Master Circular- Prudential Norms on Capital Adequacy - ఆర్బిఐ - Reserve Bank of India
Master Circular- Prudential Norms on Capital Adequacy
RBI/2007-2008/26 July 2, 2007 All Commercial Banks Dear Sir, Master Circular- Prudential Norms on Capital Adequacy Please refer to the Master Circular No. DBOD. BP. BC. 13/ 21.01.002/ 2006-2007 dated July 1, 2006 consolidating instructions/ guidelines issued to banks till June 30, 2006 on matters relating to prudential norms on capital adequacy. The Master Circular has been suitably updated by incorporating instructions issued up to 30th June 2007 and has also been placed on the RBI web-site (http: // www.rbi.org.in). 2. It may be noted that all relevant instructions on the above subject contained in the circulars listed in the Appendix have been consolidated. These instructions are applicable to all banks till March 30, 2008. However, for banks migrating to Basle II norms with effect from March 31, 2008, instructions contained in our circular DBOD. No. BP. BC.90 /20.06.001/2006-07 dated April 27, 2007 on "Implementation of the New Capital Adequacy Framework" will be applicable. For banks, which will not be migrating to Basle II, the instructions contained in this circular will continue to be applicable. Yours faithfully, (Prashant Saran) Master Circular on ‘Prudential Norms on Capital Adequacy’ Purpose The Reserve Bank of India decided in April 1992 to introduce a risk asset ratio system for banks (including foreign banks) in India as a capital adequacy measure in line with the Capital Adequacy Norms prescribed by Basel Committee. This circular prescribes the risk weights for the balance sheet assets, non-funded items and other off-balance sheet exposures and the minimum capital funds to be maintained as ratio to the aggregate of the risk weighted assets and other exposures, as also, capital requirements in the trading book, on an ongoing basis. Previous instructions Application Structure 2.1. Components of Capital This master circular covers instructions regarding the components of capital and capital charge required to be provided for by the banks for credit and market risks. It deals with providing explicit capital charge for credit and market risk and addresses the issues involved in computing capital charges for interest rate related instruments in the trading book, equities in the trading book and foreign exchange risk (including gold and other precious metals) in both trading and banking books. Trading book for the purpose of these guidelines includes securities included under the Held for Trading category, securities included under the available for sale category, open gold position limits, open foreign exchange position limits, trading positions in derivatives, and derivatives entered into for hedging trading book exposures. The basic approach of capital adequacy framework is that a bank should have sufficient capital to provide a stable resource to absorb any losses arising from the risks in its business. Capital is divided into tiers according to the characteristics/qualities of each qualifying instrument. For supervisory purposes capital is split into two categories: Tier I and Tier II. These categories represent different instruments’ quality as capital. Tier I capital consists mainly of share capital and disclosed reserves and it is a bank’s highest quality capital because it is fully available to cover losses. Tier II capital on the other hand consists of certain reserves and certain types of subordinated debt. The loss absorption capacity of Tier II capital is lower than that of Tier I capital. Credit risk is most simply defined as the potential that a bank’s borrower or counterparty may fail to meet its obligations in accordance with agreed terms. It is the possibility of losses associated with diminution in the credit quality of borrowers or counterparties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a customer or a counterparty to meet commitments in relation to lending, trading, settlement and other financial transactions. Alternatively, losses result from reduction in portfolio arising from actual or perceived deterioration in credit quality. For most banks, loans are the largest and the most obvious source of credit risk; however, other sources of credit risk exist throughout the activities of a bank, including in the banking book and in the trading book, and both on and off balance sheet. Banks increasingly face credit risk (or counterparty risk) in various financial instruments other than loans, including acceptances, inter-bank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options and in guarantees and settlement of transactions. The goal of credit risk management is to maximize a bank’s risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio, as well as, the risk in the individual credits or transactions. Banks should have a keen awareness of the need to identify measure, monitor and control credit risk, as well as, to determine that they hold adequate capital against these risks and they are adequately compensated for risks incurred. Market risk refers to the risk to a bank resulting from movements in market prices in particular changes in interest rates, foreign exchange rates and equity and commodity prices. In simpler terms, it may be defined as the possibility of loss to a bank caused by changes in the market variables. The Bank for International Settlements (BIS) defines market risk as “the risk that the value of ‘on’ or ‘off’ balance sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates and commodity prices”. Thus, Market Risk is the risk to the bank’s earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities, as well as, the volatilities of those changes. Capital funds: The capital funds for the banks are being discussed under two heads i.e. the capital funds of Indian banks and the capital funds of foreign banks operating in India. 2.1.1. Capital funds of Indian banks:For Indian banks, 'capital funds' would include the components Tier I capital and Tier II capital. 2.1.1.1. Elements of Tier I capital: The elements of Tier I capital include i) Paid-up capital (ordinary shares), statutory reserves, and other disclosed free reserves, if any. The guidelines governing the Innovative Perpetual Debt Instruments eligible for inclusion as Tier I capital indicating the minimum regulatory requirements are furnished in Annex 1 2.1.1.2. Elements of Tier II capital: The elements of Tier II capital include undisclosed reserves, revaluation reserves, general provisions and loss reserves, hybrid capital instruments, subordinated debt, deferred revenue expenditure under VRS and investment reserve account. a. Undisclosed reserves They can be included in capital, if they represent accumulations of post-tax profits and are not encumbered by any known liability and should not be routinely used for absorbing normal loss or operating losses. . b. Revaluation reserves It would be prudent to consider revaluation reserves at a discount of 55 percent while determining their value for inclusion in Tier II capital. Such reserves will have to be reflected on the face of the Balance Sheet as revaluation reserves. c. General provisions and loss reserves Such reserves can be included in Tier II capital if they are not attributable to the actual diminution in value or identifiable potential loss in any specific asset and are available to meet unexpected losses. Adequate care must be taken to see that sufficient provisions have been made to meet all known losses and foreseeable potential losses before considering general provisions and loss reserves to be part of Tier II capital. General provisions/loss reserves will be admitted up to a maximum of 1.25 percent of total risk weighted assets. 'Floating Provisions' held by the banks, which is general in nature and not made against any identified assets, may be treated as a part of Tier II capital within the overall ceiling of 1.25 percent of total risk weighted assets, if such provisions are not netted off from gross NPAs to arrive at disclosure of net NPAs Those instruments which have close similarities to equity, in particular when they are able to support losses on an ongoing basis without triggering liquidation, they may be included in Tier II capital. At present following instruments have been recognized and placed under this category. The guidelines governing the instruments at (i) above, indicating the minimum regulatory requirements are furnished in Annex 2. i. To be eligible for inclusion in Tier II capital, the instrument should be fully paid-up, unsecured, subordinated to the claims of other creditors, free of restrictive clauses, and should not be redeemable at the initiative of the holder or without the consent of the Reserve Bank of India. They often carry a fixed maturity, and as they approach maturity, they should be subjected to progressive discount, for inclusion in Tier II capital. Instruments with an initial maturity of less than 5 years or with a remaining maturity of one year should not be included as part of Tier II capital. The quantum of subordinated debt instruments eligible to be reckoned as Tier II capital will be limited to 50 percent of Tier I capital. f. Deferred Revenue Expenditure under VRS In the case of public sector banks, the bonds issued to the VRS employees as a part of the compensation package, net of the unamortised VRS Deferred Revenue Expenditure, could be treated as Tier II capital, subject to compliance with the terms and conditions stipulated in para 2.1.1.2 (e)(ii). g. Investment Reserve Account In the event of provisions created on account of depreciation in the ‘Available for Sale’ or ‘Held for Trading’ categories being found to be in excess of the required amount in any year, the excess should be credited to the Profit & Loss account and an equivalent amount (net of taxes, if any and net of transfer to Statutory Reserves as applicable to such excess provision) should be appropriated to an Investment Reserve Account in Schedule 2 –“Reserves & Surplus” under the head “Revenue and other Reserves” and would be eligible for inclusion under Tier II within the overall ceiling of 1.25 per cent of total Risk Weighted Assets prescribed for General Provisions/ Loss Reserves. h. Banks are allowed to include the ‘General Provisions on Standard Assets’ and ‘provisions held for country exposures’ in Tier II capital. However, the provisions on ‘standard assets’ together with other ‘general provisions/ loss reserves’ and ‘provisions held for country exposures’ will be admitted as Tier II capital up to a maximum of 1.25 per cent of the total risk-weighted assets. 2.1.2. Capital funds of foreign banks operating in India For the foreign banks operating in India, 'capital funds' would include the two components i.e. Tier I capital and Tier II capital. 2.1.2.1. Elements of Tier I capital: The elements of Tier I capital include i) Interest-free funds from Head Office kept in a separate account in Indian books specifically for the purpose of meeting the capital adequacy norms. 2.1.2.2. Elements of Tier II capital: The elements of Tier II capital include the following elements. a) Elements of Tier II capital as applicable to Indian banks. a) The foreign banks are required to furnish to Reserve Bank, (if not already done), an undertaking to the effect that the banks will not remit abroad the remittable surplus retained in India and included in Tier I capital as long as the banks function in India. 2.1.3 Deductions from computation of Capital funds: 2.1.5. Norms on cross holdings (i) A bank’s / FI’s investments in all types of instruments listed at 2.1.5 (ii) below, which are issued by other banks / FIs and are eligible for capital status for the investee bank / FI, will be limited to 10 per cent of the investing bank's capital funds (Tier I plus Tier II capital). (ii) Banks' / FIs' investment in the following instruments will be included in the prudential limit of 10 per cent referred to at 2.1.5(i) above. (iii) Banks / FIs should not acquire any fresh stake in a bank's equity shares, if by such acquisition, the investing bank's / FI's holding exceeds 5 per cent of the investee bank's equity capital. (iv) Banks’ / FIs’ investments in the equity capital of subsidiaries are at present deducted from their Tier I capital for capital adequacy purposes. Investments in the instruments issued by banks / FIs which are listed at paragraph 2.1.5(ii) above, which are not deducted from Tier I capital of the investing bank/ FI, will attract 100 per cent risk weight for credit risk for capital adequacy purposes. Note: Following investments are excluded from the purview of the ceiling of 10 percent prudential norm prescribed above: Banks are advised not to enter into swap transactions involving conversion of fixed rate rupee liabilities in respect of Innovative Tier I/Tier II bonds into floating rate foreign currency liabilities. 2.1.7. Minimum requirement of capital funds Banks are required to maintain a minimum CRAR of 9 percent on an ongoing basis. 2.2. Capital charge for Market risk 2.2.2. Subsequently, keeping in view the ability of the banks to identify and measure market risk, it was decided to assign explicit capital charge for market risk. Thus banks are required to maintain capital charge for market risk on securities included in the Held for Trading and Available for Sale categories, open gold position, open forex position, trading positions in derivatives and derivatives entered into for hedging trading book exposures. Consequently, the additional risk weight of 2.5% towards market risk on the investment included under Held for Trading and Available for Sale categories is not required. 2.2.5.1. Specific risk: This refers to risk of loss caused by an adverse price movement of a security principally due to factors related to the issuer. The specific risk charge is designed to protect against an adverse movement in the price of an individual security owing to factors related to the individual issuer. The specific risk charge is graduated for various exposures under three heads i.e. claims on Government, claims on banks, claims on others and is given in Annex 5 2.2.5.2. General Market Risk:
2.2.5.3. Computation of capital charge for market risk: The Basel Committee has suggested two broad methodologies for computation of capital charge for market risks i.e. the Standardised method and the banks’ Internal Risk Management models (IRM) method. As banks in India are still in a nascent stage of developing internal risk management models, it has been decided that, to start with, banks may adopt the standardised method. Under the standardised method there are two principal methods of measuring market risk, a “maturity” method and a “duration” method. As “duration” method is a more accurate method of measuring interest rate risk, it has been decided to adopt Standardised Duration method to arrive at the capital charge. Accordingly, banks are required to measure the general market risk charge by calculating the price sensitivity (modified duration) of each position separately. Under this method, the mechanics are as follows:
2.2.5.4. Capital charge for interest rate derivatives: 2.2.5.5. Interest rate derivatives The measurement system should include all interest rate derivatives and off-balance-sheet instruments in the trading book, which react to changes in interest rates, (e.g. forward rate agreements (FRAs), other forward contracts, bond futures, interest rate and cross-currency swaps and forward foreign exchange positions). Options can be treated in a variety of ways as described at para 2.2.5.5.2 below. A summary of the rules for dealing with interest rate derivatives is set out at the end of this section. a) Calculation of positions The derivatives should be converted into positions in the relevant underlying and be subjected to specific and general market risk charges as described in the guidelines. In order to calculate the capital charge, the amounts reported should be the market value of the principal amount of the underlying or of the notional underlying. For instruments where the apparent notional amount differs from the effective notional amount, banks must use the effective notional amount. i. Futures and forward contracts, including Forward Rate Agreements (FRA) ii. Swaps Swaps will be treated as two notional positions in government securities with relevant maturities. For example, an interest rate swap under which a bank is receiving floating rate interest and paying fixed will be treated as a long position in a floating rate instrument of maturity equivalent to the period until the next interest fixing and a short position in a fixed-rate instrument of maturity equivalent to the residual life of the swap. For swaps that pay or receive a fixed or floating interest rate against some other reference price, e.g. a stock index, the interest rate component should be slotted into the appropriate re-pricing maturity category, with the equity component being included in the equity framework. Separate legs of cross-currency swaps are to be reported in the relevant maturity ladders for the currencies concerned. b) Calculation of capital charges for derivatives under the standardised methodology: i. Allowable offsetting of matched positions
When the future or the forward comprises a range of deliverable instruments, offsetting of positions in the future or forward contract and its underlying is only permissible in cases where there is a readily identifiable underlying security which is most profitable for the trader with a short position to deliver. The price of this security, sometimes called the "cheapest-to-deliver", and the price of the future or forward contract should in such cases move in close alignment. No offsetting will be allowed between positions in different currencies; the separate legs of cross-currency swaps or forward foreign exchange deals are to be treated as notional positions in the relevant instruments and included in the appropriate calculation for each currency. In addition, opposite positions in the same category of instruments can in certain circumstances be regarded as matched and allowed to offset fully. To qualify for this treatment the positions must relate to the same underlying instruments, be of the same nominal value and be denominated in the same currency. In addition:
Banks with large swap books may use alternative formulae for these swaps to calculate the positions to be included in the duration ladder. The method would be to calculate the sensitivity of the net present value implied by the change in yield used in the duration method and allocate these sensitivities into the time-bands set out in Table 1 in Section 2.3.5.4.2( a) ii. Specific risk Table - Summary of treatment of interest rate derivatives
2.2.5.5.2. Treatment of Options
a) Simplified approach In the simplified approach, the positions for the options and the associated underlying, cash or forward, are not subject to the standardised methodology but rather are "carved-out" and subject to separately calculated capital charges that incorporate both general market risk and specific risk. The risk numbers thus generated are then added to the capital charges for the relevant category, i.e. interest rate related instruments, equities, and foreign exchange as described in Sections 2.2.5 to 2.2.7 of this circular. Banks which handle a limited range of purchased options only will be free to use the simplified approach set out in Table 1, below for particular trades. As an example of how the calculation would work, if a holder of 100 shares currently valued at Rs.10 each holds an equivalent put option with a strike price of Rs.11, the capital charge would be: Rs.1,000 x 18% (i.e. 9% specific plus 9% general market risk) = Rs.180, less the amount the option is in the money (Rs.11 – Rs.10) x 100 = Rs.100, i.e. the capital charge would be Rs.80. A similar methodology applies for options whose underlying is a foreign currency or an interest rate related instrument. Table 1 Simplified approach: capital charges
b) Intermediate approaches However, since delta does not sufficiently cover the risks associated with options positions, banks will also be required to measure gamma (which measures the rate of change of delta) and vega (which measures the sensitivity of the value of an option with respect to a change in volatility) sensitivities in order to calculate the total capital charge. These sensitivities will be calculated according to an approved exchange model or to the bank’s proprietary options pricing model subject to oversight by the Reserve Bank of India6. Delta-weighted positions with debt securities or interest rates as the underlying will be slotted into the interest rate time-bands, as set out in Table at Annex 6 under the following procedure. A two-legged approach should be used as for other derivatives, requiring one entry at the time the underlying contract takes effect and a second at the time the underlying contract matures. For instance, a bought call option on a June three-month interest-rate future will in April be considered, on the basis of its delta-equivalent value, to be a long position with a maturity of five months and a short position with a maturity of two months7. The written option will be similarly slotted as a long position with a maturity of two months and a short position with a maturity of five months. Floating rate instruments with caps or floors will be treated as a combination of floating rate securities and a series of European-style options. For example, the holder of a three-year floating rate bond indexed to six month LIBOR with a cap of 15% will treat it as: b. a series of five written call options on a FRA with a reference rate of 15%, each with a negative sign at the time the underlying FRA takes effect and a positive sign at the time the underlying FRA matures8. The capital charge for options with equities as the underlying will also be based on the delta-weighted positions which will be incorporated in the measure of market risk described in Section 2.2.5. For purposes of this calculation each national market is to be treated as a separate underlying. The capital charge for options on foreign exchange and gold positions will be based on the method set out in Section 2.2.7. For delta risk, the net delta-based equivalent of the foreign currency and gold options will be incorporated into the measurement of the exposure for the respective currency (or gold) position.
c. For the purpose of this calculation the following positions should be treated as the same underlying:
d. Each option on the same underlying will have a gamma impact that is either positive or negative. These individual gamma impacts will be summed, resulting in a net gamma impact for each underlying that is either positive or negative. Only those net gamma impacts that are negative will be included in the capital calculation. ii. Scenario approach The scenario approach uses simulation techniques to calculate changes in the value of an options portfolio for changes in the level and volatility of its associated underlyings. Under this approach, the general market risk charge is determined by the scenario "grid" (i.e. the specified combination of underlying and volatility changes) that produces the largest loss. For the delta-plus method and the scenario approach the specific risk capital charges are determined separately by multiplying the delta-equivalent of each option by the specific risk weights set out in Section 2.2.5 and Section 2.2.6. More sophisticated banks will also have the right to base the market risk capital charge for options portfolios and associated hedging positions on scenario matrix analysis. This will be accomplished by specifying a fixed range of changes in the option portfolio’s risk factors and calculating changes in the value of the option portfolio at various points along this "grid". For the purpose of calculating the capital charge, the bank will revalue the option portfolio using matrices for simultaneous changes in the option’s underlying rate or price and in the volatility of that rate or price. A different matrix will be set up for each individual underlying as defined in the preceding paragraph. As an alternative, at the discretion of each national authority, banks which are significant traders in options for interest rate options will be permitted to base the calculation on a minimum of six sets of time-bands. When using this method, not more than three of the time-bands as defined in Section 2.2.5 should be combined into any one set. The options and related hedging positions will be evaluated over a specified range above and below the current value of the underlying. The range for interest rates is consistent with the assumed changes in yield in Annex 6. Those banks using the alternative method for interest rate options set out in the preceding paragraph should use, for each set of time-bands, the highest of the assumed changes in yield applicable to the group to which the time-bands belong. The other ranges are ±9 % for equities and ±9 % for foreign exchange and gold. For all risk categories, at least seven observations (including the current observation) should be used to divide the range into equally spaced intervals. The second dimension of the matrix entails a change in the volatility of the underlying rate or price. A single change in the volatility of the underlying rate or price equal to a shift in volatility of + 25% and - 25% is expected to be sufficient in most cases. As circumstances warrant, however, the Reserve Bank may choose to require that a different change in volatility be used and / or that intermediate points on the grid be calculated. After calculating the matrix, each cell contains the net profit or loss of the option and the underlying hedge instrument. The capital charge for each underlying will then be calculated as the largest loss contained in the matrix. In drawing up these intermediate approaches it has been sought to cover the major risks associated with options. In doing so, it is conscious that so far as specific risk is concerned, only the delta-related elements are captured; to capture other risks would necessitate a much more complex regime. On the other hand, in other areas the simplifying assumptions used have resulted in a relatively conservative treatment of certain options positions. Besides the options risks mentioned above, the RBI is conscious of the other risks also associated with options, e.g. rho (rate of change of the value of the option with respect to the interest rate) and theta (rate of change of the value of the option with respect to time). While not proposing a measurement system for those risks at present, it expects banks undertaking significant options business at the very least to monitor such risks closely. Additionally, banks will be permitted to incorporate rho into their capital calculations for interest rate risk, if they wish to do so. 2.2.6. Measurement of capital charge for equity risk Minimum capital requirement to cover the risk of holding or taking positions in equities in the trading book is set out below. This is applied to all instruments that exhibit market behaviour similar to equities but not to non-convertible preference shares (which are covered by the interest rate risk requirements described earlier). The instruments covered include equity shares, whether voting or non-voting, convertible securities that behave like equities, for example: units of mutual funds, and commitments to buy or sell equity. Capital charge for specific risk (akin to credit risk) will be 11.25%and specific risk is computed on the banks’ gross equity positions (i.e. the sum of all long equity positions and of all short equity positions – short equity position is, however, not allowed for banks in India). The general market risk charge will also be 9% on the gross equity positions. Investments in shares and /units of VCFs may be assigned 150% risk weight for measuring the credit risk during first three years when these are held under HTM category. When these are held under or transferred to AFS, the capital charge for specific risk component of the market risk as required in terms of the present guidelines on computation of capital charge for market risk, may be fixed at 13.5% to reflect the risk weight of 150%. The charge for general market risk component would be at 9% as in the case of other equities 2.2.7. Measurement of capital charge for foreign exchange and gold open positions 2.3. Capital Adequacy for Subsidiaries i. Banks are required to maintain a minimum capital to risk weighted assets ratio of 9%. Non-bank subsidiaries are required to maintain the capital adequacy ratio prescribed by their respective regulators. In case of any shortfall in the capital adequacy ratio of any of the subsidiaries, the parent should maintain capital in addition to its own regulatory requirements to cover the shortfall. 2.4. Procedure for computation of CRAR 2.4.3. Computation of CRAR for Foreign Exchange and Interest Rate related Contracts: Foreign exchange contracts include- Cross currency interest rate swaps, Forward foreign exchange contracts, Currency futures, Currency options purchased, and other contracts of a similar nature Foreign exchange contracts with an original maturity of 14 calendar days or less, irrespective of the counterparty, may be assigned "zero" risk weight as per international practice.
(b) Step 2 - The adjusted value thus obtained shall be multiplied by the risk weight age allotted to the relevant counter-party as given in II of Annex 8. As in the case of other off-Balance Sheet items, a two stage calculation prescribed below shall be applied: (a) Step 1 - The notional principal amount of each instrument is multiplied by the percentages given below:
(b) Step 2 -The adjusted value thus obtained shall be multiplied by the risk weightage allotted to the relevant counter-party as given in II of Annex 8. 2.4.5. Aggregation of capital charge for market risks Table-2: Total capital charge for market risk
2.4.6. Calculation of total risk-weighted assets and capital ratio Table-3: Computation of Capital for Market Risk
2.5. Worked out Examples: Two examples for computing capital charge for market risk and credit risk are given in Annex 9. Terms and conditions for inclusion of Innovative Perpetual Debt Instruments as Tier I capital The Innovative Perpetual Debt Instruments (Innovative Instruments) that may be issued as bonds or debentures by Indian banks should meet the following terms and conditions to qualify for inclusion as Tier I Capital for capital adequacy purposes. 1. Terms of issue of innovative instrumentsi) Currency of issue Banks shall issue innovative instruments in Indian Rupees as well as in foreign currency. Banks may augment their capital funds through the issue of IPDI in foreign currency, subject to compliance with the under mentioned requirements: a) IPDI issued in foreign currency should comply with all terms and conditions applicable in the guidelines issued on January 25, 2006, unless specifically modified in these guidelines.b) Not more than 49% of the eligible amount can be issued in foreign currency. c) IPDI issued in foreign currency shall be outside the limits for foreigncurrency borrowings indicated in sub paragraphs 1.i.a and 1.i.b of Annex 2. ii) Amount The amount of innovative instruments to be raised may be decided by the Board of Directors of banks. iii)LimitsInnovative instruments shall not exceed 15 per cent of total Tier I capital. The above limit will be based on the amount of Tier I capital as on March 31 of previous year after deduction of goodwill and other intangible assets but before the deduction of investments. iv) Maturity periodThe innovative instruments shall be perpetual. v) Rate of interestThe interest payable to the investors may be either at a fixed rate or at a floating rate referenced to a market determined rupee interest benchmark rate. vi) OptionsInnovative instruments shall not be issued with a ‘put option’. However banks may issue the instruments with a ‘call option’ subject to strict compliance with each of the following conditions: a) Call option can be exercised after the instrument has run for at least ten years; andb) Call option shall be exercised only with the prior approval of RBI (Department of Banking Operations & Development). While considering the proposals received from banks for exercising the call option the RBI would, among other things, take into consideration the bank’s CRAR position both at the time of exercise of the call option and after the exercise of the call option. vii) Step-up option The issuing bank may have a step-up option which may be exercised only once during the whole life of the instrument, in conjunction with the call option, after the lapse of ten years from the date of issue. The step-up shall not be more than 100 bps. The limits on step-up apply to the all-in cost of the debt to the issuing banks. viii) Lock-In Clause
c) The interest shall not be cumulative. d) All instances of invocation of the lock-in clause should be notified by the issuing banks to the Chief General Managers-in-Charge of Department of Banking Operations & Development and Department of Banking Supervision of the Reserve Bank of India, Mumbai. ix) Seniority of claim The claims of the investors in innovative instruments shall be a) Superior to the claims of investors in equity shares; andb) Subordinated to the claims of all other creditors. x) Discount The innovative instruments shall not be subjected to a progressive discount for capital adequacy purposes since these are perpetual. xi) Other conditionsa) Innovative instruments should be fully paid-up, unsecured, and free of any restrictive clauses. b) Investment in these instruments by FIIs and NRIs shall be within an overall limit of 49% and 24% of the issue respectively, subject to the investment by each FII not exceeding 10% of the issue and investment by each NRI not exceeding 5% of the issue. c) Investment by FIIs in IPDI raised in Indian Rupees shall be outside the ECB limit for rupee denominated corporate debt (currently USD 1.5 billion) fixed for investment by FIIs in corporate debt instruments. d) Banks should compute their overall eligibility level for raising capital through Innovative Perpetual Debt Instruments with reference to the Tier I capital as on the last annual balance sheet date (i.e. March 31). A bank may raise fresh capital through Innovative Perpetual Debt Instruments from FIIs and NRIs up to 49 percent and 24 percent, respectively, of the amount proposed to be raised within one year or the eligible limit whichever is less. The bank should, however, raise the remaining amount from the domestic investors within a period of one year from the date of issue to FIIs / NRIs, to ensure compliance with the limits set for FIIs and NRIs at the end of the one year period. e) Banks should comply with the terms and conditions, if any, stipulated by SEBI / other regulatory authorities in regard to issue of the instruments. 2. Compliance with Reserve Requirements The total amount raised by a bank through IPDIs shall not be reckoned as liability for calculation of net demand and time liabilities for the purpose of reserve requirements and, as such, will not attract CRR/SLR requirements 3. Reporting RequirementsBanks issuing innovative instruments shall submit a report to the Chief General Manager-in-charge, Department of Banking Operations & Development, Reserve Bank of India, Mumbai giving details of the debt raised, including the terms of issue specified at item 1 above together with a copy of the offer document soon after the issue is completed. 4. Investment in innovative instruments issued by other banks/ FIs
Banks should not grant advances against the security of the innovative instruments issued by them. If the amount of innovative Tier I capital raised as Head Office borrowings shall be retained in India on a perpetual basis . ii) Rate of interestRate of interest on innovative Tier I capital raised as HO borrowings should not exceed the on-going market rate. Interest should be paid at half-yearly rests. iii) Withholding taxInterest payments to the HO will be subject to applicable withholding tax. iv) DocumentationThe foreign bank raising innovative Tier I capital as HO borrowings should obtain a letter from its HO agreeing to give the loan for supplementing the capital base for the Indian operations of the foreign bank. The loan documentation should confirm that the loan given by Head Office shall be eligible for the same level of seniority of claim as the investors in innovative instruments capital instruments issued by Indian banks. The loan agreement will be governed by and construed in accordance with the Indian law. v) DisclosureThe total eligible amount of HO borrowings shall be disclosed in the balance sheet under the head ‘Innovative Tier I capital raised in the form of Head Office borrowings in foreign currency’. vi) HedgingThe total eligible amount of HO borrowing should remain fully swapped in Indian Rupees with the bank at all times. vii) Reporting and certification Terms and conditions applicable to Debt capital Instruments to qualify for inclusion as Upper Tier II Capital The debt capital instruments that may be issued as bonds / debentures by Indian banks should meet the following terms and conditions to qualify for inclusion as Upper Tier II Capital for capital adequacy purposes. 1. Terms of Issue of Upper Tier II Capital instruments i) Currency of issue Banks shall issue Upper Tier II instruments in Indian Rupees. Instruments in foreign currency can be issued without seeking the prior approval of the Reserve Bank of India, subject to compliance with the under mentioned requirements: a. Upper Tier II Instruments issued in foreign currency should comply with all terms and conditions applicable as detailed in the guidelines issued on January 25, 2006, unless specifically modified.b. The total amount of Upper Tier II Instruments issued in foreign currency shall not exceed 25% of the unimpaired Tier I capital. This eligible amount will be computed with reference to the amount of Tier I capital as on March 31 of the previous financial year, after deduction of goodwill and other intangible assets but before the deduction of investments. c. This will be in addition to the existing limit for foreign currency borrowings by Authorised Dealers in terms of Master Circular No. RBI/2006-07/24 dated July 1, 2006 on Risk Management and Inter-Bank Dealings. d. Investment by FIIs in Upper Tier II Instruments raised in Indian Rupees shall be outside the limit for investment in corporate debt instruments i.e., USD 1.5 billion. However, investment by FIIs in these instruments will be subject to a separate ceiling of USD 500 million. ii) Amount The amount of Upper Tier II instruments to be raised may be decided by the Board of Directors of banks. iii) LimitsUpper Tier II instruments along with other components of Tier II capital shall not exceed 100% of Tier I capital. The above limit will be based on the amount of Tier I capital after deduction of goodwill and other intangible assets but before the deduction of investments. iv) Maturity periodThe Upper Tier II instruments should have a minimum maturity of 15 years. v) Rate of interestThe interest payable to the investors may be either at a fixed rate or at a floating rate referenced to a market determined rupee interest benchmark rate. vi) OptionsUpper Tier II instruments shall not be issued with a ‘put option’. However banks may issue the instruments with a ‘call option’ subject to strict compliance with each of the following conditions:
The issuing bank may have a step-up option which may be exercised only once during the whole life of the instrument, in conjunction with the call option, after the lapse of ten years from the date of issue. The step-up shall not be more than 100 bps. The limits on step-up apply to the all-in cost of the debt to the issuing banks. viii) Lock-In Clausea. Upper Tier II instruments shall be subjected to a lock-in clause in terms of which the issuing bank shall not be liable to pay either interest or principal, even at maturity, if
c. The interest amount due and remaining unpaid may be allowed to be paid in the later years in cash/ cheque subject to the bank complying with the above regulatory requirement. While paying such unpaid interest and principal, banks are allowed to pay compound interest at a rate not exceeding the coupon rate of the relative Upper Tier II bonds, on the outstanding principal and interest. d. All instances of invocation of the lock-in clause should be notified by the issuing banks to the Chief General Managers-in-Charge of Department of Banking Operations & Development and Department of Banking Supervision of the Reserve Bank of India, Mumbai. ix) Seniority of claim The claims of the investors in Upper Tier II instruments shall be Superior to the claims of investors in instruments eligible for inclusion in Tier I capital; and Subordinate to the claims of all other creditors.x) Discount The Upper Tier II instruments shall be subjected to a progressive discount for capital adequacy purposes as in the case of long-term subordinated debt over the last five years of their tenor. As they approach maturity these instruments should be subjected to progressive discount as indicated in the table below for being eligible for inclusion in Tier II capital.
Upper Tier II instruments shall not be redeemable at the initiative of the holder. All redemptions shall be made only with the prior approval of the Reserve Bank of India (Department of Banking Operations & Development). xii) Other conditions Banks issuing Upper Tier II instruments shall submit a report to the Chief General Manager-in-charge, Department of Banking Operations & Development, Reserve Bank of India, Mumbai giving details of the debt raised, including the terms of issue specified at item 1 above together with a copy of the offer document soon after the issue is completed. 4. Investment in Upper Tier II instruments issued by other banks/ FIs5. Grant of advances against Upper Tier II instruments Banks shall not grant advances against the security of the Upper Tier II instruments issued by them. 6. Disclosure Banks may indicate the amount raised by issue of Upper Tier II instruments by way of explanatory notes / remarks in the Balance Sheet as well as Schedule 5 under 'Other Liabilities & Provisions If the amount of Upper Tier II capital raised as Head Office borrowings is in tranches, each tranche shall be retained in India for a minimum period of fifteen years. ii) Rate of interestRate of interest on Upper Tier II capital raised as HO borrowings should not exceed the on-going market rate. Interest should be paid at half-yearly rests. iii) Withholding taxInterest payments to the HO will be subject to applicable withholding tax. iv) DocumentationThe foreign bank raising Upper Tier II capital as HO borrowings should obtain a letter from its HO agreeing to give the loan for supplementing the capital base for the Indian operations of the foreign bank. The loan documentation should confirm that the loan given by Head Office shall be eligible for the same level of seniority of claim as the investors in Upper Tier II debt capital instruments issued by Indian banks. The loan agreement will be governed by and construed in accordance with the Indian law. v) DisclosureThe total eligible amount of HO borrowings shall be disclosed in the balance sheet under the head ‘Upper Tier II capital raised in the form of Head Office borrowings in foreign currency’. vi) HedgingThe total eligible amount of HO borrowing should remain fully swapped in Indian Rupees with the bank at all times. vii) Reporting and certificationDetails regarding the total amount of Upper Tier II capital raised as HO borrowings, along with a certification to the effect that the borrowing is in accordance with these guidelines, should be advised to the Chief General Managers-in-Charge of the Department of Banking Operations & Development (International Banking Division), Department of External Investments & Operations and Foreign Exchange Department (Forex Markets Division), Reserve Bank of India, Mumbai. Terms and conditions for issue of unsecured bonds as I. Rupee Subordinated Debt Terms of Issue of BondTo be eligible for inclusion in Tier II capital, terms of issue of the bonds as subordinated debt instruments should be in conformity with the following:
b. The bonds should have a minimum maturity of 5 years. However if the bonds are issued in the last quarter of the year i.e., from 1st January to 31st March, they should have a minimum tenure of sixty three months. The interest rate should not be more than 200 basis points above the yield on Government of India securities of equal residual maturity at the time of issuing bonds. The instruments should be 'vanilla' with no special features like options, etc. iv) Other conditions The instruments should be fully paid-up, unsecured, subordinated to the claims of other creditors, free of restrictive clauses and should not be redeemable at the initiative of the holder or without the consent of the Reserve Bank of India. Necessary permission from Foreign Exchange Department should be obtained for issuing the instruments to NRIs/OCBs/FIIs. Banks should comply with the terms and conditions, if any, set by SEBI/other regulatory authorities in regard to issue of the instruments. In the case of foreign banks rupee subordinated debt should be issued by the Head Office of the bank, through the Indian branch after obtaining specific approval from Foreign Exchange Department. 2. Inclusion in Tier II capital Banks should not grant advances against the security of their own bonds. 4. Compliance with Reserve Requirements II. Subordinated Debt in foreign currency and Subordinated Debt in the form of Foreign Currency Borrowings from Head Office by foreign banks Banks may take approval of RBI on a case-by-case basis. III. Reporting Requirements The banks should submit a report to Reserve Bank of India giving details of the capital raised, such as, amount raised, maturity of the instrument, rate of interest together with a copy of the offer document soon after the issue is completed. Subordinated debt – Head Office borrowings Detailed guidelines on the standard requirements and conditions for Head Office (HO) borrowings in foreign currency raised by foreign banks operating in India for inclusion , as subordinated debt in Tier II capital are as indicated below:- Amount of borrowing 2. The total amount of HO borrowing in foreign currency will be at the discretion of the foreign bank. However, the amount eligible for inclusion in Tier II capital as subordinated debt will be subject to a maximum ceiling of 50% of the Tier I capital maintained in India, and the applicable discount rate mentioned in para 5 below. Further as per extant instructions, the total of Tier II capital should not exceed 100% of Tier I capital. Maturity period 3. Head Office borrowings should have a minimum initial maturity of 5 years. If the borrowing is in tranches, each tranche will have to be retained in India for a minimum period of five years. HO borrowings in the nature of perpetual subordinated debt, where there may be no final maturity date, will not be permitted. Features 4. The HO borrowings should be fully paid up, i.e. the entire borrowing or each tranche of the borrowing should be available in full to the branch(es) in India. It should be unsecured, subordinated to the claims of other creditors of the foreign bank in India, free of restrictive clauses and should not be redeemable at the instance of the HO. Rate of discount 5. The HO borrowings will be subjected to progressive discount as they approach maturity at the rates indicated below:
Rate of interest 6. The rate of interest on HO borrowings should not exceed the on-going market rate. Interest should be paid at half yearly rests. Withholding tax 7. The interest payments to the HO will be subject to applicable withholding tax. Repayment 8. All repayments of the principal amount will be subject to prior approval of Reserve Bank of India, Department of Banking Operations and Development. Documentation 9. The bank should obtain a letter from its HO agreeing to give the loan for supplementing the capital base for the Indian operations of the foreign bank. The loan documentation should confirm that the loan given by Head Office would be subordinated to the claims of all other creditors of the foreign bank in India. The loan agreement will be governed by, and construed in accordance with the Indian law. Prior approval of the RBI should be obtained in case of any material changes in the original terms of issue. Hedging 13. Such borrowings done in compliance with the guidelines set out above would not require prior approval of RBI. However, information regarding the total amount of borrowing raised from Head Office under this circular, along with a certification to the effect that the borrowing is as per the guidelines, should be advised to the Chief General Managers-in-Charge of the Department of Banking Operations & Development (International Banking Section), Department of External Investments & Operations and Foreign Exchange Department (Forex Markets Division), RBI, Mumbai.
The category ‘claim on Government’ will include all forms of Government securities including dated Government securities, Treasury bills and other short-term investments and instruments where repayment of both principal and interest are fully guaranteed by the Government. The category 'Claims on others' will include issuers of securities other than Government and banks. DURATION METHOD
Horizontal Disallowances
Note: Capital charges should be calculated for each currency separately and then summed with no offsetting between positions of opposite sign. In the case of those currencies in which business is insignificant (where the turnover in the respective currency is less than 5 per cent of overall foreign exchange turnover), separate calculations for each currency are not required. The bank may, instead, slot within each appropriate time-band, the net long or short position for each currency. However, these individual net positions are to be summed within each time-band, irrespective of whether they are long or short positions, to produce a gross position figure. In the case of residual currencies the gross positions in each time-band will be subject to the assumed change in yield set out in table with no further offsets. ANNEX 10 Reporting Formats Reporting format for the purpose of monitoring the capital ratio is given hereunder: A. Capital Base
B. Risk Weighted Assets
C. Capital Ratio
D. Memo items
Banks should furnish data in the above format as on the last day of each calendar quarter to the Chief General Manager-in-Charge, Department of Banking Supervision, Central Office, World Trade Centre I, 3rd floor, Cuffe Parade, Mumbai 400 005 both in hard copy and soft copy. Soft copy in excel format may also be forwarded through e-mail to osmos@rbi.org.in and dbodmrg@rbi.org.in. ANNEX 11 List of instructions and circulars superseded Part – A List of Circulars
Part – B List of Other Circulars containing Instructions/Guidelines/Directives related to Prudential Norms
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