The Reserve Bank of India (RBI) on Tuesday announced a series of changes for non-banking lenders to identify large exposures on scale-based regulation (SBR). These norms are aimed at addressing credit risk concentration in NBFCs.

The changes have been made to the October 2021 circular titled Scale Based Regulation (SBR): A Revised Regulatory Framework for NBFCs, in terms of which a Large Exposure Framework (LEF) is prescribed for NBFCs in the Upper Layer.

As per RBIs statement, Tier I Capital for the purpose of the guidelines has the same meaning defined in the October 2021 circular.

Further, RBI directs that profits accrued during the year will be reckoned as Tier I capital for the purpose of LEF after making necessary adjustments as per the guidelines applicable to NBFC-UL.

Also, the NBFC-UL is directed to obtain an external auditors certificate on completion of the augmentation of capital and submit the same to RBI (Department of Supervision) before reckoning the additions to capital funds.

In the new guidelines, RBI announced the term control which means the right to appoint a majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.

Further, RBI announced that a Group of connected counterparties means two or more (natural or legal) persons who satisfy at least one of the conditions - control relationship and economic interdependence.

Firstly, control relationship criteria are automatically satisfied if one entity owns more than 50% of the voting rights of the other entity.

Whereas to establish connectedness based on economic interdependence, NBFC-UL must consider, at a minimum, the following criteria as per RBI.

1. Where 50% or more of one counterpartys gross receipts or gross expenditure (on an annual basis) is derived from transactions with the other counterparty;

2. Where one counterparty 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;

3. Where a significant part of one counterpartys production/output is sold to another counterparty, which cannot easily be replaced by other customers;

4. 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;

5. 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;

6. Where the insolvency or default of one counterparty is likely to be associated with the insolvency or default of the other(s);

7. When two or more counterparties rely on the same source for the majority of their funding and, in the event of the common providers 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.

8. In order to avoid cases where a thorough investigation of economic interdependencies will not be proportionate to the size of the exposures, NBFC-UL are expected to identify possible connected counterparties on the basis of economic interdependence in all cases where the sum of all exposures to one individual counterparty exceeds 5% of the eligible capital base, and not in other cases.

Notably, RBI states large exposure term means the sum of all exposure values of an NBFC-UL measured in terms of paragraph 6 of these instructions, to a counterparty and/or a group of connected counterparties, if it is equal to or above 10 percent of the NBFC-ULs eligible capital base.

The mentioned guidelines are applicable to NBFC-UL, both at the solo level and at the consolidated (group) level. Also, exposure will comprise both on and off-balance sheet exposures by the NBFC-UL.

Meanwhile, the sum of all the exposure values of an NBFC-UL to a single counterparty must not be higher than 20% of the NBFC-ULs available eligible capital base at all times. RBI allows the board of the NBFC-UL may allow additional 5% exposure beyond 20 % but at no time higher than 25% of the NBFC-ULs eligible capital base, subject to conditions.

However, RBI allows Infrastructure Finance Company (IFC) to further exceed the exposure limit by 5% of Tier I capital for exposure to a single counterparty.

In terms of groups of connected counterparties, RBI states that the all exposure values of an NBFC-UL to a group of connected counterparties shall not be higher than 25% of the NBFC-ULs available eligible capital base at all times. However, IFC is allowed to exceed the exposure limit by 10 percent of its Tier I capital for exposure to a group of connected counterparties.

The above-mentioned guidelines will come into effect from October 1, 2022.