What changed
Previously, only 6 off-balance sheet items with linkages to NBFI activities were recognized for capital adequacy. Now, RBI introduces a broader framework requiring NBFCs to calculate risk-weighted off-balance sheet credit exposure using credit conversion factors or current exposure method, then apply risk weights. This applies to all off-balance sheet items, including derivatives like CDS.
What it means for you
NBFCs must strengthen capital buffers against off-balance sheet risks like derivatives and hedging instruments. The granular approach increases capital requirements for complex exposures, impacting liquidity management and balance sheet strategies. Lenders need to upgrade risk measurement systems to comply with the two-step calculation.
What you must do
- Implement the two-step process: convert notional amounts to credit equivalents using specified conversion factors, then apply risk weights.
- Apply new risk weights to existing contracts from the financial year beginning April 01, 2012, and to all new contracts including CDS from December 26, 2011.
- Review and update risk management frameworks to cover expanded off-balance sheet items beyond the earlier 6 categories.
- Ensure meticulous compliance with the amending notifications DNBS.PD.No.237/CGM (US) 2011 and DNBS.PD.No. 238/CGM (US) 2011.
Who it affects
All NBFCs excluding RNBCs, Deposit-taking NBFCs, Non-deposit taking NBFCs, NBFCs using derivatives for hedging or balance sheet management
What is the effective date for existing off-balance sheet contracts?
For contracts already entered into, the new risk weights apply from the financial year beginning April 01, 2012.
Does this circular apply to credit default swaps (CDS)?
Yes, for all new contracts including CDS, the new risk weights are applicable from the date of the circular, December 26, 2011.
How is the risk-weighted amount calculated for off-balance sheet items?
It is a two-step process: first, convert the notional amount into a credit equivalent using a credit conversion factor or current exposure method; second, multiply that credit equivalent by the applicable risk weight.