On 24th May 2019, the Reserve Bank of India (RBI) suggested changes in the Asset Liability Management (ALM) framework for Non-Banking Financial Companies (NBFCs) and Core Investment Companies (CICs) in order to strengthen their framework of liquidity risk management. These guidelines were proposed in order to help NBFCs and CICs to deal with severe liquidity problems and survive a debt crisis. Before issuing the final guidelines, the RBI is awaiting the opinions and comments of NBFCs, market participants and other stakeholders till 14th June 2019.

RBI has modified some of the extant guidelines on liquidity risk management, to enhance the standards of the ALM framework of NBFCs. Apart from this, RBI has also introduced few additional features including disclosure standards.

The liquidity risk management guidelines should be abided by

A] NBFCs who do not engage in deposit collection with an asset size of Rs.100 crores and above

B] Systemically important Core Investment Companies

C] NBFCs which take deposits

Introduction of Liquidity Coverage Ratio :

Liquidity Coverage Ratio (LCR) = 

HQLA Explained:

• HQLAs are assets that can be readily sold or converted into cash with minimal or no loss or can be utilised as collateral for obtaining additional secured funding.

• These funds should be unencumbered. Which means that they should be under no legal, contractual or regulatory restriction that would delay or stop transfer, sale or liquidation of the asset.

LCR for banks has already been implemented at 100%. With the IL&FS crisis witnessed in FY18, it was crucial for the same to be enforced for NBFCs. This is a major change regulatory reform introduced by the RBI.

All non-deposit taking NBFCs with an asset size of Rs.5000 crores, and all NBFCs that take deposits, along with CICs should adhere to the guidelines of RBI while computing LCR.

The LCR will be applicable for NBFCs from 1st April 2020.  In the period of the next 4 years, these regulations will be completely enforced. Meanwhile, a progressive provision rate has been provided by the RBI to the NBFCs to achieve the target. The required level of LCR will reach 100% by 1st April 2024.

These funds can only be utilized in extreme financial situations, which will be notified to the RBI. The rectification steps along with the disbursement strategy will also be disclosed mandatorily.

Bifurcation of Maturity Buckets and Tolerance Limits

The calculation of surplus or deficit at the end of the maturity period is assistive to manage the net funding required. With maturity profiling, the Future Cash Flows (FCF) are estimated.

The FCFs of NBFCs are measured in different time buckets. Furthermore, RBI has introduced further granularity into the calculations. The bifurcated time buckets in the Statement of Structural Liquidity areas follows:

• 1 day to 7 days

• 8 day to 14 days

• 15 days to 30/31 days (One month)

• Over one month and up to 2 months

• Two months above and up to 3 months

• Over 3 months and up to 6 months

• More than 6 months and up to 1 year

• Over 1 year and up to 3 years

• Over 3 years and up to 5 years

• More than 5 years

The NBFCs will be required to hold mandatory and non-mandatory securities in their investment portfolios. It is expected that the cash flows will experience mismatches. Further, the mismatches up to 1 year are supposed to early warning signals that indicate impending liquidity problems. The key focus of the regulation is short term mismatch of the cash flows. The net cumulative negative mismatch in the 1-7 days, 8-14 days, 15-30/31 days should not exceed 10%, 10% and 20% respectively.

Monitoring of liquidity risk with tools

In order to capture strains in liquidity position, RBI suggested NBFCs to adopt liquidity risk monitoring tools. Moreover, these monitoring tools should cover the concentration of funding, availability of unencumbered assets and market-related monitoring tools.

• The concentration of Funding: Under this, the source of funding and withdrawal is the primary focus. The sources that could trigger liquidity problems are under the radar.

• Unencumbered assets: The assets which bear high liquidity and can be used as collateral in the secondary market are recognized.

• Market-related monitoring tools: The delta of book-equity ratio and the coupon at which the short term and long term debts are raised should be monthly inspected.

Extension of liquidity risk management principles

In addition to the liquidity risk management principles underlining extant prescriptions on key elements of the ALM framework, it has been decided to extend relevant principles covering other aspects of monitoring and measurement of liquidity risk, viz., off-balance sheet and contingent liabilities, stress testing, intra-group fund transfers, diversification of funding, collateral position management, and contingency funding plan.

Stock approach for liquidity risk measurement

RBI suggested NBFCs to adopt the Stock approach in order to measure liquidity risk and to monitor certain critical ratios in regard to the liquidity risk management capability of NBFCs. The critical ratios which are to be monitored are a short-term liability to total assets, short-term liability to long term assets, commercial papers to total assets, non-convertible debentures to total assets, short-term liabilities to total liabilities, long-term assets to total assets.

The guideline is a step forward for strengthening the balance sheet of the NBFCs. The crises witnessed due to the ALM should be avoided in the future if the draft is enforced. A strong economy stands on the pillars of a sound financial system. The Liquidity Risk Management Framework forms a concrete ground for that.