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Capital and Provisioning Requirements for Exposures to entities with Unhedged Foreign Currency Exposure-Clarifications


 Notice Date : 03 June 2014

RBI/2013-14/620
DBOD.No.BP.BC.116/21.06.200/2013-14

June 3, 2014

The Chairman and Managing Director/
Chief Executive Officer
All Scheduled Commercial Banks
(Excluding RRBs and LABs)

Dear Sir,

Capital and Provisioning Requirements for Exposures to entities with Unhedged Foreign Currency Exposure-Clarifications

Please refer to our circular DBOD.No. BP.BC. 85/21.06.200/2013-14 dated January 15, 2014 detailing guidelines on capital and provisioning requirements for exposures to entities with Unhedged Foreign Currency Exposure (UFCE). In this connection, we have received a number of queries from banks on certain provisions of the guidelines, clarifications for which are given as under.

2. The implementation of guidelines is dependent on getting quality data from entities on a periodic basis. The banks have mentioned that the accuracy of the information on UFCE received from entities could be ensured if entities submit information to banks which is audited by statutory auditors. It is, therefore, advised that information on UFCE may be obtained from entities on a quarterly basis on self-certification basis, and preferably should be internally audited by the entity concerned. However, at least on an annual basis, UFCE information should be audited and certified by the statutory auditors of the entity for its authenticity. In case of exposures of overseas branches/subsidiaries, to begin with, the requirement of statutory audit may not be insisted upon.

3. The guidelines assess the riskiness of the unhedged foreign currency exposure of the corporate from the perspective of the volatility of USD-INR exchange rates. On requests from banks, it is clarified that Foreign Currency Exposure (FCE) in currencies other than USD may be converted into USD using the current market rates.

4. The guidelines have given a detailed step-by-step procedure for calculating USD-INR annualised volatility. Banks feel that annualised volatility computed by them may vary from bank to bank. Banks have requested that in order to ensure that a consistent annualised volatility is used across banking industry, RBI may mandate Foreign Exchange Dealers’ Association of India (FEDAI) to publish the USD-INR annual volatility which has to be used for computation of likely loss. Accordingly, it is advised that RBI will request FEDAI to compute the volatility of USD-INR rate based on the RBI reference rate by following the provisions of the guidelines and the same may be used for computing the extent of likely loss on account of UFCE. However, till the time FEDAI starts placing this information on its website on a daily basis, banks may continue to compute the volatility figure by following the provisions of the guidelines.

5. UFCE guidelines require that the likely loss on account of exchange rate movements should be compared with the annual EBID as per the latest quarterly results certified by the statutory auditors. Banks have mentioned that in case of private/unlisted companies, the audited EBID may not be available on a quarterly basis. In this context, it is advised that in case of unavailability of the audited results of the last quarter, latest audited quarterly or yearly results available have to be used. The yearly EBID figure used should at least be of the last financial year. It is also clarified that the guidelines do not differentiate between limited audited results and full audited results.

6. The guidelines introduce incremental capital and provisioning requirements over and above present requirements. Banks have requested clarification on the amount of exposure on which incremental capital and provisioning amount has to be computed, as the exposure used for computing capital and provisions are computed differently. In this context, it is advised that incremental provisioning for UFCE should be based on the exposure amount which is used for computing standard asset provisioning and incremental capital requirements for UFCE should be based on the exposure amount which is used for computing credit risk capital requirements.

7. The guidelines are applicable to all entities on which the bank has taken credit exposure. Banks have requested clarification if the guidelines are applicable to inter-bank exposures also. In this context, it is clarified that inter-bank exposures may be excluded from the ambit of the UFCE guidelines.

8. The guidelines are applicable to all entities irrespective of the size of the entity. Banks have mentioned that computation of incremental capital and provisioning requirements on a quarterly basis for smaller entities will be operationally cumbersome. In this context, for exposures to smaller entities which are having unhedged foreign currency exposure, banks may have the option of following a standardised method which would require an incremental provisioning of 10 bps over and above extant standard asset provisioning. Banks following standardised method for smaller entities will not be required to get UFCE data from these entities and therefore will not be required to compute incremental capital and provisioning based on likely loss as a percentage of EBID in respect of these smaller entities. It is further clarified that smaller entities are those entities on which total exposure of the banking system is at ` 25 crore or less.

9. Standard asset provisions are presently eligible for inclusion in the Tier 2 capital within certain limits. Banks have requested to clarify if the incremental provisioning kept by following the guidelines will also be eligible for including in the Tier 2 capital in line with the present requirements. In this context, it is clarified that the incremental provision required is in addition to the present standard asset provisioning requirement. It may, therefore be treated as general provision for disclosures and inclusion in Tier 2 capital, similar to the existing treatment applicable to general provisions. Presently, for banks following standardised approach for credit risk, general provisions are admitted as Tier 2 capital up to a maximum of 1.25% of credit risk weighted assets. Under Internal Ratings Based Approach, where the total expected loss amount is less than total eligible provisions, banks may recognise the difference as Tier 2 capital up to maximum of 0.6% of credit-risk weighted assets calculated under IRB approach.

10. The computation of incremental capital and provisioning is dependent on the extensive data collected from entities. Banks have mentioned that it may not be possible to get the required data in a timely manner in respect of all entities on which a bank has the credit exposure. Banks have requested clarification on the course of action to be followed in respect of exposure to entities which are not able to provide required data. In this context, it is advised that in cases, where the bank is not able to get sufficient data to compute UFCE, the bank may take a conservative view and place the exposure at the last bucket which requires incremental provisioning of 80bps and a 25 per cent increase in risk weight. It would be appropriate for a bank to price the cost of compliance with the UFCE guidelines on its lending rate for the borrower as it would improve quality and timeliness of information/data.

11. UFCE guidelines have become effective from April 1, 2014. Some banks have mentioned that as the required provision will be computed for the first time for the April-June quarter, the entire provisioning burden will fall on the earnings of one quarter. In this context, it is advised that the additional provisioning requirement applicable for April-June 2014 quarter based on the UFCE guidelines may be distributed equally during the financial year 2014-15. However, such relaxation would not be there for capital requirements.

Yours faithfully,

(Rajesh Verma)
Chief General Manager-in-Charge

                                                

RBI/2013-14/448
DBOD.No.BP.BC. 85 /21.06.200/2013-14

January 15, 2014

The Chairman and Managing Director/
Chief Executive Officer
All Scheduled Commercial Banks
(Excluding RRBs and LABs)

Dear Sir,

Capital and Provisioning Requirements for Exposures to entities with Unhedged Foreign Currency Exposure

Please refer to the draft guidelines on the captioned subject issued on July 2, 2013 and paragraph 22 of second quarter review of the monetary policy announced on October 29, 2013 (extract enclosed). Unhedged foreign currency exposures of the entities1are an area of concern not only for individual entity but also to the entire financial system; entities who do not hedge their foreign currency exposures can incur significant losses due to exchange rate movements. These losses may reduce their capacity to service the loans taken from the banking system and thereby affect the health of the banking system.

2. We have issued various guidelines advising banks to closely monitor the unhedged foreign currency exposures of their borrowing clients and also factor this risk into the pricing. However, the extent of unhedged foreign currency exposures of the entities continues to be significant and this can increase the probability of default in times of high currency volatility. It has, therefore, been decided to introduce incremental provisioning and capital requirements for bank exposures to entities with unhedged foreign currency exposures. For calculating the incremental provisioning and capital requirements, the following methodology may be followed:

a. Ascertain the amount of Unhedged Foreign Currency Exposure (UFCE):

Foreign Currency Exposure (FCE) refers to the gross sum of all items on the balance sheet that have impact on profit and loss account due to movement in foreign exchange rates. This may be computed by following the provisions of relevant accounting standard. Items maturing or having cash flows over the period of next five years only may be considered.

UFCE may exclude items which are effective hedge of each other. For this purpose, two types of hedges which may be considered are - financial hedge and natural hedge. Financial hedge is ensured normally through a derivative contract with a financial institution. Hedging through derivatives may only be considered where the entity at inception of the derivative contract has documented the purpose and the strategy for hedging and assessed its effectiveness as a hedging instrument at periodic intervals. For the purpose of assessing the effectiveness of hedge, guidance may be taken from the pronouncements of the Institute of Chartered Accountants of India on the matter.

Natural hedge may be considered when cash flows arising out of the operations of the company offset the risk arising out of the FCE defined above. For the purpose of computing UFCE, an exposure may be considered naturally hedged if the offsetting exposure has the maturity/cash flow within the same accounting year. For instance, export revenues (booked as receivable) may offset the exchange risk arising out of repayment obligations of an external commercial borrowing if both the exposures have cash flows/maturity within the same accounting year.

b. Estimate the extent of likely loss:

The loss to the entity in case of movement in USD-INR exchange rate may be calculated using the annualised volatilities. For this purpose, largest annual volatility seen in the USD-INR rates during the period of last ten years may be taken as the movement of the USD-INR rate in the adverse direction2.

c. Estimate the riskiness of unhedged position and provide appropriately:

Once the loss figure is calculated, it may be compared with the annual EBID3 as per the latest quarterly results certified by the statutory auditors. This loss may be computed as a percentage of EBID. Higher this percentage, higher will be the susceptibility of the entity to adverse exchange rate movements. Therefore, as a prudential measure, all exposures to such entities (whether in foreign currency or in INR) would attract incremental capital and provisioning requirements (i.e., over and above the present requirements) as under:

Likely Loss/EBID (%)

Incremental Provisioning Requirement on the total credit exposures over and above extant standard asset provisioning

Incremental Capital Requirement

Upto15 per cent

0

0

More than 15 per cent and upto 30 per cent

20bps

0

More than 30 per cent and upto 50 per cent

40bps

0

More than 50 percent and upto 75 per cent

60bps

0

More than 75 per cent4

80 bps

25 per cent increase in the risk weight

3. In terms of circular DBOD.BP.BC.No.61/21.04.103/2012-13 dated November 21, 2012, banks have to monitor the UFCE on a monthly interval. Banks should calculate the incremental provisioning and capital requirements at least on a quarterly basis. However, during periods of high USD-INR volatility, the calculations may be done at monthly intervals.

4. The implementation of these guidelines may pose some issues for exposures to project under implementation and to new entities which may not have annual EBID figure available.The calculation of incremental provisioning and capital requirements for projects under implementation will be based on projected average EBID for the three years from the date of commencement of commercial operations and incremental capital and provisioning should be accordingly computed subject to a minimum floor of 20 bps of provisioning requirement. For new entities also, the same framework may be made applicable.

5. While computing the UFCE of the foreign MNCs (i.e. MNCs incorporated outside India), intra-group foreign currency exposures (e.g. a subsidiary of a foreign MNC in India may have borrowed from its parent) may be excluded if the bank is satisfied that such foreign currency exposures are appropriately hedged or managed robustly by the parent.

6. These guidelines have been framed keeping in view the domestic borrowers’ vulnerability to the foreign currency exposure. However, currency induced credit risk may also be considered for exposures of overseas branches and foreign subsidiaries. For operationalizing these guidelines in case of exposures of overseas branches and foreign subsidiaries of the bank, INR should be replaced by the domestic currency of that jurisdiction.

7. Banks may ensure that their policies and procedures for management of credit risk factor their exposure to currency-induced credit risks and are calibrated towards borrowers whose capacity to repay is sensitive to changes in the exchange rate and other market variables. These could include stipulation of internal limits for these exposures, which may be fixed while considering the overall risk appetite. Where such exposures are high, the options available to the banks to reduce the associated risks may include reducing these exposures, encouraging borrowers to reduce their currency mismatches by hedging foreign currency exposures, maintaining higher provisioning and capital, etc. Banks should also ensure that the risk of unhedged foreign currency exposure are effectively incorporated in their internal credit rating system and ensure that their loan pricing policies adequately reflect overall credit risks. Implementation of these requirements will be dependent on a robust MIS for getting sufficient and credible data on a regular basis from the borrowers.

8. Banks may disclose their policies to manage currency induced credit risk as a part of financial statements certified by statutory auditors. In addition, banks should also disclose the incremental provisioning and capital held by them towards this risk.

9. The quantification of currency induced credit risk will form a part of banks’ Internal Capital Adequacy Assessment Programme (ICAAP) and banks are expected to address this risk in a comprehensive manner. The ICAAP should measure the extent of currency induced credit risk the bank is exposed to and also concentration of such exposures. Banks may also like to perform stress tests under various extreme but plausible exchange rate scenarios under ICAAP. Outcome of ICAAP may lead a bank to take appropriate risk management actions like risk reduction, maintenance of more capital or provision, etc. As a part of Supervisory Review and Evaluation Process (SREP) under Pillar 2, RBI may review the risk management measures taken by the bank and its adequacy to manage currency induced credit risk, especially if exposure to such risks is assessed to be on higher side.

10. This framework may be implemented from April 1, 2014.

Yours faithfully,

(Chandan Sinha) 
Principal Chief General Manager


Annex

Extract from Second Quarter Review of Monetary Policy Statement for 2013-14
Unhedged Foreign Currency Exposure

22. Unhedged foreign currency exposures of corporates are a cause for concern as they pose a risk to individual corporates as also to the entire financial system. Based on feedback received from industry participants, it is proposed to:

  • issue final guidelines on unhedged foreign currency exposures by end-December 2013.

1 For the purpose of this circular, ’entities’ means those entities which have borrowed from banks including borrowing in INR and other currencies.

2 Banks may compute largest annual volatility over a period of last ten years in the following manner: First, daily changes in the USD-INR rates may be computed as a log return of the today’s rate over the yesterday’s rate. Second, daily volatility may be computed as standard deviation of these returns over a period of one year (250 observations). Third this daily volatility may be annualised by multiplying it by square root of 250. This computation has to be performed on a daily basis for the all the days in the last ten years. The largest annual volatility thus computed should be used for the computation of the likely loss by multiplying it with the UFCE.

3 EBID, as defined for computation of DSCR = Profit After Tax + Depreciation + Interest on debt + Lease Rentals, if any.

4 This category is most likely to default on account of high unhedged exposures due to volatility in the USD-INR rate. If the account becomes NPA, bank has to make provisions accordingly.

 

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on 04 June 2014
Notification No : RBI/2013-14/620
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