RBI introduces incremental provisioning for bank loans to firms with unhedged foreign currency exposures

The central bank has decided to introduce incremental provisioning and capital requirements for banks having exposure to firms with unhedged foreign currency positions. The norms which would be applicable from April 1, 2014, is to plug concerns that entities which do not hedge their foreign currency exposures can incur significant losses not just to themselves but also to the banking system due to exchange rate movements.

RBI restricted incremental capital requirement only to cases where the expected losses is more than 75 per cent but decided to have a risk tiered incremental provisioning requirement.

If the losses are expected to be under 15 per cent, then no provisioning is required. However, the central bank mandated an incremental provisioning requirement of 20 bps on the total credit exposures over and above extant standard asset provisioning when the losses range in the 15-30 per cent range. It has asked for provisioning of 

40 bps if the expected loss is in the 30-50 per cent range and 60 bps for loss in the 50-75 per cent bracket.

If the anticipated loss is over 75 per cent it has asked for incremental provisioning of 80 bps along with a 25 per cent increase in the risk weight in terms of incremental capital requirement.

RBI noted that the implementation of the guidelines may pose some issues for exposures to project under implementation and to new entities which may not have annual earnings before interest and depreciation (EBID) figure available. It said 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.

While computing the unhedged foreign currency exposure of MNCs incorporated outside India, intra-group foreign currency exposures (for instance, 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.

RBI said 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.

It added that 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.

(Edited by Joby Puthuparampil Johnson)

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