Instruction Circular No.

9716/CP&RMD/2007-2008/08

Date : 04.08.2007

BANK’S
Policy on Credit Risk Mitigation and Collateral
Management under New Capital
Adequacy Framework

ALLAHABAD BANK
CREDIT POLICY & RISK MANAGEMENT DEPARTMENT

ALLAHABAD BANK
CREDIT POLICY & RISK MANAGEMENT DEPARTMENT
Head Office : 2, Netaji Subhas Road, Kolkata – 700 001
Instruction Circular No. 9716/CP&RMD/2007-08/08

Date : 04.08.2007

To All Offices and Branches
POLICY ON CREDIT RISK MITIGATION AND COLLATERAL MANAGEMENT UNDER NEW
CAPITAL ADEQUACY FRAMEWORK

1. INTRODUCTION:
1.1.

Credit Risk Mitigation implies to reduction of Credit Risk in an exposure by a safety
net tangible and realizable securities including third party guarantee / insurance i.e.
exposure may be collateralized in whole or in part.

1.2.

In the “Final Guidelines on Implementation of the New Capital Adequacy
Framework” under Basel-II Framework, RBI has prescribed certain norms for Credit
Risk Mitigation.

1.3.

RBI guidelines on Credit Risk Mitigation are with reference to Standardised
Approach, which the Bank is adopting for calculation of capital requirement under
Credit Risk.

1.4

RBI in its guidelines has stipulated to put in place “Board Approved Policy on
Utilisation of the Credit Risk Mitigation Techniques and Collateral Management”.

2. SALIENT FEATURES OF RBI GUIDELINES:
2.1.

Banks are allowed for a wider range of credit risk mitigants.

2.2.

Under Financial Collaterals, the permissible items are as under (with conditionalties)
to be recognized for regulatory capital purposes :
2.2.1.

Cash (As well as Certificate of Deposit or comparable instruments including
Fixed Deposit Receipts issued by the Lending Bank).

2.2.2.

Gold

2.2.3.

Securities issued by Central/State Govt.

2.2.4.

KVPs/NSCs

2.2.5.

Life Insurance Policies with a declared surrender value.

2.2.6.

Debt Securities rated / un-rated by a chosen credit Rating Agency in
respect of which the Banks should be sufficiently confident about the
market liquidity.

.2 .Contd.

4.6. Contd.2.3. 2. 2. IMF. MDBs 2. Equities (including Convertible Bonds) that are listed on a recognized Stock Exchange and are included in prescribed indices. “counterparty” is used to denote a party to whom a bank has an on-or off-balance sheet credit exposure. Credit Risk Mitigation approach will be applicable to the Banking Book Exposures. Eligibility / Permissible Guarantees are : 2. 2.9.2. Guarantee offered by Banks and Primary Dealers with lower risk weight etc. 2.9. No transaction in which Credit Risk Mitigation (CRM) techniques are used should receive a higher capital requirement than an otherwise identical transaction where such techniques are not used.1.3 . In order for Banks to obtain capital relief for any use of CRM techniques.3.) 2. Principal-only ratings will not be allowed within the CRM framework. A Collateral transaction is one in which : 2. Therefore.. no additional supervisory recognition of CRM for regulatory capital purposes will be granted on claims for which an issue-specific rating used that already reflects that CRM.8. 2.4. Units of Mutual Funds.9.:: 2 :: 2. 2.2.7.5. Guarantee offered by Sovereigns (State & Central Govt.5. Here. banks have a credit exposure and that credit exposure is hedged in whole or in part by collateral posted by a counterparty or by a third party on behalf of the counterparty. ECB. Guarantee offered by Sovereign Entities (including BIS.) than counter party.7.3. 2. Guarantee offered by other entities having rated AA(-) or better as per rating agencies. banks have a specific lien on the collateral and the requirements of legal certainty are met. 2. This will also be applicable for calculation of the counterparty risk charges for OTC derivatives and repo-style transactions booked in the trading book. the minimum prescribed standards for legal documentation must be met. EC. 2. The effects of CRM will not be double counted.3.1.8.3. 2.3.3 Guarantee offered by CGTSI & ECGC 2.2.

2007. it simultaneously may increase other risks (residual risks). does not prohibit obtention of securities out side the purview of “eligible collaterals” which however will not be eligible for mitigation purposes.1. even within regulatory retail portfolio. Only “eligible collaterals” prescribed in this policy are allowed to be recognised for computation of regulatory capital charge for credit risk.10. POLICY FRAMEWORK OF THE BANK 3. Credit Risk Mitigation is allowed only on account-by-account basis. 2. pursue credit risk mitigation by insisting for eligible collaterals.12. 3. which allows fuller offset of collateral against exposure. (b).1.13. 3. Contd. 3.1.4 . Prescribed disclosure requirements must always be observed for Banks to obtain capital relief in respect of any CRM techniques. 2.2. therefore. 2. reduce the volume of risk weighted assets reducing thereby the quantum of minimum capital requirement.2.2. Use of such permissible CRMs will enable the Bank to: (a). 3. 3.11.1. Under “Final Guidelines of New Capital Adequacy Framework (Basel-II) released by Reserve Bank Of India (RBI) in April.1 Credit Risk Mitigation (CRM) approach/techniques as detailed in this policy are applicable to the Banking Book exposures. Residual risks include legal. All securities which are obtained by the Bank against credit exposure in the normal course of business are not eligible for mitigation purposes.3.2. liquidity and market risks..2. Coverage of Risk Mitigants under the Policy: 3.1. Applicability / General Principles 3.2.:: 3 :: 2.3. While the use of CRM techniques reduces or transfers credit risk. 3. Banks in India shall adopt the Comprehensive Approach. the Bank can use a wide range of prescribed Credit Risk Mitigants (CRMs) covering financial collaterals/ guarantees to be recognised for regulatory capital calculation purposes.3 Objective of the Policy: 3. This policy. operational. by effectively reducing the exposure amount by the value ascribed to the collateral subject to “ haircuts” that will provide volatility adjusted amounts for both exposure and collateral.

4. However. Residual risks include legal. Collateralised transactions 3. (ii) Bank has a specific lien on the collateral and the requirements of legal certainty are met. (ii) The effects of CRM will not be double counted. and management of concentration risk arising from the Bank’s use of CRM techniques and its interaction with the Bank’s overall credit risk profile.4 Principal-only ratings will not be allowed within the CRM framework. Therefore.:: 4 :: 3.1 3.5 (iii) A collateralised transaction is one in which: (i) Bank has a credit exposure and that credit exposure is hedged in whole or in part by collateral posted by a counterparty or by a third party on behalf of the counterparty. liquidity and market risks. before capital relief is considered the standards set out below must be met.3.3 The general principles applicable to use of credit risk mitigation techniques are as under: (i) No transaction in which Credit Risk Mitigation (CRM) techniques are used should receive a higher capital requirement than an otherwise identical transaction where such techniques are not used. Contd. operational. it simultaneously may increase other risks (residual risks). “counterparty” is used to denote a party to whom a bank has an on. (Note: The above stipulation implies that if mitigating factors are already built into issue-specific rating. consideration of the underlying credit. no additional supervisory recognition of CRM for regulatory capital purposes will be granted on claims for which an issue-specific rating is used that already reflects that CRM.5.2 This will also be applicable for calculation of the counterparty risk charges for OTC derivatives and repo style transactions booked in the Trading Book.1.or off-balance sheet credit exposure.) 3. 3. Credit risk mitigation is allowed only on an account-by-account basis. even within regulatory retail portfolio. valuation. it is imperative that Bank’s laid down procedures and processes are strictly adhered to control these risks.3. including strategy.5 .2. 3. (iv) While the use of CRM techniques reduces or transfers credit risk. Minimum Conditions 3. control of roll-off risks. systems. Therefore.. Here.5. the benefit of mitigation can not be again counted for capital requirement. policies and procedures.

when taking collateral. more specifically defined herein after). by registering it with a registrar.6 Approach A capital requirement will be applied on either side of the collateralised transaction: for example. (iii) Bank’s laid down procedures for the timely liquidation of collateral declaring the default of the counterparty and liquidating the collateral are observed.1. 3. Bank must take all steps necessary to fulfil those requirements under the law applicable to the Bank’s interest in the collateral for obtaining and maintaining an enforceable security interest. Furthermore. is allowed to reduce Bank’s credit exposure to a counterparty when calculating its capital requirements to take account of the risk mitigating effect of the collateral. For example. which allows fuller offset of collateral against exposures. by effectively reducing the exposure amount by the value ascribed to the collateral. in the event of the default. the credit quality of the counterparty and the value of the collateral must not have a material positive correlation. where applicable. bank when take eligible Financial Collateral (e. (iv) Where the collateral is held by a custodian. insolvency or bankruptcy (or one or more otherwise-defined credit events set out in the transaction documentation) of the counterparty (and. The application of haircuts will produce volatility-adjusted amounts for both exposure and collateral. In the comprehensive approach. of the custodian holding the collateral). e. These adjustments are referred to as ‘haircuts’. both repos and reverse repos will be subject to capital requirements.3 3. both sides of securities lending and borrowing transactions will be subject to explicit capital charges. the ‘haircut’ for the exposure will be a premium factor and the ‘haircut’ for the collateral will be a discount factor. occasioned by market movements. Likewise. 3. the legal mechanism by which collateral is pledged or transferred must ensure that the bank has the right to liquidate or take legal possession of it. and that collateral shall be liquidated promptly. Bank will adopt the Comprehensive Approach. In other words.g. The volatility-adjusted amount for the exposure will be higher than the exposure and the volatility adjusted amount for the collateral will be lower than the collateral.(i) (ii) :: 5 :: In addition to the general requirements for legal certainty. Bank is required to adjust both the amount of the exposure to the counterparty and the value of any collateral received in support of that counterparty to take account of possible future fluctuations in the value of either. unless either side of the transaction is cash.6. securities issued by the counterparty or by any related group entity would provide little protection and so would be ineligible.2. Under this policy. 3.6.5. cash or securities. Under this approach.g. Bank must take reasonable steps to ensure that the custodian segregates the collateral from its own assets. as will the posting of securities in connection with a derivative exposure or other borrowing. Bank will calculate its adjusted exposure to a counterparty for capital adequacy purposes in order to take account of the effects of that collateral. . in a timely manner. In order for collateral to provide protection.

. Life insurance policies with a declared surrender value of an insurance company which is regulated by IRDA (Insurance Regulatory & Development Authority).6.: 7 : 3.3. Bank shall calculate the risk-weighted assets as the difference between the two multiplied by the risk weight of the counterparty. the value of the collateralized jewellery should be arrived at after notionally converting these to 99. Gold & Jewellery • 3. Additionally where the exposure and collateral are held in different currencies an additional downwards adjustment must be made to the volatility adjusted collateral amount to take account of possible future fluctuations in exchange rates. LIC Policies • Cash (as well as Certificates of Deposits like DDP. 3.1. Eligible Financial Collateral 3.Cash and with Bank Financial Deposits Eligibility/ Stipulations/ Restrictions • 2. The following collateral instruments are eligible for recognition in the Comprehensive Approach: Type of Collateral 1.4. However. Govt Securities • 4.99 purity Securities issued by Central and State Governments Kisan Vikas Patra and National Savings Certificates provided no lock-in period is operational and if they can be encashed within the holding period.9 herein after).6. Contd. FDR. (Also refer to Paragraph-3. Where the volatility-adjusted exposure amount is greater than the volatility-adjusted collateral amount (including any further adjustment for foreign exchange risk). The framework for performing calculations of capital requirement is indicated in Paragraph 3.8 .8 hereinafter.RD etc issued by our Bank ) on deposit with the Bank which is incurring the counterparty exposure Gold would include both bullion and jewellery. KVP/NSC • 5.7 3.7.

e. and b). Debt Securities (UnRated) • Debt securities rated by a chosen Credit Rating Agency in respect of which the bank should be sufficiently confident about the market liquidity@ where these are either: a. and e) The bank has no information to suggest that the issue justifies a rating below BBB(-) or PR3/P3/F3/A3 (as applicable) and. or b. 8. Units of Mutual Funds • Equities (including convertible bonds) that are listed on a recognised stock exchange and are included in the following indices: ‘BSE.) • Debt securities not rated by a chosen Credit Rating Agency in respect of which the bank should be sufficiently confident about the market liquidity where these are: a) Issued by a bank.. Debt Securities (Rated) 7. Equities • 9. rated at least PR3/P3/F3/A3 for short-term debt instruments. f) Bank should be sufficiently confident about the market liquidity of the security.. Further. and b) Listed on a recognised exchange.9 . and c) Classified as senior debt. Mutual fund is limited to investing in the instruments listed in recognised stock exchanges specified under “Equity” head as above. (@ A debenture would meet the test of liquidity if it is traded on a recognised stock exchange(s) on at least 90% of the trading days during the preceding 365 days. Contd. a price for the units is publicly quoted daily i. Attracting 100% or lesser risk weight i. rated at least BBB(-)when issued by public sector entities and other entities (including bank and Primary Dealers).SENSEX’ and ‘BSE-200’ of the Bombay Stock Exchange. ‘S&P CNX NIFTY’ and ‘Junior NIFTY’ of the National Stock Exchange and the main index of any other recognised stock exchange.e.. Attracting 100% or lesser risk weight i. liquidity can be evidenced in the trading during the previous one month in the recognised stock exchange if there are a minimum of 25 trades of marketable lots in securities of each issuer. in the jurisdiction of bank’s operation Units of Mutual Funds regulated by the securities regulator of the jurisdiction of the Bank’s operation mutual funds where: a).. where the daily NAV is available in public domain.:: 8 :: 6. and d) All rated issues of the same seniority by the issuing bank are rated at least BBB(-) or PR3/P3/F3/A3 by a chosen Credit Rating Agency.e.

Haircuts 3.Hc .9.C x (1 .1. and CGTSI..9.) A 3.8. (Table-1). Illustrative examples calculating the effect of Credit Risk Mitigation is furnished in Appendix-B 3. (A few illustrations for determining the applicable Hair Cuts for exposures) He is indicated in (Appendix-A. (* Holding period will be the time normally required by the Bank to realise the value of collateral. “own-estimate haircut” is not permissible in this policy). The standard supervisory haircuts applicable to exposure/ eligible unrated securities issued by the Central or State Governments. (ii) 3.2. (Alternative way of calculating haircuts i.e. [E x (1 + H e) .4.9.e. Bank will use the Standard Supervisory Haircuts under this policy for both the exposure as well as the collateral. which are eligible for zero per cent risk weight. Contd.5. The Standard Supervisory Haircuts (assuming daily mark-to-market..2. Table-2)). DICGC.:: 9 :: 3. E*) will be multiplied by the risk weight of the counterparty to obtain the risk-weighted asset amount for the collateralised transaction. Sovereign will include Reserve Bank of India. For a collateralised transaction.8 Calculation of Capital Requirement 3.9. will be the same as applicable to AAA rated debt securities.8. 3. 3.10 .Hfx )]} where: E* = the exposure value after risk mitigation E = current value of the exposure for which the collateral qualifies as a risk mitigant He= haircut appropriate to the exposure C = the current value of the collateral received Hc= haircut appropriate to the collateral Hfx= haircut appropriate for currency mismatch between the collateral and exposure. daily re-margining and a 10 business day holding period*) expressed as percentages are given in Appendix-A. the exposure amount after risk mitigation will be calculated as follows: E* = max {0. external rating assigned to the exposure and the counterparty category. The exposure amount after risk mitigation (i.9.1. Haircuts (He) will apply to exposures to all counterparties where the bank desires to avail of credit risk mitigation benefits and will be determined by the maturity of the exposure.9. 3.3.

.e.:: 10 :: 3.9. 3. 3. 3. H10 = 10-business day standard supervisory haircut for instrument NR = actual number of business days between remargining for capital market transactions or revalidation for secured transactions.9. Credit Risk Mitigation Techniques – On-Balance Sheet Netting 3. and Bank’s own deposits. the haircut to be applied on the exposure should be the same as the one for equity traded on a recognised stock exchange which is not part of main index i. involving specific lien with proof of documentation. 3. the haircut on the basket will be.9. and Hi the haircut applicable to that asset.11 .9. Where the collateral is a basket of assets. where Bank has legally enforceable netting arrangements.7.9.9. Bank will calculate capital requirements on the basis of net credit exposures subject to the following conditions where the Bank: Contd. where ai is the weight of the asset (as measured by units of Currency) in the basket. H = ∑ aiHi .10. 3. For transactions in which the Bank’s exposures are unrated or bank lends non eligible instruments e. Kisan Vikas Patras. The standard supervisory haircut for currency risk where exposure and collateral are denominated in different currencies is 8% (also based on a 10-business day holding period and daily mark-tomarket) 3. the 10.11.9. For using the Standard Supervisory Haircuts.8. surrender value of Insurance Policies. 25%.10.1. Bank will apply a zero haircut for eligible collateral where it is National Savings Certificates.6.g. On-balance sheet netting is confined to loans/advances and deposits. The standard supervisory haircuts prescribed above would apply to the security (Hc) with reference to the rating of the issuer and to the exposure (He) with reference to the rating of counterparty.business day haircuts provided above will be the basis and this haircut will be scaled up or down depending on the type of transaction and the frequency of remargining or revaluation using the formula below: ___________ H=H10√ NR+ iTM –1j 10 Where: H= haircut . non investment grade corporate securities.10. TM =minimum holding period for the type of transaction.

whereas the uncovered portion retains the risk weight of the underlying counterparty. A range of guarantors are recognised and a substitution approach will be applied. Thus. Bank may use the net exposure of loans/advances and deposits as the basis for its capital adequacy calculation in accordance with the formula in Paragraph 3.12 . Contd.Operational requirements for guarantees (i) A guarantee (counter-guarantee) must represent a direct claim on the protection provider.11.2. b) is able at any time to determine the loans/advances and deposits with the same counterparty that are subject to the netting agreement. On fulfilment of aforesaid conditions. 3.11. 3.11.11 Credit Risk Mitigation Techniques . explicit. (ii) The guarantee must be explicitly referenced to specific exposures or a pool of exposures. only guarantees issued by entities with a lower risk weight than the counterparty will lead to reduced capital charges since the protected portion of the counterparty exposure is assigned the risk weight of the guarantor. Loans/Advances are treated as exposure and deposits as collateral. Where guarantees are direct. 3. All the requirements contained in Paragraph 3. so that the extent of the cover is clearly defined and incontrovertible..3.:: 11 :: a) has a well-founded legal basis for concluding that the netting or offsetting agreement is enforceable in each relevant jurisdiction regardless of whether the counterparty is insolvent or bankrupt.1.8. (iii) The guarantee must be irrevocable. Detailed operational requirements for guarantees eligible for being treated as a CRM are as under: 1. there must be no clause in the contract that would allow the protection provider unilaterally to cancel the cover or that would increase the effective cost of cover as a result of deteriorating credit quality in the guaranteed exposure.12 will also apply. The haircuts will be zero except when a currency mismatch exists. irrevocable and unconditional Bank may take account of such credit protection in calculating capital requirements. 3. and c) monitors and controls the relevant exposures on a net basis.8 and 3.2.10.Guarantees 3.

the following conditions must be satisfied: (i) On the qualifying default/non-payment of the counterparty.Additional operational requirements for guarantees In addition to the legal certainty requirements.. there should be no clause in the guarantee outside the direct control of the Bank that could prevent the protection provider from being obliged to pay out in a timely manner in the event that the original counterparty fails to make the payment(s) due. When a guaranteed exposure is classified as nonperforming. (v) All exposures will be risk weighted after taking into account risk mitigation available in the form of guarantees. the bank is able in a timely manner to pursue the guarantor for any monies outstanding under the documentation governing the transaction. Contd.13 . or the guarantor may assume the future payment obligations of the counterparty covered by the guarantee. The guarantor may make one lump sum payment of all monies under such documentation to the bank. 2.:: 12 :: (iv) The guarantee must also be unconditional. (ii) The guarantee is an explicitly documented obligation assumed by the guarantor. the guarantee will cease to be a credit risk mitigant and no adjustment would be permissible on account of credit risk mitigation in the form of guarantees. The entire outstanding. will attract the appropriate risk weight. net of specific provision and net of realisable value of eligible collaterals / credit risk mitigants. in order for a guarantee to be recognised. The Bank must have the right to receive any such payments from the guarantor without first having to take legal actions in order to pursue the counterparty for payment.

(iii) Other entities rated AA(-) or better. where a guarantee covers payment of principal only. or against which credit protection is held. margin payments etc. the bank and the guarantor share losses on a prorata basis. ECGC and CGTSI) (* List enclosed as Appendix-3) (ii).e. and the secured and unsecured portions are of equal seniority. The uncovered portion of the exposure will be assigned the risk weight of the underlying counterparty Where the amount guaranteed. is less than the amount of the exposure. IMF. However.Proportional cover (iii) The guarantee covers all types of payments the underlying obligor is expected to make under the documentation governing the transaction.Range of eligible guarantors (counterguarantors 4.:: 13 :: 3. The rating of the guarantor should be an entity rating which has factored in all the liabilities and commitments (including guarantees) of the entity. capital relief will be afforded on a proportional basis: i.Risk weights 5. for example notional amount. Exposures covered by State Government guarantees will attract a risk weight of 20%. i. interests and other uncovered payments should be treated as an unsecured amount in accordance with Point No. with the remainder treated as unsecured. This would include guarantee cover provided by parent.14 .5 herein below under “Proportional Cover”. European Central Bank and European Community as well as various MDBs* . The protected portion will be assigned the risk weight of the protection provider. Banks and Primary Dealers with a lower risk weight than the counterparty. Contd. Credit protection given by the following entities will be recognised: (I) Sovereigns. subsidiary and affiliate companies when they have a lower risk weight than the obligor.e. Sovereign Entities (including BIS. the protected portion of the exposure will receive the treatment applicable to eligible guarantees..

except that the counterguarantee need not be direct and explicit to the original claim. (A Haircut of 8% for currency mismatch will be applicable as permissible under the Supervisory Haircut Approach) A claim may be covered by a guarantee that is indirectly counter-guaranteed by a sovereign.12.Currency mismatches Where the credit protection is denominated in a currency different from that in which the exposure is denominated – i. In other cases where there is a maturity mismatch. For the purposes of calculating risk-weighted assets.e. Maturity Mismatch 3. the amount of the exposure deemed to be protected will be reduced by the application of a haircut ( HFX) .1. i.Sovereign guarantees and counterguarantees where: G = nominal amount of the credit protection HFX =haircut appropriate for currency mismatch between the credit protection and underlying obligation. (ii). the CRM will not be recognised for capital purposes. both the original guarantee and the counterguarantee meet all operational requirements for guarantees.15 .e. a maturity mismatch occurs when the residual maturity of collateral is less than that of the underlying exposure. GA = G x (1. the cover should be robust and no historical evidence suggests that the coverage of the counter-guarantee is less than effectively equivalent to that of a direct sovereign guarantee. 3.H FX) 7. and (iii). Such a claim may be treated as covered by a sovereign guarantee provided that: (i).13 to 3. the sovereign counter-guarantee covers all credit risk elements of the claim.:: 14 :: 6. there is a currency mismatch.12. Where there is a maturity mismatch and the CRM has an original maturity of less than one year.15 Contd. partial recognition is given to the CRM for regulatory capital purposes as detailed below in Paragraphs 3..

Contd. Treatment of Pools of CRM Techniques 3. residual maturity of the exposure) expressed in years 3. 3.1.25) Where: Pa = value of the credit protection adjusted for maturity mismatch P = credit protection (e. Bank has both collateral and guarantee partially covering an exposure).2. As a result. Risk Weights for Maturity Mismatches 3.g. embedded options which may reduce the term of the collateral should be taken into account so that the shortest possible effective maturity is used. on-balance sheet netting and guarantees) the following adjustment will be applied: Pa = P x (t-0. guarantee amount) adjusted for any haircuts t = min (T.1. taking into account any applicable grace period.g. When there is a maturity mismatch with recognised credit risk mitigants (collateral. portion covered by collateral.15. The maturity of the underlying exposure and the maturity of the collateral should both be defined conservatively.1.13.2.14.14. As outlined in Paragraph 3. collateral with maturity mismatches will no longer be recognised when they have a residual maturity of three months or less. the maturity of collateral for exposures with original maturities of less than one year must be matched to be recognised.25) ÷ (T-0. When credit protection provided by a single protection provider has differing maturities.g.14.:: 15 :: 3. collateral amount. portion covered by guarantee) and the risk-weighted assets of each portion must be calculated separately.15.16 .15. they must be subdivided into separate protection as well. In all cases. 3. 3. The maturity relevant here is the residual maturity.13.. In the case where Bank has multiple CRM techniques covering a single exposure (e. residual maturity of the credit protection arrangement) expressed in years T = min (5. The effective maturity of the underlying should be gauged as the longest possible remaining time before the counterparty is scheduled to fulfil its obligation. the bank will be required to subdivide the exposure into portions covered by each type of CRM technique (e. For the collateral.1 collateral with maturity mismatches are only recognised when their original maturities are greater than or equal to one year.13 Definition of Maturity 3.

where applicable. in the event of default.g. 4. e) Banks have legally enforceable on balance-sheet netting arrangement confined to loans /advances and deposits involving specific lien with proof of documentation in each relevant jurisdiction regardless of whether the counter-party is insolvent or bankrupt.16. Commencement of Implementation of the Policy: 3. the following minimum standards for legal documentation must be met.1. b) The legal mechanism by which collateral is pledged or transferred must ensure that the Bank has the right to liquidate or take legal possession of it. The implementation of the policy would commence with immediate effect consequent upon approval of the Board.:: 16:: 3. a) Documentation used in collaterised transactions and guarantees must be binding on all parties and legally enforceable in all relevant jurisdictions.1 In order for Banks to obtain capital relief for any use of CRM technique. Bank is able at any time to determine the loan/advances and deposits with the same counter-party that are subject to the netting arrangement. so that the extent of the cover is clearly defined and incontrovertible. A guarantee (counter-guarantee) must represent a direct claim on the protection provider and must be explicitly referenced to specific or pool of exposures. c) Banks must take all steps necessary to fulfill those requirements under the law applicable to the Bank’s interest in the collateral for obtaining and maintaining an enforceable security interest e. d) Banks must have clear and robust procedures for the timely liquidation of collateral to ensure that any legal condition required for declaring the default of the counter-party and liquidating the collateral are observed. f) In order for a guarantee to be recognized. Contd. of the custodian holding the collateral). the following conditions must be satisfied: i).. LEGAL CERTAINTY 4. by registering it with a registrar.16. and the collateral can be liquidated promptly.17 . insolvency or bankruptcy (or one or more otherwise – defined credit events set out in the transaction documentation) of the counter-party (and. in a timely manner..

1 6. it is imperative that Banks employ robust procedures to address mitigation of such risks. The guarantee should be explicitly documented and obligation must be amended by the guarantor. irrevocable and unconditional. The guarantee must be clearly defined. Hindi Version of the Circular follows. RESIDUAL RISKS 5. g) In order for a guarantee to be recognized. there must be no clause in the contract that would allow the protection provider unilaterally to cancel the cover or that would increase the effective cost of cover as a result of deteriorating credit quality in the guaranteed exposure. h). and (iii) The cover should be robust and no historical evidence suggests that the coverage of the counter-guarantee is less than effectively equivalent to that of a direct sovereign guarantee. Therefore. it may simultaneously increase other risks (Residual Risks). Sovereign Guarantees and counter-guarantees: A claim may be covered by a Guarantee that is indirectly counter-guaranteed by a Sovereign. (ii) both the original guarantee and the counter-guarantee meet all operational requirements for guarantees. I). (PRABIR MOULIK) GENERAL MANAGER (CP&RMD) . the following conditions must be satisfied. except that the counter guarantee need not be direct and explicit to the original claim. Branches/Offices should take note of the policy framework and comply with the requirements on receipt of various instructions thereof.:: 17 :: ii). Further the guarantee should not contain an erroneous clause wherein the guarantee will be outside the direct control of the Bank and thus prevent the protection from timely pay out in the event that the original counter party fails to make payment. 5. Such a claim may be treated as covered by a Sovereign Guarantee provided that: (i) the sovereign counter-guarantee covers all credit risk elements of the claim. While the use of CRM techniques reduces or transfers Credit Risk.

Haircut for exposures – Illustration Counterparty Sovereign Sovereign Bank Bank Corporate Corporate Individuals Maturity (years) <1 year >5 years < 1 year >5 years 1 to 5 years Irrespective of Maturity Irrespective of Maturity External rating AAAA+ AAAA+ AAAUnrated Haircut for Exposure (%) 0.0 1. >1 year. < 5 years PR3/P3/F3/A3 and Unrated Bank Securities > 5 years (as specified below) Main Index equities @ 4 1 3 8 2 6 6 12 AAA to AA PR1/P1/F1/A1 1 15 ( including convertible bonds) and Gold Other Equities ( including convertible bonds) listed on a recognised stock exchange Mutual Funds Cash in the same currency @ This Other Issues 25 Highest Haircut applicable to any security in which the fund can invest 0 would be equities included in the BSE Sensex and the NSE NIFTY.5 6.5 >1 year.Appendix-A Table-1: Standard Supervisory Haircuts Issue rating for debt securities Residual Maturity Sovereigns < 1 year 0. < 5 years 2 4 > 5 years A+ to BBB< 1 year PR2/P2/F2/A2. Table-2.0 12 4 25 Unrated 25 .

.06 0. Currency INR INR INR INR INR INR Rating of A UnAA AAA BB Collateral rated Haircut for 0. CASE 7 : Ineligible for CRM since the maturity of the collateral is less than one year & Rating is Below A-.06 0.25 0. E* = Exposure value after risk mitigation E = Current value of the exposure He = Haircut appropriate to the exposure C = Current value of the collateral received Hc = Haircut appropriate to the collateral Hfx = Haircut appropriate for currency mismatch between collateral & exposure Exposure Maturity of Exposure (Yrs) Nature of Exposure Currency Rating of Exposure Haircut for Exposure Collateral Maturity of Collateral (Yrs) Nature of Collateral Case 1 100 2 Case 2 100 3 Case 3 100 6 Case 4 100 2 Case 5 100 3 Case 6 100 3 Case 7* 100 3 Corporate Corporate Corporate Corporate Corporate Corporate INR BB Corporate INR A USD BBB INR Unrated INR AAA INR B- INR B- 0.15 0.5 Sovereign Bank Bonds Corporate Bonds Equity outside main index INR Equity in main index Corporate Bonds Corporate Bonds.5 150 CASE 4. the exposure is Zero.12 0.25 0.25 0.6 & 7 : The Haircut for the Exposure is the highest as applicable to other equities CASE 5 : As value of the Collateral is higher than the exposure after haircuts.06 Collateral Haircut for 0.04 0.Appendix – B Illustrations on Credit Risk Mitigation E* = Max {0.12 0.08 urrency Mismatch Exposure after 115 106 112 125 104 125 Haircut Collateral 97 94 80 75 110 96 after Haircut Net Exposure 18 12 32 50 0 29 100 Risk Weight 150 50 100 100 20 150 150 RWA 27 6 32 50 0 43.12 0.25 100 2 100 3 100 6 100 125 3 100 3 100 0.03 0.04 0. [E x (1+He) – C x (1-Hc-Hfx)]} Where.

Appendix-C List of Eligible Multilateral Development Banks (MBDs) • • • • • • • • • • • World Bank Group: IBRD and IFC. Caribbean Development Bank. European Bank for Reconstruction & Development. Inter-American Development Bank. European Investment Bank. Islamic Development Bank and Council of Europe Development Bank . Asian Development Bank. European Investment fund. Nordic Investment Fund. African Development Bank.