Selective empowerment for Capital Conservation
Subsequent to Basle implementation expansion of lending business requires substantial enhancement of capital for continuing lending operations. Quality of portfolio plays a vital role, since any degradation of qualitative status of portfolio requires acquisition of additional capital ( lower rated exposures attract higher capital adequacy) for which bank has to approach government/ other stake holders. It is imperative that the credit policy contains in- built strategies for strengthening the portfolio which can result in capital conservation. We can identify some areas where bank’s exposure is high and develop strategy to create mechanisms for qualitative improvement in the quality of portfolio. The risk weights are modified from time to time by RBI in order to control/ direct exposure in certain areas. We have considered original guidelines for the purpose of our discussion.
In terms of the RBI guidelines Capital to Risk weighted Assets Ratio (CRAR) is to be reckoned as under:
Eligible total Capital / ( Credit Risk RWA+ Market Risk RWA + Operational Risk RWA).
Minimum requirement is 9%, but banks are advised to maintain anti cyclical buffer which brings up to 11% or more. Risk weights for credit risk, because of large coverage, is the deciding factor which influences the capital requirement of the bank. It is imperative that Credit Management keeps a close surveillance on the utilization of those facilities which requires low risk weights. The facilities are chosen by the obligors but there can be built- in incentive in credit dispensation so that the borrowers prefer to avail those facilities which attract comparatively low risk weights. In terms of the guidelines banks were permitted to shift from standardized approach depending upon their state of preparedness. However, for uniformity we have considered risk weights prescribed for standardized approach in present discussion.
In terms of the RBI guidelines , “……The Direct loan / credit / overdraft exposure, if any, of banks to the State Governments and the investment in State Government securities will attract zero risk weight. State Government guaranteed claims will attract 20 per cent risk weight. The risk weight applicable to claims on central government exposures will also apply to the claims on the Reserve Bank of India, DICGC, Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) and Credit Risk Guarantee Fund Trust for Low Income Housing (CRGFTLIH)29. The claims on ECGC will attract a risk weight of 20 per cent. The above risk weights for both direct claims and guarantee claims will be applicable as long as they are classified as ‘standard’ / performing assets.” The risk weights on Corporate exposure is as under:
Bank has to make an assessment of the profitability vis a vis the capital adequacy requirement. While formulating the Credit Policy of the bank , higher delegation may be vested on those exposures where the aforesaid criteria are fulfilled subject to the rate of return and reliability within a reasonable time period. AS advised by RBI “With a view to reflecting a higher element of inherent risk which may be latent in entities whose obligations have been subjected to re-structuring / re-scheduling either by banks on their own or along with other bankers / creditors, the unrated standard / performing claims on these entities should be assigned a higher risk weight until satisfactory performance under the revised payment schedule has been established for one year from the date when the first payment of interest / principal falls due under the revised schedule. The applicable risk weights will be 125 per cent.”
Planning Strategies –
The objective of the discussion is how their prescriptions could be utilized for the benefit of the bank. Based on the prescriptions, banks refrain from considering proposals with rating lower than the eligible rating for 100% risk Weight. It may be difficult to obtain higher rated borrowers, because they have various avenues for raising capital. However, at times such corporate have an immediate requirement for raising capital which may not be feasible through other channels. Generally delegated authorities in the branches are empowered to permit emergency drawing for say up to 10% of the working capital limits, subject to certain conditions. As a strategy for attracting better rated clients for availing credit limits, the credit policy may authorize the delegated incumbent to exercise higher delegated power for accounts with rating higher than BBB. In this process it may be possible to improve exposure in higher rated accounts. The degree of sanction will be based on the rating scale, i.e higher the rating , more is the emergency power, subject to standard condition such as , availability of sufficient drawing power, account discipline, industry risk etc. The strategy will make desk level officials concerned about the necessity of proper management of capital adequacy which will lead to capital conservation.
One area which often ignores attention is renewal of working capital limits. While restructuring attracts higher risk weights, banks are empowered to realign facilities at the time of renewal/ review of limits. Assessments based on cash budget can identify the intrinsic requirement of a borrower. The facilities can be realigned which help in maintaining the status of the account and facilities can be realigned to the advantage of the obligor.
Granularity principle was adopted to ensure there is distribution of assets and short fall in one do not affect the entire basket. As advised by RBI “ …Granularity Criterion – Banks must ensure that the regulatory retail portfolio is sufficiently diversified to a degree that reduces the risks in the portfolio, warranting the 75 per cent risk weight. One way of achieving this is that no aggregate exposure to one counterpart should exceed 0.2 per cent of the overall regulatory retail portfolio. ‘While banks may appropriately use the group exposure concept for computing aggregate exposures, they should evolve adequate systems to ensure strict adherence with this criterion. NPAs under retail loans are to be excluded from the overall regulatory retail portfolio when assessing the granularity criterion for risk-weighting purposes.
Bank already adopted policy to prioritize retail portfolio to reduce the degree of risk and permitted wider discretion. It is necessary to identify which retail loans attract lower capital adequacy. However there should be a balance between the revenue and risk weights.
Housing sector attracts the following Risk weighted assets:
Loan to Value ratio (LTV) Risk Weights
The guidelines clearly exempt cases where the borrower’s stake is high and loan component is low. The policy may contain provisions of expeditious sanction in cases where the risk weights are less. Higher exposure to the branch/ Zonal incumbent, subject to certain conditions regarding quality of asset, can gradually result in improvement of the portfolio.
The Risk weight for certain off balance sheet items, which are frequently utilized by borrowers , is determined by applying credit conversion factor at the following rates :
Performance guarantee, bid bonds, standby letter of credit , warranty , indemnity etc =50%
Short term self liquidating trade related contingencies, i.e. LC collaterised by underlying documents evidencing supply of goods based on mutual agreement and acceptance =20%
While availing working capital finance borrowers weigh between availing LCs and payment of cash. Very often, in order to avoid hassles in paper work, borrowers prefer to pay upfront. This is an area where counseling coupled with empowerment of sanction could be useful. Normally borrowers do not have much concern about facility planning. Assessment of working capital by using cash budget method could be useful in such cases. Budgeted cost and use of the funds, if displayed before the borrower, can make them realize the advantage of availing non fund based facilities. This is true for term loans also. Wider delegation of power can create an in built mechanism to reduce capital adequacy and banks can increase lending without much increase in the capital charge. The facilities mentioned above are regularly used in branches. However, depending upon the exposure e.g foreign exchange /investment/ merchant banking segments the delegated power can consider prescribed risk weight also to ensure capital conservation by reducing risk weights.
