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Large Exposures Framework

al Banks) Dear Sir/Madam, Please refer to the instructions contained in circulars DBR.No.BP.BC.43/21.01.003/2016-17 dated December 01, 2016 and DBR.No.BP.BC.31/21.01.003/2018-19 dated April 01, 2019 on (LEF) . 2. In order to capture exposures and concentration risk more accurately and to align the above instructions with international norms, the following amendments have been incorporated in the above mentioned instructions: i) Exclusion of entities connected with the sovereign from definition of group of connected counterparties. ii) Introduction of economic interdependence criteria in definition of connected counterparties. iii) Mandatory application of look-through approach (LTA) in determination of relevant counterparties in case of collective investment undertakings, securitisation vehicles and other structures. 3. Revised guidelines superseding the above mentioned circulars are annexed. These have come into effect from April 1, 2019 (as was already specified in our LEF circular dated December 1, 2016), except guidelines in respect of para 2(ii) above (contained in paragraphs 6.2(b), 6.7, 6.8, 6.9, and 6.10 of the Annex) and non-centrally cleared derivatives exposures, which w .....

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ps of connected counterparties, excluding the exposures listed below3, will be considered for exposure limits. The exposures that are exempted from the LEF are listed below: a. Exposures to the Government of India and State Governments which are eligible for zero percent Risk Weight under the Basel III - Capital Regulation framework of the Reserve Bank of India; b. Exposures to Reserve Bank of India; c. Exposures where the principal and interest are fully guaranteed by the Government of India; d. Exposures secured by financial instruments issued by the Government of India, to the extent that the eligibility criteria for recognition of the credit risk mitigation (CRM) are met in terms of paragraph 7.III of this circular; e. Intra-day interbank exposures; f. Intra-group exposures4; g. Borrowers, to whom limits are authorised for food credit; h. Banks clearing activities related exposures to Qualifying Central Counterparties (QCCPs), as detailed in paragraph 10.I of this circular; i. Deposits maintained with NABARD on account of shortfall in achievement of targets for priority sector lending. 3.2 Where two (or more) entities that are outside the scope of the sovereign exemption are co .....

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times. In exceptional cases, Board of banks may allow an additional 5 percent exposure of the bank s available eligible capital base. Banks shall lay down a Board approved policy in this regard. 5.2 Groups of Connected Counterparties: The sum of all the exposure values of a bank to a group of connected counterparties (as defined in paragraph 6 of this circular) must not be higher than 25 percent of the bank s available eligible capital base at all times. 5.3 The eligible capital base for this purpose is the effective amount of Tier 1 capital fulfilling the criteria defined in the Master Circular on Basel III - Capital Regulation dated July 1, 2015 (as amended from time to time) as per the last audited balance sheet. However, the infusion of capital under Tier I after the published balance sheet date may also be taken into account for the purpose of . Banks shall obtain an external auditor s certificate on completion of the augmentation of capital and submit the same to the Reserve Bank of India (Department of Banking Supervision) before reckoning the additions to capital funds. Further, for Indian Banks, profits accrued during the year, subject to provisions contained in para 4.2.3 .....

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Banks must assess the relationship amongst counterparties with reference to (a) and (b)5 above in order to establish the existence of a group of connected counterparties. In assessing whether there is a control relationship between counterparties, banks must automatically consider that the control relationship criterion (paragraph 6.2(a) above) is satisfied if one entity owns more than 50 percent of the voting rights of the other entity. In addition, banks must assess connectedness between counterparties based on control using the following evidences: a. Voting agreements (e.g., control of a majority of voting rights pursuant to an agreement with other shareholders); b. Significant influence on the appointment or dismissal of an entity s administrative, management or supervisory body, such as the right to appoint or remove a majority of members in those bodies, or the fact that a majority of members have been appointed solely as a result of the exercise of an individual entity s voting rights; c. Significant influence on senior management, e.g., an entity has the power, pursuant to a contract or otherwise, to exercise a controlling influence over the management or policies of anot .....

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rty has fully or partly guaranteed the exposure of the other counterparty, or is liable by other means, and the exposure is so significant that the guarantor is likely to default if a claim occurs; Where a significant part of one counterparty s production/output is sold to another counterparty, which cannot easily be replaced by other customers; When the expected source of funds to repay the loans of both counterparties is the same and neither counterparty has another independent source of income from which the loan may be serviced and fully repaid; Where it is likely that the financial problems of one counterparty would cause difficulties for the other counterparties in terms of full and timely repayment of liabilities; Where the insolvency or default of one counterparty is likely to be associated with the insolvency or default of the other(s); When two or more counterparties rely on the same source for the majority of their funding and, in the event of the common provider s default, an alternative provider cannot be found - in this case, the funding problems of one counterparty are likely to spread to another due to a one-way or two-way dependence on the same main funding source. .....

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e assets: The exposure value is defined as the accounting value of the exposure6. As an alternative, a bank may consider the exposure value gross of specific provisions and value adjustments. 7.3 Banking book and trading book OTC derivatives (and any other instrument with counterparty credit risk): The exposure value for instruments which give rise to counterparty credit risk and are not securities financing transactions, should be determined as per the extant instructions as prescribed by the Reserve Bank (on exposure at default) for the counterparty credit risk7. 7.4 Securities financing transactions (SFTs): Banks should use the method they currently use for calculating their risk-based capital requirements against SFTs. 7.5 Banking book traditional off-balance sheet commitments: For the purpose of the LEF, off-balance sheet items will be converted into credit exposure equivalents through the use of credit conversion factors (CCFs) by applying the CCFs set out for the Standardised Approach for credit risk for risk-based capital requirements, with a floor of 10 percent. 7.III Eligible credit risk mitigation (CRM) techniques 7.6 Eligible credit risk mitigation techniques for LE Fra .....

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counterparty credit risk exposure value for any instruments with counterparty credit risk, such as OTC derivatives; the value of the collateral adjusted after applying the required haircuts, in the case of financial collateral. The haircuts used to reduce the collateral amount are the supervisory haircuts under the comprehensive approach11 as specified under risk based capital requirements. 7.V Recognition of exposures to CRM providers 7.13 Where a bank reduces its exposure to the original counterparty on account of an eligible CRM instrument provided by another counterparty (CRM provider) with respect to that exposure, it must also recognise an exposure to the CRM provider. The amount assigned to the CRM provider will be the amount by which the exposure to the original counterparty is reduced (except in the cases defined in paragraph 7.14 below). It is clarified that any CRM instrument (e.g. SBLC/BG from Head Office/other overseas branch) from which CRM benefits like shifting of exposure/ risk weights etc are not derived, may not be counted as an exposure on the CRM provider. 7.14 When the credit protection takes the form of a credit default swap (CDS) and either the CDS provider .....

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rparty within the scope of the should be considered15 for calculating a bank s total exposure to that counterparty. 7.18 In the case of credit derivatives that represent sold protection, the exposure will be to the referenced name, and it will be the amount due in case the respective referenced name triggers the instrument, minus the absolute value of the credit protection16. For credit-linked notes (CLNs)17, the protection seller bank will be required to consider its positions both in the bond of the note issuer and in the underlying referenced by the note. 7.19 The measures of exposure values of options (primarily meant for credit and equity options, where permitted) under this framework differ from the exposure values used for risk-based capital requirements. The exposure value of option under this framework will be based on the change(s) in option prices that would result from a default of the respective underlying instrument. The exposure value for a simple long call option would therefore be its market value and for a short put option would be equal to the strike price of the option minus its market value. In the case of short call or long put options, a default of the underl .....

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xposure for the purpose of LEF. 8. Treatment of specific exposure types 8.1 This section covers exposures for which a specific treatment is deemed necessary. Interbank Exposures 8.2 The interbank exposures, except intra-day interbank exposures, will be subject to the large exposure limit of 25% of a bank s Tier 1 capital (also refer to paragraph 10.III). In stressed circumstances, RBI may accept a breach of an interbank limit ex post, in order to help ensure stability in the interbank market. Collective Investment Undertakings (CIUs), securitisation vehicles and other structures - adoption of Look Through Approach (LTA) 8.3 There are cases when a structure lies between the bank and its exposures, that is, the bank invests in structures which themselves have exposures to assets underlying the structures (hereafter referred to as the underlying assets ). Such structures include funds18, securitisations and other structures19 with underlying assets. Banks must assign such exposure amount, i.e., the amount invested in a particular structure, to specific counterparties of the underlying assets following the LTA described below. Illustrative example is provided in Appendix 4. 8.4 A bank .....

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share that the bank holds in the structure multiplied by the value of the underlying asset in the structure. Thus, a bank holding a ₹1 investment in a structure, which invests in 20 assets each with a value of ₹ 5, must assign an exposure of ₹ 0.05 to each of the counterparties. An exposure to such counterparty must be added to any other direct or indirect exposures the bank has to that counterparty. 8.10 Any structure with different seniority levels among investors (e.g. securitisation vehicles) - When the LTA (in terms of paragraphs above) is required for an investment in a structure with different levels of seniority, the exposure value to a counterparty should be measured for each tranche within the structure, assuming a pro rata distribution of losses amongst investors in a single tranche. To compute the exposure value to the underlying asset, a bank must: i. first, consider the lower of the value of the tranche in which the bank invests and the nominal value of each underlying asset included in the underlying portfolio of assets ii. second, apply the pro rata share of the bank s investment in the tranche to the value determined in the first step above. 9. Id .....

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y related to clearing activities. 10.5 Calculation of exposures related to clearing activities: Banks must identify exposures to a CCP related to clearing activities and sum together these exposures. Exposures related to clearing activities are listed in the table below together with the exposure value to be used: Trade exposures The exposure value of trade exposures must be calculated using the exposure measures prescribed in other parts of this framework for the respective type of exposures. Segregated initial margin The exposure value is 021. Non-segregated initial margin The exposure value is the nominal amount of initial margin posted. Pre-funded default fund contributions Nominal amount of the funded contribution Unfunded default fund contributions The exposure value is 0 10.6 Regarding exposures subject to clearing services (the bank acting as a clearing member or being a client of a clearing member), the bank must determine the counterparty to which exposures must be assigned by applying the provisions of the risk-based capital requirements. 10.7 Other exposures: Other types of exposures that are not directly related to clearing services provided by the CCP, such as equity .....

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e capital base. 10.13 The Reserve Bank has issued the Framework for dealing with Domestic Systemically Important Banks (D-SIBs) on July 22, 2014 and discloses names of the banks classified as D-SIBs on an annual basis. There is no separate exposure limit applicable to D-SIBs and they will continue to be governed by interbank exposure limits under the LEF. 11. Implementation date and transitional arrangements All aspects of the LE Framework except guidelines with reference to economic interdependence criteria and non-centrally cleared derivatives exposures, (both of which are applicable from April 1, 2020), are applicable in full with effect from April 1, 2019 (as was already specified in our LEF circular dated December 1, 2016) and the exposure norms applicable to single/group of connected counterparties are no longer applicable from that date25. Banks must adjust their exposures so as to comply with the LE limit with respect to their eligible capital base by the date of implementation. Accordingly, for aspects applicable from April 01, 2020, prior to this date, banks should avoid taking any additional exposure/reduce exposure in cases where their exposure is at or above the exposu .....

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ter Circular - Basel III Capital Regulations 15 At present, banks are not permitted to have exposures to equity derivatives, however, for the sake illustration, a future on stock X, for example, is decomposed into a long position in stock X and a short position in a risk-free interest rate exposure in the respective funding currency, or a typical interest rate swap is represented by a long position in a fixed and a short position in a floating interest rate exposure or vice versa. 16 In the case that the market value of the credit derivative is positive from the perspective of the protection seller, such a positive market value would also have to be added to the exposure of the protection seller to the protection buyer (counterparty credit risk; see paragraph 7.3 of this circular). Such a situation could typically occur if the present value of already agreed but not yet paid periodic premiums exceeds the absolute market value of the credit protection. 17 CLNs are not permitted to be issued by banks in India under the extant RBI guidelines. 18 such as mutual funds, venture capital funds, alternative investment funds 19 such as investment in security receipts, real estate investment .....

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