Permitted exposures & other prudential exposure limits – Basel III
Financial institutions should set their own internal limits for how much they commit to specific sectors, like textiles, chemicals, engineering, and so on. This helps ensure that their exposures are spread out across different areas. These limits need to be based on the risks and performance associated with each sector. It’s important to review and adjust these limits regularly to keep up with changes in the market and industry risks.
Financial institutions can provide bridge loans or interim finance to companies, excluding NBFCs, for specific purposes like against expected equity flows or issues, as long as they follow a policy approved by their Board. However, they shouldn’t advance loans against rights issues. Also, they can finance projects pending completion of formalities only against their own commitment, not relying on commitments from other financial institutions or banks. This rule doesn’t apply if the other institution is facing temporary liquidity issues as prescribed by the Reserve Bank. These restrictions also apply to financial institutions’ subsidiaries.
Financial institutions can issue guarantees for infrastructure projects in favor of other lending institutions. But, they must have a funded share in the project of at least five percent of the project cost. They should also conduct a normal credit appraisal, monitoring, and follow-up of the project.
Financial institutions can lend to InvITs, but they need a Board-approved policy covering various aspects like appraisal mechanism, sanctioning conditions, and monitoring. They must assess critical parameters, including cash flow sufficiency at the InvIT level for debt servicing. The overall leverage of the InvITs and the underlying Special Purpose Vehicles (SPVs) should be within the permissible leverage as per the financial institution’s policy. Since InvITs are trusts, legal provisions regarding enforcement of security should be considered. Lending is allowed only to InvITs where none of the underlying SPVs is facing financial difficulty. The performance of these SPVs should be monitored regularly. The Audit Committee of the Board should review compliance with these conditions every six months.
A financial institution’s investment in capital instruments issued by other banks or financial institutions should not exceed 10 percent of its eligible capital base. These instruments include equity shares, preference shares, subordinated debt instruments, hybrid debt capital instruments, and any other approved capital-like instruments. When acquiring a new stake in a bank or another financial institution, the holding should not exceed five percent of the investee’s equity capital.
The aggregate capital market exposure of a financial institution includes both direct and indirect exposures. This encompasses direct investments in equity shares, convertible bonds, debentures, and equity-oriented mutual funds, as well as advances against shares or for investment in these instruments. It also includes secured and unsecured advances to stockbrokers, loans sanctioned against shares for meeting promoter’s contributions, bridge loans against expected equity flows, and all exposures to Alternative Investment Funds.The total exposure to capital markets should not exceed 40 percent of the institution’s net worth, with direct exposure capped at 20 percent. Equity investments in non-financial/commercial enterprises are limited to 49 percent of the investee company’s equity in certain cases, and 10 percent in others. Investments in equity of non-financial/commercial enterprises should not exceed 10 percent of the institution’s net worth. Exemptions from these limits include investments in subsidiaries, certain financial infrastructure institutions, Tier I and II debt instruments, CDs, preference shares, non-convertible debentures and bonds, certain mutual funds, and shares acquired through debt conversion.
For computing capital market exposure, loans and advances are considered based on the higher of sanctioned limits or outstanding amounts. Direct investments in shares and similar instruments are calculated at cost price.
Financial institutions generally are not allowed to provide working capital finance. This can only be done if the Reserve Bank gives specific permission. However, there are exceptions. For instance, if banks are temporarily unable to meet the credit needs of a counterparty due to liquidity issues, financial institutions can step in to provide working capital. In situations where a counterparty’s working capital is already being financed under a multiple banking arrangement, the financial institution needs to get a certificate from an auditor. This certificate should indicate how much the counterparty has already borrowed before the institution considers offering additional working capital finance.
Financial institutions are not allowed to provide a Revolving Underwriting Facility for Short Term Floating Rate Notes, Bonds, or Debentures issued by companies. This type of financial support is off-limits.