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TMI BlogLarge Exposures FrameworkX X X X Extracts X X X X X X X X Extracts X X X X ..... 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 will become applicable with effect from April 1, 2020. Yours faithfully, (Saurav Sinha) Chief General Manager-in-Charge Annex Large Exposures Framework 1. Introduction 1.1 A bank's exposures to its counterparties may result in concentration of its assets to a single counterparty or a group of connected counterparties. As a first step to address the concentration risk, the Reserve Bank, in March 1989, fixed limits on bank exposures to an individual business concern and to business concerns of a group. RBI's prudential exposure norms have evolved since then and a bank's exposure to a single borrower and a borrower group was restricted to 15 percent and 40 percent of capital funds respectively. A comprehensive policy framework on the subject is consolidated in the Master Circular - Exposure Norms. 1.2 In January 1991, the Basel Committee on Banking Supervision (BCBS) issued superv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t; 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 controlled by or are economically dependent on an entity that falls within the scope of the sovereign exemption (para 3.1 (a) and 3.1 (b)), and are otherwise not connected, those entities will not be deemed to constitute a group of connected counterparties. 3.3 However, a bank's exposure to an exempted entity which is hedged by a credit derivative shall be treated as an exposure to the counterparty providing the credit protection notwithstanding the fact that the original exposure is exempted. 3.4 All exempted exposures must be reported by a bank as required under regulatory reporting specified in paragraph 4.2 below, if these exposures meet the criteria for definition of a 'Large Exposure' as per para 4.1 below. 4. Definition of a large exposure and regulatory reporting 4.1. Under the LEF, the sum of all exposure values of a bank ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... into account for the purpose of Large Exposures Framework. 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 4.2.3.1 (vii) of Master Circular on Basel III - Capital Regulation dated July 01, 2015 (as amended from time to time), will also be reckoned as Tier I capital for the purpose of Large Exposures Framework 5.4 The exposures must be measured as specified in paragraphs 7 -10 ibid. It may be noted that the LE limits will be modulated in case of certain counterparties as mentioned in paragraph 10. 5.5 Any breach of the above LE limits shall be under exceptional conditions beyond the control of the bank, shall be reported to RBI (DBS, CO) immediately and rapidly rectified. 6. Definition of connected counterparties 6.1 In some cases, a bank may have exposures to a group of counterparties with specific relationships or dependencies such that, were one of the counterparties to fail, all of the counterpar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... agement 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 another entity (e.g., through consent rights over key decisions, to decide on the strategy or direct the activities of an entity, to decide on crucial transactions such as transfer of profit or loss); d. The above criteria may also be assessed with respect to a common third party (such as holding company), irrespective of whether the bank has an exposure to that entity or not; 6.4 Banks are also expected to refer to criteria specified in the extant accounting standards for further qualitative guidance when determining control. 6.5 While determining control relationship, banks should also examine cases where clients have common owners, shareholders or managers; for example, horizontal groups where an undertaking is related to one or more other undertakings be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he 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. Illustrations are provided in appendix 2. 6.8 There may, however, be circumstances where some of these criteria do not automatically imply an economic dependence that results in two or more counterparties being connected. Provided that the bank can demonstrate that a counterparty which is economically closely related to another counterparty may overcome financial difficulties, or even the second counterparty's default, by finding alternative business partners or funding sources within an appropriate time period, the bank does not need to combine these counterparties to form a group of connected counterparties. 6.9 In order to avoid cases where a thorough investigation of economic interdependencies will not be proportiona ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inst 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 Framework purposes are those that meet the minimum requirements and eligibility criteria for the recognition of unfunded credit protection8 and financial collateral that qualify as eligible financial collateral under the Standardised Approach for credit risk for risk-based capital requirement purposes. 7.7 Other forms of collaterals that are only eligible under the Internal-Ratings based (IRB) Approach (receivables, commercial and residential real estate and other collateral) are not eligible to reduce exposure values for LEF purposes. 7.8 A bank must recognise an eligible CRM technique in the calculation of an exposure whenever it has used this technique to calculate the risk-based capital requirements, prov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 or the referenced entity is not a financial entity, the amount to be assigned to the credit protection provider is not the amount by which the exposure to the original counterparty is reduced but will be equal to the counterparty credit risk exposure value calculated according to the Standardised Approach - Counterparty Credit Risk (SA-CCR), once the guidelines in the matter are finalised by the RBI. Till such time, the banks may follow the extant method as prescribed by the RBI for the counterparty credit risk in the Master Circular - Basel III Capital Regulation. For the purpose of this paragraph, financial entities comprise: * Regulated financial institutions, defined as a parent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 underlying would lead to a profit (i.e., a negative exposure) instead of a loss, resulting in an exposure of the option's market value in the former case and equal the strike price of the option minus its market value in the latter case. The resulting positions in all cases should be aggregated with those from other exposures. After aggregation, negative net exposures shall be treated as zero. 7.20 Exposure values of banks' investments in transactions (i.e., index positions, securitisations, hedge funds or investment funds) must be calculated applying the same rules as for similar instruments in the banking book (see paragraphs under 8.3 to 8.10). ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .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 may assign the exposure amount to the structure itself, defined as a distinct counterparty, if it can demonstrate that the bank's exposure amount to each underlying asset of the structure is smaller than 0.25% of its eligible capital base, considering only those exposure to underlying assets that result from the investment in the structure itself and using the exposure value calculated according to paragraph 8.9 and 8.10. In this case, a bank is not required to look through the structure to identify the underlying assets. 8.5 A bank must look through the structure to identify those underlying assets for which the under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. Identification of additional risks 9.1 While taking exposures to structures, banks should identify such third parties which may constitute an additional risk factor and which are inherent in the structure itself rather than in the underlying assets. Such a third party could be a risk factor for more than one structure that a bank invests in. Examples of roles played by third parties include originator, fund manager, liquidity provider and credit protection provider. RBI as a part of its pillar 2 supervisory review and evaluation process will look into this aspect and if required specify a specific course o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alue 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 stake22, funding facilities, credit facilities, guarantees etc., must be measured according to the rules set out in this framework, as for any other type of counterparty. These exposures will be added together and be subjected to the LE limit. 10. II. Exposures to NBFCs 10.8 Exposure Ceilings proposed under LE Framework (i) Exposures to NBFCs: Banks' exposures to a single NBFC will be restricted to 15 percent of their eligible capital base. However, based on the risk perception, more stringent exposure limits in respect of certain categories of NBFCs may be considered. (ii) Banks ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch 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 exposure limit prescribed under this Framework. While non-centrally cleared derivatives exposures are exempt till March 31, 2020, banks must compute these exposures separately and report to the Department of Banking Regulation on quarterly basis. 1 This requires that banks shall apply LE framework at the consolidated group level, after consolidating the assets and liabilities of its subsidiaries / joint ventures / associates (including overseas operations through bank's branches) etc., except those engaged in insurance and any non-financial activities 2 Banks shall apply L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om 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 trusts, infrastructure investment trusts 20 For designation of CCPs as QCCPs please refer to circular DBOD.No.BP.BC.82/21.06.217/2013-14 dated January 7, 2014 on Banks' Exposure to Central Counterparties (CCPs) - Interim Arrangements, 21 When the initial margin (IM) posted is bankruptcy-remote from the CCP - in the sense that it is segregated from the CCP's own accounts, eg when the IM is held by a third-party custodian - this amount cannot be lost by the bank if the CCP defaults; therefore, the IM posted by the bank can be exempted from the large ..... 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