credit (CRILC) as stipulated in circular DBS.OSMOS.No.14703/33.01.001/2013-14 dated May 22, 2014.

4.17.2 AIFIs shall report their clearing exposures to each QCCP to Reserve Bank through email and to the Principal Chief General Manager, Department of Banking Supervision, Reserve Bank of India, Centre 1, 3rd Floor, World Trade Centre, Cuffe Parade, Colaba, Mumbai- 400 005 within seven days of each succeeding month. The data on clearing exposure should be end of day clearing exposures to each QCCP separately for all the days in a month. The reporting format in this respect is given in the Annex 26. In cases where a AIFI’s exposures to QCCPs are considered high, the Reserve Bank may initiate suitable measures requiring the AIFI to initiate suitable risk mitigation plans such as either reducing the exposure within reasonable time or maintaining a higher level of capital on such exposure

3 Investment Portfolio Prudential Norms for Classification, Valuation and Operation of Investment Portfolio by FIs- Master Circular DBR.No.FID.FIC.3/01.02.00/2015-16 dated July 1, 2015

3.1 Para 2.5.13 on limits on FI’s exposure to capital markets on solo basis, consolidated basis and consequent risk weights on CME to be deleted.

6 The prescribed format is given as Appendix J

20

3.2 Para 2.5.1.1.(c) to be modified as under (c) units of debt-oriented schemes of Mutual Funds i.e., the schemes whose major part the corpus is invested in debt securities; and units of liquid/short term debt schemes (by whatever name called)

3.3 Para 2.5.1.2.(e) to be modified as under (e) Units of venture capital funds

3.4 A new paragraph 2.5.6.4 shall be added as given below.

With effect from April 1, 2023, the total investment by banks/AIFIs in liquid/short term debt schemes (by whatever name called) of mutual funds with weighted average maturity of portfolio of not more than 1 year, shall be subject to a prudential cap of 10 per cent of their net worth as on March 31 of the previous year. The weighted average maturity would be calculated as average of the remaining period of maturity of securities weighted by the sums invested.

4 Resource Raising Norms for Financial Institutions

Resource Raising Norms for Financial Institutions - Master Circular DBR.No.FID.FIC.1/01.02.00/2015-16 dated July 1, 2015

Withdrawn (Replaced by Basel III Leverage Ratio and Liquidity Risk Coverage requirement – Item no 2 in Part A and Item no 3 in Part B)

APPENDIX A

Statement on Liquidity Risk Coverage (LRC)

Name of the AIFI Reporting Frequency (Bucket Description) 0-14

Position as on

Sr. No. Particulars

Amount (in Rs. crore)

A Total cash outflows 1000.00

B Total contractual cash inflows other than those under Line of Credit (LOC) liquidity facilities or other contingent funding facilities

1000.00

C

Lines of credit (LOC) - Credit or liquidity facilities or other contingent funding facilities that the AIFI holds at other institutions for its own purpose and excluding the drawn portion 300.00

D Prudential Cash Flow (PCF) Surplus/Gap -250.00

E Stock of Central Government securities required to meet the gap 50.00

F Stock of Central Government securities available 50.00

G Net Prudential Cash Flow (NPCF) Surplus/Gap -200.00

H Haircut-adjusted LOC available to meet the NPCF Gap 100.00

I Shortfall in LRC 10%

Steps to determine compliance with the LRC requirement

1. Calculation of Prudential Cash Flow (PCF) Surplus/Gap

Prudential Cash Flow (PCF) Surplus/Gap = Normal cash inflows (i.e. cash flows excluding

LOCs) - alpha (α)*total cash outflows

Where α is,

1.25 for cumulative cash outflows from 0-14 days,

1.20 for cumulative cash outflows from 0-28 days and

1.00 for cumulative cash outflows from 0-90 days

2. Determining the minimum central government securities requirement

If the PCF Gap is zero or in surplus, the AIFI will not be required to hold any stock of central

government securities. However, if there is a PCF Gap i.e. the PCF value is negative, the AIFI

will be required to meet the gap upto 5% of cash outflows by maintaining a stock of liquid

unencumbered Central Government securities other than that maturing within the target liquidity

horizon ( 14 days or 28 days or 90 days as the case may be).

3. Calculation of Net Prudential Cash Flow (NPCF) Surplus/Gap

Net Prudential Cash flow (NPCF) Surplus/Gap is the total amount of the PCF and the Central

Government securities available. If an AIFI has NPCF Gap, i.e. the value of NPCF is negative,

this gap will be required to be met by LOCs or any other liquidity facilities.

However, if there is any shortfall in meeting the minimum stock of government securities

required to meet the gap, this cannot be met by the LOC etc.

4. Determining the shortfall in meeting the LRC requirements

The LRC requirement shall be deemed not to have been met if

(i) the minimum stock of government securities is not maintained, and/or

(ii) the NPCF is not fully met by the LOCs.

5. An Excel-based LRC calculator is attached.

APPENDIX B

Statement of Funding Concentration

Name of the AIFI

Reporting Frequency Monthly

Statement for the Month

Part A Funding Concentration based on Counterparty

A1 Significant Counterparty4 - Deposits and borrowings

A1.1 Significant Counterparty – Deposits with option of premature withdrawal

Sr No. Name of the Counterparty Amount

(Rs.crore) % of Total deposits

% of Total Liabilities

1

2

----

n

A1.2 Significant Counterparty – Borrowings which are expected to be rolled over, LOCs and any other similar facilities

Sr No. Name of the Counterparty Amount

(Rs.crore) % of Total deposits

% of Total Liabilities

1

2

----

n

A2

Top 20 Large Deposits that have premature withdrawal option

Sr No. Name of the Depositor Amount (Rs. Crore) % of Total Deposits

1

----

20

Total

A3 Top 10 borrowings/ LOCs

Sr No. Name of the counterparty Amount

(Rs.crore)

% of Total borrowings/

LOC

1

----

10

Total

Part B Funding Concentration based on instrument / product

B1 Significant instrument / product

Sr. No.

Name of the instrument / product Amount (Rs.

crore) % of Total liabilities

1

2

----

Total

B2 Details of funding sources through Securitisation

Sr. No.

Particulars Amount (Rs.

crore) % of Total liabilities

1

2

----

Total

Note : This statement is to be furnished separately for domestic and overseas operations. In case of overseas operations, the reporting may be done jurisdiction wise.

APPENDIX C

Part A2 Statement of Structural Liquidity- Foreign Currency, Indian Operations

Reporting Frequency - Fortnightly

Name of the AIFI:

Position as on:

Indicate Currency (To be furnished in four major currencies namely US Dollar, Pound Sterling, Euro and Japanese Yen. In respect of other foreign

currencies the statement should be submitted where the transactions in the currency concerned exceed 5 per cent of the total foreign exchange turnover.)

Denote the foreign currency in million

Outflows Day 1 2-7 days 8-14

days

15-28

days

29 days

and upto

3

months

3

months

and upto

6

months

6

months

and upto

1 year

Over 1

year and

upto 3

years

Over 3

years

and upto

5 years

Over 5

years

Total

1 2 3 4 5 6 7 8 9 10 11

1

Off balance sheet items

Merchant Sales

Interbank Sales

Overseas Sales

Sales to RBI

Foreign currency rupee

swaps - Sale against

INR

Cross Currency Swaps -

Sale against Cross

Currency

Options

Currency Futures

LCs and Guarantees

Others - Pl specify

2 On-Balance Sheet

items

FCNR(B)

EEFC

RFC and RFC (D)

Other FC deposits #

Overdrafts in Nostro

A/c.

Inter-bank/borrowings

LOC/BAF

Others - Pl specify

3 Total Outflows

4

Total Outflows (in

Rupees crores)*

*converted into INR using relevant spot rates as published by FEDAI

# Such as Escrow accounts, Diamond dollar accounts, external agencies foreign currency accounts, etc.

Inflows Day 1 2-7 days 8-14

days

15-28

days

29 days

and upto

3

months

3

months

and upto

6

months

6

months

and upto

1 year

Over 1

year and

upto 3

years

Over 3

years

and upto

5 years

Over 5

years

Total

1 2 3 4 5 6 7 8 9 10 11

1

Off Balance Sheet

Items

Merchant Purchases

Inter-bank Purchases

Overseas Purchases

Purchases from RBI

Foreign currency rupee

swaps- purchases

against INR

Cross currency Swaps -

Purchases against cross

currency

Options

Currency Futures

Others - Pl specify

2

On- Balance Sheet

items

Nostro Balances (Cash

and Bank Balances)

Short Term Investments

Loans:

PCFC

Bills Discounted

Other FC loans

Inter-bank

lending

Others

3 Total Inflows

4

Total Inflows (in Rupees

crores)*

Gap (Total Inflows -

Total outflows)

*converted into INR using relevant spot rates as published by FEDAI

Additional Details

1) Aggregate Gap Limit (in US Dollar mio)

2) Maximum AGL during the period (in US Dollar mio)

3) Value at Risk Limit approved by the management

4) Maximum VAR figure during the month (in US Dollar

mio)

Note : Banks which are not yet equipped to capture data as per Day 1 bucket may report the data in 1-7 days bucket for an initial period of 3 months. Statement A3 may also be reported accordingly i.e. with first bucket as 1-7 days.

APPENDIX D

Statement on Liquidity Risk Coverage (LRC) by significant currency

Name of the AIFI

Reporting Unit value (Currency Description)

Reporting Frequency (Bucket Description) Position as on

Sr. No. Particulars Amount

A Total cash outflows

B Total contractual cash inflows other than that under LOCs liquidity facilities or other contingent funding facilities

C

Lines of credit available in reporting currency- Credit or liquidity facilities or other contingent funding facilities that the AIFI holds at other institutions for its own purpose and excluding the drawn portion

D Prudential Cash Flow (PCF) Surplus/Gap

E Stock of Central Government securities required to meet the gap

F Stock of Central Government securities earmarked against the reporting currency

G Net Prudential Cash Flow (NPCF) Surplus/Gap

H Haircut adjusted LOC available in reporting currency

I Shortfall in LRC

APPENDIX E

Annual statement on Liquidity Risk Coverage (LRC)

Name of the AIFI Position as on….

Sr. No. Particulars Amount

A Total annual cash outflows

B Total annual contractual cash inflows other than that under LOCs liquidity facilities or other contingent funding facilities

C

Lines of credit available over the year - Credit or liquidity facilities or other contingent funding facilities that the AIFI holds at other institutions for its own purpose and excluding the drawn portion

D Annual Prudential Cash Flow (PCF) Surplus/Gap

E Annual Stock of Central Government securities required to meet the gap

F Annual Stock of Central Government securities available

G Annual Net Prudential Cash Flow (NPCF) Surplus/Gap

H Haircut adjusted LOC available over the year

I Shortfall in annual LRC

APPENDIX F

Credit risk management considerations specific to the AIFIs

Most aspects of credit risk management described in this guidance note above would be

relevant for the AIFIs as well. The AIFIs should follow this guidance to the extent applicable to

them. However, the credit portfolios of the AIFIs differ from that of banks in many respects

including the following:

Predominance of long term project loans,

Focus on one or few sectors,

Predominance of institutional borrowers;

Loans intended as refinance of existing loans extended by the credit institutions;

Significant exposure to State Governments and the public sector enterprises owned by

the State Governments;

Limited freedom to change the portfolio composition given the specific statutory

mandates of the AIFIs; and

Significant public policy considerations.

2. The above differences necessitate incorporating in the credit risk management process

appropriate elements to take care of the additional risks arising from them. This Chapter

describes the credit risk management considerations specific to the AIFIs.

3. Exposures to credit institutions

Important factors impacting credit risk of Credit Institutions (CI) (banks, NBFCs, etc.) are:

Management expertise and depth relative to key business activities

Size of the FI and critical mass in key activities

Market position in core operations

Ability to exercise pricing power and/or differentiate itself through efficiency

Nature and concentration of its customer base

Current business mix and competitive advantages/ disadvantages in each segment

Geographic and industrial sector diversification of its activities, both domestic and

international

Diversity of services and products it provides to customers and the ability to create

new products

Systemic importance of an institution

Quality of the CI’s distribution network

Financial strength of the CI

The framework for credit risk assessment of CIs on a stand-alone basis should use both

quantitative and qualitative parameters. Quantitative measures are more transparent and lend

empirical support to the analysis. These help in identifying long-term trends useful in testing the

efficacy of assumptions that drive performance forecast. Qualitative measures provide

contextual backdrop in the form of a financial institution’s competitive strengths and weaknesses

to explain trends identified in quantitative measures.

Risk factors to be evaluated

1. Qualitative evaluation

A. Industry Risk

Changes to legislation and regulation; the business cycle; product obsolescence; changes in

consumer preferences; technology shifts; changes to entry barriers; industry capacity utilisation

and capacity constraints; and changes in the competitive landscape and market dynamics that

alter the balance of power between industry stakeholders. Industry Risks for financial institutions

are subdivided into the following categories:

i. Systemic Risk: This is the risk of major contagion in the financial system which leads to

material, long-lasting disruption and value destruction in the real economy. This may arise from

the concentration and interconnectedness of major financial service providers to the real

economy, and each other; the similarity of their business models; and the structure and

homogeneity of their funding models (e.g. proportion of wholesale funding).

ii. Regulation: Regulatory/ prudential framework, including the role and functions (if any) of the

appropriate supervisory authorities, as well as the degree of state control (or privatization) can

act as both a catalyst and a moderator of risk. It can reduce the risk of competitive asymmetry

and prevent product mispricing by encouraging pricing transparency; mitigate the agency risk

and the moral hazard associated with management’s obligations to all the institution’s

stakeholders. On the other hand, tight regulation can reduce an institution’s ability to

differentiate its products and introduce a source of uncertainty to the returns to capital providers.

NBFCs are often subject to less formal regulation. NBFCs must also comply with various other

statutes concerning their area of operations. An effective regulatory body and compliance levels

with statutory requirements add to the confidence level for credit rating.

iii. Macro-economic factors: Macro-economic factors can be size and composition of economy

in which the FI operates, GDP growth, inflation, growth in consumer lending, growth in real

estate lending, savings and investment, trends in unemployment, exchange rates, bond yields,

and national and/ or regional property price indices, political and cultural aspects, as well as

demographic trends. Indicators of macro-economic performance include changes to the industry

risk profile due to weakening of the general economy, formation of asset bubbles, fluctuations in

capital flows, trends in lending practices, system lending growth rates and mix; terms of trade

and asset prices (commodity prices, house prices, equity prices, bond yields). The risks to the

financial institution’s capital emanating from general market volatility can be measured by using

standard/ formal indices which reflect market expectations for volatility based on the weighted

average implied volatilities of a range of products traded on the exchanges. An institution’s

market risk exposure should be measured vis-à-vis the quality of its risk management expertise

and controls. An institution’s credit rating is constrained when a higher risk appetite is not

supported by demonstrated management expertise in market risk management.

iv. Competition: The stability of profits is mainly a factor of market concentration as well as the

cyclicality of the industry. Industry concentration is mainly a result of entry barriers and the size

of the market. The level of concentration in an industry is evidenced in the historical and

forecast margins of the typical competitor.

B. Structural Risk

The purpose of this analytical category is to identify risks resulting from the legal form, or

constitution, of the financial institution or banking group. Legal structure can affect institution risk

by adding opacity, complexity and leverage. Structural Risk can be subdivided into the following

categories:

i. Opacity: Structural complexity adds opacity to elements such as asset ownership, sources of

cash generation, tax liability, contingent liability and legal recourse. Structural complexity of a

financial institution reduces its transparency and impedes the testing of forecast assumptions

and rating computations.

ii. Double Leverage: An institution’s group structure may involve two levels of debt. Debt in the

capital structure of a parent entity may support the equity capital of an operating entity. This

structural influence may be of little consequence when assessing the rating of the consolidated

group. However, when assessing the rating of a standalone operating entity – debt funded

equity is viewed as a weaker source of capital than vanilla equity because debt funded equity is,

normally, associated with a less flexible dividend stream that is used by the parent to service

debt.

iii. Ownership, Support, and Group Factors: In general, ownership of FIs can include

institutional owners, private individuals and families, public shareholders, and state owners

(national or regional), as well as banks with mutual ownership structures. In cases where a

sovereign has a material ownership stake in an institution, the credit rating assessment could be

linked to the sovereign rating. While assessing a firm within a group, it would be necessary to

consider the primary operating subsidiary, related financial services entities, and subsidiaries or

related entities, while also considering the unique characteristics and attributes of the holding

company as a standalone legal entity. Regulatory issues play an important role in the analysis

of a financial holding company and distinguish the analysis from that of unregulated corporate

entities. Mutual support mechanisms, intercompany guarantees, and legal and/or regulatory

restrictions surrounding flow of funds between subsidiaries and the parent company within a

group that could ultimately impede or improve debt service capabilities in times of stress could

be factored into the analysis.

iv. Structural Subordination: Structural subordination arises when the entity being rated is a

holding company whose primary source of cash flow is dividends received from the operating

entities held by it. Creditors of the operating entity rank enjoy higher priority in the cash flow

than the creditors of the holding company. This is referred to as structural subordination.

v. Cash Traps: Cash traps are restrictions which can be: contractual, such as dividend

stoppers; regulatory – where a local regulator does not permit unilateral cash payments

overseas; and convertibility – where the exchange rate of the functional currencies of major

operating entities is volatile. These restrictions may impede a group from being able to readily

provide internal support to weaker or vulnerable group members, and thereby reduce the

structural integrity of the group.

C. Business Risk

The purpose of this analytical category is to identify structural or cyclical risks associated with

the institution’s business activities that are usually within the scope of management’s control.

Business risk factors can be of the following types:

i. Scale and Diversification: Diversity of operations across product and geographic segments

may provide strong - intrinsic - cyclical loss mitigation.

ii. Brand and Reputation: An institution with a track record of robust earnings, innovation, risk-

management, technological leadership, demonstrated responsiveness to the needs and trends

in its competitive arenas and which possesses a diversified service offering, cost advantages

and pricing power will be assessed as having a strong brand and reputation.

iii. Management, Strategy, and Corporate Governance: It is essential to carry out an

assessment of a firm’s management and its stated strategies. Management should be rated on

credibility, dependability, experience, and competence. Management qualifications, track record

and board meeting attendance are scrutinised for their impact on the rating. The other relevant

factors would be the organizational structure of the entity, dependence of the management team

on one or more persons, the coherence of the team, the independence of management from

major shareholders, management’s culture; and its track record in terms of business mix,

operating efficiency, and market position; the quality and credibility of management’s business

strategy, including plans for future internal or external growth both in general and in terms of

target markets/segments. Important aspects of the corporate governance methodology for credit

analysis of FIs could include independence and effectiveness of the board of directors,

oversight of related-party transactions, and executive and director remuneration. When

evaluating future plans, it is important to determine how realistic these are, and significant credit

is given for delivering on past projections and keeping to strategies. Risk assessment could be

based on clearly articulated strategic vision and evidence of management alignment with that

vision that determines the potential management responses to industry and market challenges.

iv. Opportunities and Execution: Balance-sheet expansion or contraction is compared against

underlying economic growth or contraction compared with the peer, sector and industry

averages to identify any outliers and assess the build-up of potential risks. Rapid loan growth

can also obscure financial analysis, for example making it difficult to form a view of true asset

quality because loan portfolios have not had time to mature, and may be indicative of a lowering

of underwriting standards.

v. Service Proposition: The magnitude and volatility of loss vary across segments.

vi. Underwriting Standards and Portfolio Quality: An institution’s risk appetite and the quality

of its loan book can be scrutinised based on loan-to-value ratios for secured lending products,

the level of unsecured lending, the individual and sector portfolio limits and the stratification of

approval delegation.

vii. Funding Profile: The strength of an institution’s liquidity is governed by its ability to access

a funds. Such access is dependent on its cost competitiveness. While evaluating the funding

profile, it is necessary to consider the term debt funding burden and the level of laddering of that

debt; asset-liability mismatch both on a market value and on a cash flow basis; wholesale to

retail funding mix as well as the currency mix of its borrowings.

viii. Risk Controls: A financial institution requires strong and effective risk management tools to

adhere to its stated risk appetite and underwriting standards. These controls include; the

reporting and monitoring of limits pertaining to product or credit concentrations, geography,

market risks; policies for escalating breaches to controls; operational controls (e.g. separation of

duties and consistency in the alignment of employee incentive structures) They may also

include tools such as custom scorecards, internal ratings or third-party data sources such as

national credit bureaus.

Quantitative evaluation

This primarily relates to assessment of financial strength of a cIient. Key financial parameters

relevant from this perspective are as follows:

1. For Banks

(i). Profitability Ratios-

Return on Assets, Return on Risk-weighted Assets, Return on Equity, Loans to Assets,

Net Interest Margin, Efficiency Ratio

(ii). Capitalization Ratios-

Common Equity Tier I Capital Ratio, Tier I Capital Ratio, Total Capital Ratio, Leverage

Ratio, Prudential Buffers

(iii). Asset Quality Ratios-

Write-offs, Special mention accounts, Gross NPA and Net NPA, Provisioning Coverage

Ratio,

(iv). Liquidity/Funding Ratios-

Liquidity Coverage Ratio, Net Stable Funding Ratio, Loans to Deposits, Liquid Assets

Ratio

2. For NBFCs

(i). Asset Quality Ratios-

Delinquent loans/Period-End loans or leases, Impaired or nonperforming loans/Period-

end loans or leases, Gross charge-offs/Average loans, Net charge-offs/Average loans,

Reserves/Nonperforming assets, Impairment charges/Average loans, Gain/(loss) on

residual asset sales/Book value of assets

(ii). Profitability Ratios-

Return on average assets, Operating return on average assets, Return on average

equity, Operating return on average equity, Risk-Adjusted revenue margin, Net interest

margin, Efficiency ratio, EBITDA margin, Gross revenue-producing

equipment/Equipment depreciation, Operating expenses/Loans, Fixed-Charge coverage,

EBITDA/ Interest expense

(iii). Capitalization and leverage Ratios-

Tangible equity/Assets, Core capital/Tangible assets, Core capital plus

reserves/Tangible assets, Debt/core capital, Debt/Tangible equity, Combined payout

ratio, Internal capital generation, Debt/EBITDA.

(iv). Funding Ratios-

Short-Term debt/Total interest-bearing liabilities, Short-Term debt plus CPLTD/Total

interest-bearing liabilities, Secured debt/Total interest-bearing liabilities, Committed

funding facilities/Total funding, Available credit facilities/Outstanding commercial paper,

Unencumbered assets/Unsecured debt, Managed assets, Nonperforming assets,

Operating income Core capital, Short-Term debt.

4. Exposures to State Governments and State PSEs

Exposure to a central government is generally considered risk free as a government possesses

wide range of tools to service its obligations and in the worst case scenario, can monetise the

deficit. However considering the federal structure of India, States don’t have this flexibility.

Nevertheless, State Governments do enjoy some amount of implicit backing from the Central

Government. Based on banks experience with the honouring of their claims by the State

Governments so far, while the direct exposures to them are risk weighted at 0%, the exposures

guaranteed by the State Governments are risk assigned a risk weight of 20%. Thus, at least the

exposures guaranteed by the State Governments are not considered risk free. In addition,

although these exposures attract uniform risk weighting, in practice there may be differences

across the State Governments in the matter of honouring their guarantees. Further, even if an

AIFI may finally get repaid by a State Government, it may be with a considerable delay causing

liquidity problem. Owing to these considerations, it is necessary that the AIFIs carry out analysis

of the credit proposals involving State Government guarantees diligently. The general

framework for credit risk appraisal of State government exposures may consist of following

factors:

1. Access to grants and transfers of central government

2. Economic stability

3. State Finances: Revenue and expenditure structure

4. Debt burden

5. Political and social stability

6. Reform process

These factors can be measured across different parameters, of both subjective and objective

nature.

Access to grants and transfers of central government

The major sources of finances for the States are the fiscal transfers and grants from central

government which are in form of share of union taxes and union grants. The following factors

are relevant in this context:

(a) One of the determinants of a State’s share is the existing horizontal imbalance among

the States that is sought to be corrected by varying the central transfer in accordance

with the recommendations of the Finance Commissions (FCs); the FC transfers

simultaneously aim to reduce horizontal imbalances among States. While various FCs

have incorporated efficiency and performance parameters into their formulae, achieving

horizontal equity remains a critical objective. Hence, so far, the lesser-developed States

have been receiving a larger share of the transfers.

(b) Another large source is the allocation by the Planning Commission (PC), which focuses

on the development needs of States.

(c) External transfers may be important is some cases and it may be important to look for

any cross loan provisions and also assess the extent of end-use linked assistance as

opposed to general restructuring loans. These would indicate the likelihood of the

assistance continuing in future.

Economic Stability

Each State needs to be self-sufficient to generate its own revenue sufficient enough to service

its loans and manage its expenditures. This capability can be broadly measured from the

following aspects of economy:

a. Availability of relevant physical and legal infrastructure

b. Availability of skilled and unskilled labour at competitive rates

c. Availability of natural resources

d. Demographic trends

e. A well developed and regulated market

f. Various incentives to manufacturing and service sector of the economy.

g. Number of well-functioning active entrepreneurial and innovation hubs present.

These parameters can be studied cross-sectionally across different States to gauge the level of

their economic growth and stability.

State finances

Revenue Structure

The revenue generated by a State can be subdivided into two classes which are:

a. State tax revenue

b. State non tax revenue

The major components of State non Tax revenue are:

a. Profits of public sector enterprises

b. Interests and returns on loans and investment

c. Statutory and administrative charges as levied by the States for the services provided by

them.

Historically, it is the State tax revenue which generally forms the bulk of the revenue. A cross-

sectional and a time series analysis of these parameters can be conducted to measure a State’s

relative standing and the parameters growth rates over the years. The AIFIs should carry out an

analysis of States’ revenue structure encompassing assessment of the sources of revenue,

diversity of revenue streams, correlation of key revenue streams with trends in the economy,

and flexibility the State has to raise additional taxes.

There is scope for rationalisation of tax structures across revenue streams and potential for

further growth through simplification and rationalisation of structures. A State’s performance in

this regard should be factored in the credit analysis.

The AIFI should assess the flexibility a State enjoys in changing tax rates or structures. While

high Tax/GSDP ratios, are a positive, very high tax rates on a narrow base or sustained

additional resource mobilisation by States may have an adverse impact on the competitiveness

of the State concerned in the long term. For instance, high stamp duties and electricity duties in

some States, while resulting healthy contributions to the State exchequer at present, may

impact the competitiveness of the State economy over the long term. While rationalisation of

existing tax structures is an effective way to increasing revenue buoyancy, there exists

considerable scope for improving collections by streamlining the existing administrative and

collections systems. Efforts made by the State to improve collections not only by getting arrears

cleared, but also by putting in place systems to reduce leakage and avoidance should be taken

into account.

Expenditure Structure

The expenditure of the State is a determining factor but the nature of expenditure is more

important. Expenditure can be classified as: consumption driven expenditure (b) capital asset

creation expenditure. A critical aspect of analysing a State’s expenditure management is

assessing the flexibility it has to curtail expenses in case of an economic downturn or revenue

decline. With this perspective, a higher share of capital expenditure normally indicates greater

flexibility for curtailment in the immediate term; however, sustained pressures on capital

investments may have an adverse impact on the State’s infrastructure in the long term. Hence,

effectively, the quality and extent of existing infrastructure largely determine a State’s flexibility

to defer capital expenditure. However, given that almost all States are still n urgent need of

development funding, the AIFIs should assesses States’ policies aimed at creating capital

assets, encouraging private investments, and creating a conducive investment climate. The

trend in public asset creation necessarily has to be seen in tandem with the returns generated

by these assets and the State’s policies on user charges.

Apart from long-term capital commitments, employee costs, subsidies, support to public sector

units, and debt servicing remain the most immediate and critical cost concerns for most States.

The AIFIs should analyse the trends in the salary and pension expenses of States and the

extent of linkage between their and Central structures. The analysis should also cover States’

commitments to grant-in-aid institutions, the status of arrears on payments, and the position of

accrued pension liabilities.

Further, apart from the high level of implicit subsidies that States extend through low user

charges and free services, they also provide a very high level of explicit subsidies. While many

States have their own welfare schemes, the key subsidies common to most States are related

to power and food. The power sector, across States, has been the single largest claimant of

subsidies; thus, progress of reforms in this sector should be a key factor in the AIFIs’ credit

assessment of the States.

Sustained assistance to inefficient State entities has also been a drain on States’ finances.

Thus, the AIFIs should also evaluate the progress made by the States concerned in

restructuring their state-level enterprises and the possible assistance requirements of such

enterprises in future.

The analysis should also cover the framework for and trend in transfers from the state to local

bodies, likely trends in States’ interest costs in the context of their projected funding

requirements and the mix of borrowings (current and proposed).

Financial Position, Borrowings and Liquidity

The AIFIs should make an assessment of the trends and outlook for deficits or surpluses that

may reflect the sustainability of States’ efforts to raise revenues on the one hand, and lower

expenditure on the other. In this context, the AIFIs should analyse the trends in States’ revenue

deficit, financing gap, and fiscal deficit, both in absolute terms and in correlation with the States’

economic output. The analysis also factors in the economic, business and monsoon cycles

affecting the States, besides changes in policies.

A declining or stable level of deficits is critical for States to avoid having an unsustainable

reliance on debt.

Apart from the levels of deficits and borrowings, the analysis should encompass assessment of

the mix, maturity profiles and cost of borrowings by States, States’ contingent liabilities including

off-budget liabilities and guarantees extended (with or without budgetary provisions) to lenders

and suppliers, non-guaranteed liabilities of financially dependent State-level entities, and losses

accumulated in the books of the State-level entities.

While analyzing contingent liabilities, the AIFIs should take into account the robustness of the

databases and the regular tracking of likely contingencies, including maintenance, if any of

sinking funds that would support States’ willingness to meet contractual debt and guarantee

obligations. An assessment of the maturity profile of States’ debt and guarantees is critical to

understanding the timing of repayment obligations and the likely liquidity requirements.

A State’s ability to forecast and manage cash flows plays a critical role in ensuring timely debt

servicing.

Among the various indicators of liquidity, the AIFIs may track the trends in payment of current

liabilities; utilization of ways and means advances (WMA) and overdrafts (OD) with the Reserve

Bank of India; and the difference between Gap and Fiscal Deficit (FD). Assuming a certain level

of reliability of systems for tracking contractual liabilities, an “easy” response to liquidity strain is

to delay payments to contractors and employees. And short-term mismatches are usually met

from WMA and OD (though not always).

Recurring instances of delayed contracted payments and sustained utilisation of WMA and OD

could be indicators of liquidity strain, or bad cash flow management—both pointers to inferior

credit quality. Another likely indicator of liquidity strain is the difference between Gap and FD;

continued high levels of public account funding of the Gap reflects an inability to undertake

expenditure, and is likely to be the result of strain on cash flows.

Debt burden

Debt of a state government is studied in reference to the size of its economy. Ratios such as

debt service coverage ratio and Interest coverage ratio are used to measure the level of debt

and interest against the net revenue receipts. The ratio of short term debt to total debt can be

used to evaluate the near term stress on the AIFIs. Apart from these absolute measures other

subjective indicators like tenure of debt, applicable interest rates, bunching of repayment and

present and forecasted lines of credit available at concessional interest rates need to be

considered.

Political and social stability

Political and social stability is an important factor for the functioning of the State to its potential.

The various determinants of the political and social stability that should be factored in the credit

analysis include:

a) The institutional framework and the extent of federal structure

b) The participation of various stakeholders in the decision process

c) The level of decentralization in the functioning of the society

d) Standard of living measured as per capita income

e) The value and validity of fundamental rights and duties

f) The strength, independence and authority of the legal and judicial system.

Reform process

Reforms form the basis of future performance and sustenance of the States. Determinants of a

reform process are.

a. A defined reform process roadmap

b. Tangible benefits of the reform process

c. The extent and efficiency of implementation

d. Alternative solution to roadblocks in achieving the reform objectives

5. Exposure to infrastructure projects

The AIFIs must evaluate an infrastructure projects intended to be financed with the same rigour

regardless of the nature of the borrower i.e. whether a State government, a state PSE or a

private company. Infrastructure projects have a number of inherent complexities and adequately

addressing these complexities is a major challenge for the loan officers and the credit risk

managers. Understanding the roles of various parties to the transaction as well as contractual,

legal, and regulatory requirements, currency and sovereign risks, and other characteristics of

these investments can be challenging. An effective risk assessment approach would reflect a

sound understanding of these issues.

Key challenges to project appraisal

Coordination of multiple parties with individual interests, including construction

companies, suppliers, governments, off-takers, sponsors, and guarantors

Long-term horizon of projects makes estimating revenues and cash flows from the

financed asset difficult

Reliance on a cash-flow stream from a single project

Dramatically changing risk profile through the project lifecycle, from construction to start-

up to operation

Unique default characteristics and minimal historical data due to great variety of project

types and few defaults

Relatively high risk of construction delays, cost overruns, and start-up problems

Multiple, and potentially conflicting, regulatory requirements

Imperfect information and markets

Complex or weak structural aspects of transactions

Key risks in project finance

The AIFIs should take into account the major risks indicated below while apprising credit

proposals for project finance

Project Finance Appraisal

A significant portion of loan portfolios of all the AIFIs consists of long term loans in the nature of

project finance. Project finance involves raising of finance for the purposes of developing a large

capital- intensive infrastructure project, where the borrower may be a special purpose vehicle

and repayment of the financing by the borrower will be dependent on the internally generated

cash flows of the project.

Financing high-profile infrastructure projects not only requires lenders to commit for long

maturities, in the case of projects located overseas it also exposes the lenders to the risk of

political interference by host governments. Therefore, project lenders are making increasing use

of political risk guarantees, especially in emerging economies.

Key Challenges in project finance

Coordination of multiple parties with individual interests, including construction companies,

suppliers, governments, offtakers, sponsors, and guarantors

Long-term horizon of projects makes estimating revenues and cash flows from the

financed asset difficult

Reliance on a cash-flow stream from a single project

Dramatically changing risk profile through the project lifecycle, from construction to start-

up to operation

Unique default characteristics and minimal historical data due to great variety of project

types and few defaults

Relatively high risk of construction delays, cost overruns, and start-up problems

Multiple, and potentially conflicting, regulatory requirements

Imperfect information and markets

Complex or weak structural aspects of transactions

Pre-requisites to Project Finance

There are a number of practical pre-conditions to financing a project where the repayment a

recovery primarily depends upon the cash flows generated by the project rather than the

general cash flows of the corporate or government sponsoring the project. In some cases, the

exposures may be guaranteed by central or state governments. Notwithstanding the high quality

of these guarantees, being government owned entities it would be imperative on the part of the

AIFIs to make the viability assessment of the projects with the same rigour as it would have

done in the absence of guarantee. This would not only ensure safety of the loan, but also

achieve the broader public policy objectives.

It would be helpful to look at the following aspects of the project which an AIFI proposes to

finance:

Sustainable economics: Whilst comfort can be gained from (a) undertaking detailed financial

due diligence and modelling to stress-test the projected cash flows of the asset and (b)

contractually mitigating revenue risk, experienced investors and bankers will ultimately look for a

clearly identifiable demand for the project’s goods or services in order to ‘rationalise the credit’

Identifiable risks: An unidentified and unmitigated risk could potentially jeopardise the stability of

a project.

Accessible financing: From both Sponsor and (if applicable) Procurer perspectives, high

leverage and long-tenor financing is a de facto requirement to achieving attractive economics

for large infrastructure financings

Political stability: Even if political ‘force majeure’ risk is contractually born by the government (as

is common practise in many PPP programs), the efficacy of that remedy to Lenders/investors

would be negated by a strategic sovereign default – expropriation/nationalisation of assets

being one potential example. Whilst such risks cannot be mitigated against in the insurance

markets, varying degrees of political risk insurance can be obtained through the use of financing

products available from multilateral and export credit agencies

If the pre-conditions above are satisfied, there is good chance that a project financing for an

infrastructure asset is achievable without dependence on extra comfort in the form of sponsor or

parental guarantees.

Risk Allocation, Bankability and Mitigation in Project Financed Transactions

A number of key risks that need to be allocated and managed to ensure the successful

financing of the project are:

Construction and Completion Risk

Cost of Construction - Clearly, the cost of completion will be fundamental to the financial viability

of the project as the financial assumptions and ratios are all dependent on the assumed cost of

construction of the project. The lenders will need some mechanism to manage the risk if the

project company’s cost of completion increases as compared with that anticipated at financial

close. The project company will also seek to lock in certain costs such as costs of commodities,

as early as possible in the project, so as to limit price escalation.

Delay - Completion represents the end of the construction phase of the project. The

construction contractor will be liable for liquidated damages for late completion, therefore the

definition of "completion" will have a large impact on the construction contractor's risk.

Performance - The lenders will want to ensure that completion requires the works to be in a

condition sufficient to merit release of the construction contractor from delay liquidated damages

liability. The works will therefore be subject to certain technical tests and demonstration of

performance capacity before completion is achieved.

The project company will want to ensure that the criteria placed on completion can be measured

objectively as set out in the construction contract, and that the lenders do not have the right to

refuse completion owing to their own subjective evaluation of the works. This may involve

technical testing effectuated by independent experts, or by standard measures or tests with

clearly ascertainable results, not unreasonably subject to dispute.

Operating Risks

As noted under Certainty of Revenue Stream, the financial model and assumptions to viability of

the project are dependent on the projected costs of operations. If there is something in the cost

of the operation that increases, lenders will want to be protected to the extent that it will impact

the revenue stream. For instance, one of the key costs of operation in a power generation

project will be the cost of the fuel and in the case of a water treatment plant, the cost of power.

The cost can be locked in, to some extent, through hedging and futures contract and through

input agreements but there are likely to be some costs that are not hedged and the lenders will

want to be sure that these are limited (for instance, the increased cost is reflected in the tariff

calculation for the power or treated water). Another key cost in operations will be the cost of

workers and an assumption for wage inflation is usually built into the agreement by reference to

an index such as the retail price index. It is important to ensure that the index covers increases

in the sorts of costs incurred by the project.

The other key risk in operations is performance. The lenders and other investors are likely to

have chosen an experienced operator to operate the project but there will be risks associated

with operations such as key pieces of plant breaking down when they are out of construction

warranty and also in the project company failing to meet the performance requirements and

facing penalties and even the risk of termination for default. The lenders will seek to mitigate

these risks through warranties and step-in rights.

Economic Risk

The project is unlikely to generate revenue until the operations period and so it is going to be

key to lenders and other investors that the revenue stream is certain and that forecasts of

revenues are accurate. Future forecasts of demand, cost and regulation of the sector in any

relevant site country will be important to private sector investors considering the revenue

prospects of the project. For example, they may wish to:

review the demand profile for project offtake, in the context of the extent to which the

project company will bear project risk and will be able to influence demand;

examine demand projections and information on the historical willingness of consumers to

pay tariffs and to pay such tariffs on time (where the offtake is directly to consumers, for

instance in the case of a toll road);

look at prospects for growth, demographic movements, current tariffs and projections of

consumer attitudes towards paying increased tariffs;

where tariffs are based on indices, look at projections of the future movement of such

indices and their relation to actual costs, including operating costs, finance costs, capital

expenditure requirements and other such costs;

review public, residential, commercial and industrial consumption and usage, actual and

forecast, within the service area; and

consider the impact of technical changes on the revenue stream, for example the

installation of meters may cause a reduction in use and therefore project revenues.

The risk that a project will not generate such revenues is a function of many variables such as

demand, pricing and variable costs.

Demand: A project may function perfectly and yet fail to generate sufficient income as a result

of a lack of demand for it or its product. This is true for projects as diverse as toll roads, power

projects, or telecommunications infrastructure.

Pricing: A project may function properly, attain projected demand levels, and yet fail to

generate sufficient income because of low prices of the products. This is a particular risk for

projects producing commodities the prices of which have historically been volatile.

Variable costs : The economics of a project may be predicated on fundamental assumptions

as to certain variable

costs over its life. These assumptions may, however, fail to hold, exposing the project to

fluctuations in its variable costs that cannot be passed on to buyers in the form of higher prices.

This can take, for example, the form of exposure to fuel costs in the case of power projects.

The project participants must ensure that the project has received all necessary approvals from

the host government and any local authorities, and that the government will not change its

regulation of the project's operation in such a way as to inhibit the project development and

production plans, or the revenue stream. This risk is often difficult to manage in particular in

countries with developing or highly volatile legal and regulatory structures.

The project company will want to review the reasonableness of sanctions for failure to operate

to the standards required, the payment structure for financial penalties, and any further

sanctions for project company breach. The project structure should be reasonable and flexible,

especially where the project in question is to continue over a long period, as the incentive

mechanisms may need to change to ensure efficiency as the project evolves over time.

Force Majeure and Change in Law

It is important to note that the financing agreements will not include force majeure or change in

law provisions. The obligation to repay the loans will continue in the event of force majeure or

change in law. The lenders will want to review the force majeure and change in law provisions in

the project documents and ensure that they are back-to-back (as far as possible) with the

concession agreement.

Political and Regulatory Risk and Expropriation or Nationalization Risk

As the market for project finance transactions has expanded into developing countries,

concerns about political risk have grown. Key risks that arise are the decision by a government

to cancel a project or to change the terms of the contract or not to fulfil its obligations, political or

regulatory risk in failing to implement the tariff increases agreed upon in the contract, the risk of

expropriation or nationalization of project assets by a government. Some of this will be managed

in the project agreements with the government taking some of the risk in terms of compensation

to be paid in the case of unilateral termination or expropriation, but not all political risks are likely

to be borne by the government.

Commercial lenders may be prepared to take a degree of political risk, but in some countries the

perceived political risk inhibits or even prevents the financing of projects which otherwise might

be viable. Since the commercial insurance market can only absorb a limited degree of true

political risk, many project sponsors have turned to multilateral agencies or export credit

agencies to shoulder some or all of this burden.

Environmental Risk

Environmental and social laws and regulations will impose liabilities and constraints on a

project. The cost of compliance can be significant, and will need to be allocated between the

project company and the grantor.

Equally, in order to attract international lenders, in particular International Financial Institutions

(IFIs), the project must meet minimum environmental and social requirements that may exceed

those set out in applicable laws and regulations. This process is made easier where local law

supports similar levels of compliance.

The Equator Principles constitute a voluntary code of conduct originally developed by the IFC

and a core group of commercial banks, but now recognized by most of the international

commercial banks active in project finance. These banks have agreed not to lend to projects

that do not comply with the Equator Principles. They follow generally the IFC system of

categorizing projects, identifying those that are more sensitive to environmental or social impact,

and requiring specialist assessment where appropriate. During project implementation, the

borrower must prepare and comply with an environmental management plan.

Environmental due diligence in respect of such projects and in respect of the legal regime within

which they are being constructed, and an appreciation of the environmental requirements of

public agencies which will be involved with the project, are crucial if the project company and

lenders are to make a proper assessment of the risks involved.

Social Risk

Infrastructure projects generally have an important impact on local communities and quality of

life, in particularly delivery of essential services like water and electricity or land intensive

projects like toll roads. Project impact of society, consumers and civil society generally, can

result in resistance from local interest groups that can delay project implementation, increase

the cost of implementation and undermine project viability. This social risk should be high on a

lenders due diligence agenda, though it often is not. The lenders and project company often

look to the grantor to manage this risk. The grantor in turn may underestimate its importance,

since the social risk paradigm for public utilities is very different, the grantor may not have

experience of its implications for private investors.

Currency Exchange Risk

Project finance debt is often sourced from foreign lenders, in foreign currencies, yet project

revenues are generally denominated in local currency. Where the exchange rate between the

currency of revenue and the currency of debt diverge, the cost of debt can increase, often

dramatically. Though under the theory of purchasing power parity, inflation pressures on the

devalued currency will eventually bring the foreign exchange rate back to parity, project finance

lenders are generally not prepared to wait quite so long (with average periods of about 10

years).

Where revenues are to be earned in some currency other than that in which the debt is

denominated, the lenders will want to see the revenue stream is adjusted to compensate for any

relevant change in exchange rate or devaluation. If this is not available, the lenders will want to

see appropriately robust hedging arrangements or some other mechanism to manage currency

exchange risk.

Interest Rate Risk

Interest may be charged at a fixed rate, at variable rates (usually based on the banks lending

rate or an inter-bank borrowing rate plus a margin) or a floating rate (calculated by reference to

cost of short-term deposits). Project finance debt tends to be fixed rate. This helps provide a

foreseeable, or at least somewhat stable, repayment profile over time to reduce fluctuations in

the cost of infrastructure services. If lenders are unable to provide fixed rate debt and no project

participant is willing to bear the risk, hedging or some other arrangements may need to be

implemented to manage the risk that interest rates increase to a point that debt service

becomes unaffordable to the project.

APPENDIX G

Sl. No. Ratio Significance

1. (Volatile liabilities1 – Temporary Assets2) /(Earning Assets3 – Temporary Assets)

Measures the extent to which volatile money supports AIFI’s basic earning assets. Since the numerator represents short-term, interest sensitive funds, a high and positive number implies some risk of illiquidity.

2. Stable funds4/Total Assets Measures the extent to which assets are funded through stable funds.

3. (Loans + HTM Investments+ Equity investments in VCFs and unlisted companies+ Fixed Assets)/Total Assets

Loans, HTM Investments, equity investments in VCFs and unlisted companies including strategic investments, fixed assets are least liquid and hence a high ratio signifies the degree of ‘illiquidity’ embedded in the balance sheet.

4. (Loans + Fixed Assets) / Stable funds

Measure the extent to which illiquid assets are financed out of stable funds.

5. Temporary Assets/Total Assets

Measures the extent of available liquid assets. A higher ratio could impinge on the asset utilisation of AIFIs in terms of opportunity cost of holding liquidity.

6. Temporary Assets/ Volatile Liabilities

Measures the cover of liquid investments relative to volatile liabilities. A ratio of less than 1.00 indicates the possibility of a liquidity problem.

7. Volatile Liabilities/Total Assets

Measures the extent to which volatile liabilities fund the balance sheet.

1 Volatile Liabilities: (Certificate of Deposits and other borrowings payable up to 1 year). Letters of credit – full outstanding. Component-wise CCF of other contingent credit and commitments. Swap funds (buy/ sell) up to one year.

2Temporary assets = Cash + Balances with banks + Bills purchased/discounted up to 1 year + Investments up to one year + Swap funds (sell/ buy) up to one year.

3 Earning Assets = Total assets – (Fixed assets + Balances in current accounts with other banks + Other assets excluding leasing + Intangible assets). 4 Stable funds = All deposits and borrowings above 1 year (as reported in structural liquidity statement)+ net worth.

APPENDIX H

Part A1 Statement of Structural Liquidity - Domestic Currency, Indian Operations

Reporting Frequency : Fortnightly

Name of the AIFI :

Position as on :

(Amounts in Crores of Rupees) Amount in Rupees crores

Residual Maturity

Outflows Day - 1 2-7 Days 8-14 Days 15-28 Days

29 Days & upto 3

months

Over 3 Months and

upto 6 months

Over 6 Months

and upto 1 year

Over 1 Year and

upto 3 years

Over 3

Year and upto

5 years

Over 5 Total

Years

1 Capital

2 Reserves & Surplus

3 Deposits *** *** *** *** *** *** *** *** *** *** ***

(i) Current Deposits

(ii) Savings Bank

Deposits

(iii) Term Deposits

(iv) Certificates of

Deposit

4 Borrowings *** *** *** *** *** *** *** *** *** *** ***

(i) Call and Short

Notice

(ii) Inter-Bank (Term)

(iii) Refinances

(iv) Others (specify)

5 Other Liabilities & *** *** *** *** *** *** *** *** *** *** ***

Provisions

(i) Bills Payable

(ii) Provisions

(iii) Others

6 Lines of Credit *** *** *** *** *** ***

*** *** *** *** ***

committed to

(i) Institutions

(ii) Customers

7 Unavailed portion of

Cash Credit /

Overdraft / Demand

Loan component of

Working Capital

8 Letters of credit /

Guarantees

9 Repos

10 Bills Rediscounted

(DUPN)

11 Swaps (Buy / Sell) /

Maturing / Forwards

12 Interest Payable

13 Others (specify)

14 A. Total Outflows

15 B. Cumulative

Outflows

Amount in Rupees crores

Residual Maturity

Inflows Day - 1 2-7 Days 8-14 Days 15-28 Days

29 Days and upto 3

months Over 3

Months and upto 6

months

Over 6 Months

and upto 1 year

Over 1 Year and

upto 3 years

Over 3

Years and upto

5 years

Over 5

years Total

1 Cash

2

Balances with RBI ***

3 Balances with *** *** *** *** *** ***

*** *** *** ***

Banks

(i) Current Account

(ii) Money at Call

and Short Notice,

Term Deposits

and other

placements

4 Investments (including *** *** *** *** *** *** *** *** *** *** ***

those under Repos

but excluding Reverse

Repos)

5 Advances Performing *** *** *** *** *** *** *** *** *** *** ***

(i) Bills Purchased and

Discounted

(including bills

under DUPN)

(ii) Cash Credits,

Overdrafts and

Loans repayable on

demand

(iii) Term Loans

6 NPAs (Advances

and Investments)*

7 Fixed Assets

8 Other Assets *** *** *** *** *** *** *** *** *** *** ***

(i) Leased Assets

(ii) Others

9 Reverse Repos

10 Swaps (Sell / Buy) /

maturing forwards

11 Bills Rediscounted

(DUPN)

12

Interest receivable

13 Committed Lines

of Credit

14 Export Refinance

from RBI

15 Others (specify)

16 C. Total Inflows

17 D. Mismatch (C-A)

18 E. Mismatch as %

to Outflows (D as

% to A)

19 F. Cumulative

Mismatch

20 G. Cumulative

Mismatch as a

% to Cumulative

Outflows (F as a

% to B)

* Net of provisions, interest suspense and claims received from ECGC / DICGC

Part B Statement of Structural Liquidity for Overseas branch Operations - Country Wise

Reporting Frequency : Monthly

Name of the AIFI :

Position as on :

(Amounts in Crores of Rupees) Amount in USD million

Residual Maturity

Outflows Day - 1 2-7 Days 8-14 Days 15-28 Days 29 Days &

upto 3 months

Over 3 Months and

upto 6 months

Over 6 Months

and upto 1 year

Over 1 Year and

upto 3 years

Over 3

Years and upto

5 years

Over 5 Total

Years

1 Capital /HO funds

2 Reserves & Surplus

3 Deposits *** *** *** *** *** *** *** *** *** *** ***

(i) Current Deposits

(ii) Savings Bank

Deposits

(iii) Term Deposits

(iv) Certificates of

Deposit

4 Borrowings *** *** *** *** *** *** *** *** *** *** ***

(i) Call and Short

Notice

(ii) Inter-Bank (Term)

(iii) Refinances

(iv)

Others (specify)

5 Other Liabilities & *** *** *** *** *** ***

*** *** *** *** ***

Provisions

(i) Bills Payable

(ii) Provisions

(iii) Others

6 Lines of Credit *** *** *** *** *** ***

*** *** *** *** ***

committed to

(i) Institutions

(ii) Customers

7 Unavailed portion of

Cash Credit /

Overdraft / Demand

Loan component of

Working Capital

8 Letters of credit /

Guarantees

9 Repos

10 Bills Rediscounted

(DUPN)

11 Swaps (Buy / Sell) /

Maturing / Forwards

12 Interest Payable

13 Others (specify)

A. Total Outflows

B. Cumulative

Outflows

Amount in USD million

Residual Maturity

Inflows Day - 1 2-7 Days 8-14 Days 15-28 Days 29 Days and upto 3

months

Over 3 Months and

upto 6 months

Over 6 Months

and upto 1 year

Over 1 Year and

upto 3 years

Over 3

Years and upto

5 years

Over 5

years

Total

1 Cash

2 Balances with Central Bank

3 Balances with *** *** *** *** *** *** *** *** *** *** ***

Banks

(i) Current Account

(ii) Money at Call

and Short Notice,

Term Deposits

and other

placements

4 Investments (including

those under Repos

but excluding Reverse

Repos)

5 Advances Performing) *** *** *** *** *** *** *** *** *** *** ***

(i) Bills Purchased and

Discounted

(including bills

under DUPN)

(ii) Cash Credits,

Overdrafts and

Loans repayable on

demand

(iii) Term Loans

6 NPAs (Advances

and Investments)*

7 Fixed Assets

8 Other Assets *** *** *** *** *** *** *** *** *** *** ***

(i) Leased Assets

(ii) Others

9 Reverse Repos

10

Swaps (Sell / Buy) /

maturing forwards

11 Bills Rediscounted

(DUPN)

12 Interest receivable

13 Committed Lines

of Credit

14 Export Refinance

from RBI

15 Others (specify)

C. Total Inflows

D. Mismatch (C-A)

E. Mismatch as %

to Outflows (D as

% to A)

F. Cumulative

Mismatch

G. Cumulative

Mismatch as a

% to Cumulative

Outflows (F as a

% to B)

* Net of provisions, interest suspense and claims received from ECGC / DICGC

II. Maturity Profile of structured vehicles sponsored by the AIFI

(Amounts in Crores of Rupees) Amount in USD million

Residual Maturity

Inflows

Day - 1 2-7 Days 8-14 Days 15-28 Days

29 Days and upto 3

months

Over 3 Months and

upto 6 months

Over 6 Months

and upto 1 year

Over 1 Year and

upto 3 years

Over 3

Years and upto

5 years

Over 5 Total

Years

Cumulative Mismatches

Cumulative Mismatches as a percentage to Cumulative Outflows

Note : This statement is required to be prepared country wise. AIFIs should also report figures in respect of subsidiaries/joint ventures in the same format on a stand-alone basis, i.e. these figures should not be reckoned while preparing country-wise reports. In respect of joint ventures where more than one bank/ AIFI has equity stake, the bank/ AIFI having the largest stake only need to report the figures. If, however, the entities have equal stake, the responsibility for filing the return would rest with the bank/ AIFI having the largest presence in the region. All amounts to be indicated in US dollars. For uniformity, banks/ AIFIs should use the London Inter branch closing rate on the last working day of the reporting quarter for their currency conversion. However, in the absence London Inter branch closing rate, banks/ AIFIs may use other rates like Reuters / Bloomberg trading screen exchange rate.

Part C Statement of Structural Liquidity - For Consolidated AIFI Operations

Reporting Frequency : Quarterly

Name of the AIFI :

Position as on :

(Amounts in Crores of Rupees) Amount in Rupees crores

Residual Maturity

Outflows Day - 1 2-7 Days 8-14 Days 15-28 Days

29 Days & upto 3

months

Over 3 Months

and upto 6 months

Over 6 Months

and upto 1 year

Over 1

Year and upto

3 years

Over 3

Year and upto

5 years

Over 5

years

Total

1 Capital

2 Reserves & Surplus

3 Deposits *** *** *** *** *** *** *** *** *** *** ***

(i) Current Deposits

(ii) Savings Bank

Deposits

(iii) Term Deposits

(iv) Certificates of

Deposit

4 Borrowings *** *** *** *** *** *** *** *** *** *** ***

(i) Call and Short

Notice

(ii) Inter-Bank (Term)

(iii) Refinances

(iv) Others (specify)

5 Other Liabilities &

*** *** *** *** *** *** *** *** *** *** ***

Provisions

(i) Bills Payable

(ii) Provisions

(iii) Others

6 Lines of Credit *** *** *** *** *** ***

*** *** *** *** ***

committed to

(i) Institutions

(ii) Customers

7 Unavailed portion of

Cash Credit /

Overdraft / Demand

Loan component of

Working Capital

8 Letters of credit /

Guarantees

9 Repos

10 Bills Rediscounted

(DUPN)

11 Swaps (Buy / Sell) /

Maturing / Forwards

12 Interest Payable

13 Others (specify)

14 A. Total Outflows

15 B. Cumulative

Outflows

Amount in Rupees crores

Residual Maturity

Inflows Day - 1 2-7 Days 8-14 Days 15-28 29 Days Over 3 Over 6 Over Over Over Total

Days and upto 3

months Months

and upto 6 months

Months and

upto 1 year

1 Year and upto

3 years

3 Years and upto

5 years

5 years

1 Cash

2

Balances with RBI ***

3 Balances with *** *** *** *** *** ***

*** *** *** ***

Banks

(i) Current Account

(ii) Money at Call

and Short Notice,

Term Deposits

and other

placements

4 Investments (including *** *** *** *** *** *** *** *** *** *** ***

those under Repos

but excluding Reverse

Repos)

5 Advances Performing) *** *** *** *** *** *** *** *** *** *** ***

(i) Bills Purchased and

Discounted

(including bills

under DUPN)

(ii) Cash Credits,

Overdrafts and

Loans repayable on

demand

(iii) Term Loans

6 NPAs (Advances

and Investments)*

7 Fixed Assets

8 Other Assets *** *** *** *** *** *** *** *** *** *** ***

(i) Leased Assets

(ii) Others

9 Reverse Repos

10 Swaps (Sell / Buy) /

maturing forwards

11 Bills Rediscounted

(DUPN)

12 Interest receivable

13 Committed Lines

of Credit

14 Export Refinance

from RBI

15 Others (specify)

16 C.

Total Inflows

17 D. Mismatch (C-A)

18 E. Mismatch as %

to Outflows (D as

% to A)

19

F.

Cumulative

Mismatch

20 G. Cumulative

Mismatch as a

% to Cumulative

Outflows (F as a

% to B)

* Net of provisions, interest suspense and claims received from ECGC / DICGC

Note : This return is under Consolidated Prudential Reports (CPR) and will replace the CPR -1 on Structural Liquidity Position for the consolidated AIFI

APPENDIX (I)

Public Finance Institutions

1. Industrial Finance Corporation of India Ltd. (IFCI)

2. Tourism Finance Corporation of India Ltd. (TFCI)

3. Risk Capital and Technology Finance Corporation Ltd. (RCTC)

4. Technology Development and Information Company of India Ltd. (TDICI)

5. National Housing Bank (NHB)

6. Small Industries Development Bank of India (SIDBI)

7. National Bank for Agriculture and Rural Development (NABARD)

8. Export Import Bank of India (EXIM Bank)

9. Life Insurance Corporation of India (LIC)

10. General Insurance Corporation of India (GIC)

APPENDIX J

Format for reporting of exposures to QCCPs

Name of the AIFI:

Reporting Month:

Name of QCCP1…………

Date2 Trade

Exposure

Default Fund

Exposure

Other

Exposures4

Total Exposure as a

Percentage of Tier 1 capital

1The clearing exposure in respect of each QCCPs need to be reported in separate tables.

2The exposures need to be reported in respect of each working day of the month.

4All exposures other than trade exposure and default fund exposure should be reported in this column.