RBI, by its circular dated June 3, 2019 has amended and restated the Large Exposures Framework (‘LEF’) issued in 2016, applicable to scheduled commercial banks. Some of the key features of the new LEF are:
i. Infusion of Tier 1 capital after the last audited balance sheet may be taken into account for calculating ‘eligible capital base’ (i.e., effective amount of Tier 1 capital fulfilling the requisite criteria under the RBI Master Circular on Basel III – Capital Regulation, dated July 1, 2015, as amended (‘Basel III norms’)). Profits accrued during the year will also be reckoned as Tier 1 capital, subject to the Basel III norms.
ii. Banks have to apply the LEF at a standalone level (including overseas operations through branches) to determine exposures to a counterparty based on its standalone capital strength and risk profile, and at a consolidated (group) level (i.e. include 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).
iii. Non-centrally cleared derivatives exposures are excluded from the purview of exposure limits till April 1, 2020. However, banks must compute these exposures and report to the RBI on quarterly basis.
iv. The LE limit for non-G-SIB to a global systemically important bank (‘G-SIB’) in India or overseas is 20% of the eligible capital base. In calculation of LE limits for G-SIBs and non-GSIBs under the LEF, Indian branches of foreign G-SIBs are not considered as G-SIBs.
v. Exposure limit of Indian branches of foreign G-SIBs on a G-SIB (including its head office) is 20% of the eligible capital base and on any other bank is 25% of the eligible capital base. Exposure limit of Indian branches of foreign non-G-SIBs on a non-G-SIB (including its head office) is 25% of the eligible capital base and on any G-SIB is 20% of the eligible capital base.
vi. If 2 or more entities cannot avail of any specific exemption under the LEF in respect of its exposures and if such entities are controlled by or are economically dependent on any entity that can avail of the exemptions in relation to exposures to the Government of India, State Governments or the RBI and if such first mentioned entities are not otherwise connected as set out in the LEF, they are not deemed to be a ‘group of connected counterparties’.
vii. In addition to the criterion of control by one party over the other in order to determine if two parties were ‘connected counterparties’ under the LEF, the RBI has now introduced ‘economic interdependence’ as an alternative criteria. The criteria of ‘control’ and ‘economic interdependence’ are to both be assessed by banks from all directions to ascertain possible default of all entities concerned. Some of the factors to be considered to establish connectedness based on economic interdependence have been detailed in the circular.
viii. The LEF states that ‘control’ is also to be ascertained based on whether two counterparties are directly or indirectly, controlled by a third party towards which the bank may or may not have exposure, and while determining such control, banks are also required to look at clients who have common owners, shareholders or managers. Under the LEF, banks are required to frame board approved policies for determining connectedness using the criteria provided in the LEF, which policies will be subject to supervisory scrutiny.
ix. The LEF has also laid down the application of the look-through approach in cases where the bank is investing in structures (such as funds, securitizations, security receipts, real estate investment trusts, etc.) that themselves have exposures to assets underlying the structures.
x. If a bank’s exposure amount in an underlying asset is equal to or greater than 0.25% of its eligible capital base, the counterparty corresponding to such underlying asset must be identified and such exposure will be added to any other direct or indirect exposure to the same counterparty. A ‘large exposure (LE)’ is where the sum of all exposure values of a bank to a counterparty or a group of connected counterparties is equal to or above 10% of the bank’s eligible capital base (i.e., Tier 1 capital fulfilling the criteria defined in the Basel III norms as per the bank’s last audited balance sheet).