Article:
In an effort to mitigate financial crises similar to the IL&FS debacle, the Reserve Bank of India (RBI) has issued a draft circular titled “Liquidity Risk Management Framework for Non-Banking Financial Companies (NBFCs) and Core Investment Companies (CICs)”. The proposed protocols aim to regulate all deposit-taking and non-deposit taking NBFCs with an asset size of Rs 100 crore and above as well as all CICs registered with the RBI.
A Closer Look at the IL&FS Debt Crisis
The crisis surrounding Infrastructure Leasing & Financial Services (IL&FS) occurred when the group’s financial services company defaulted on payment obligations of bank loans, term and short-term deposits, and failed to meet the commercial paper redemption obligations. As a result, ratings agency ICRA downgraded the ratings of its short-term and long-term borrowing programs. This not only affected numerous investors, banks, and mutual funds linked with IL&FS but also resulted in a Liquidity Crisis among NBFCs.
Key Features of RBI Guidelines
The new guidelines include introducing Liquidity Coverage Ratio (LCR), a requirement under Basel III that compels banks to hold an amount of high-quality liquid assets (HQLA) that can fund cash outflows for 30 days. HQLA are readily exchangeable into cash with little to no loss in value or can be used as collateral for borrowing purposes. This rule will apply to all deposit taking non-banking financial entities and non-deposit taking shadow banks with assets worth Rs 5,000 crore and above.
NBFCs are also obliged to hold government securities as high-quality liquidity assets. The comprehensive risk mitigation policies require all NBFCs with assets of more than Rs 5,000 crore to have an Asset Liability Management Committee, Asset Risk Management Committee, and an Asset-Liability Management Support Group for executing Liquidity Risk Mitigation Policies.
Addressing the Asset-Liability Mismatch
In an attempt to regulate the asset-liability mismatch, it should not be more than 10% of the total outflows of NBFCs. This regulation, along with the requirement for NBFCs to formulate their own Contingency Funding Plans, are aimed at preventing crises from over-reliance on single sources of funding.
| Parameter | Value |
|---|---|
| Default Limit | Not more than 10% of the outflows |
| Asset Size Requirement | Above Rs 5,000 crore |
| LCR Requirement | Hold enough HQLA to cover outflows for 30 days |
Introducing the Granular Maturity Bucket System
A granular maturity bucket system is proposed to monitor mismatches across tenures. The 1-30 days bucket will be bifurcated into 1-7 days, 8-14 days, and 15-30 days buckets. NBFCs are also required to track their cumulative mismatches (running total) across all other time frames up to 1 year. These measures are to be enforced with the approval of their boards, ensuring company-wide adherence to these risk mitigation strategies.