On February 17, the Reserve Bank of India (RBI) issued draft guidelines on minimum capital requirements for market risk Under the Basel-III framework. This is as a part of convergence of the Reserve Bank’s regulations for banks with Basel III standards.
Essentially, the draft guidelines set boundaries between the banking book and trading book of banks.
If you have already about the news development and want to understand more about it, here is an explainer.
What did the RBI say?
In its draft guidelines, the RBI set out the instruments to be included in the trading book (which are subject to market risk capital requirements) and those to be included in the banking book (which are subject to credit risk capital requirements).
“A bank shall have clearly defined policies, procedures and documented practices for determining which instruments to include in or to exclude from the trading book for the purposes of calculating their regulatory capital, ensuring compliance with the criteria set forth in this section, and taking into account the bank’s risk management capabilities and practices,” RBI said.
Apart from this, the central bank also talked about restrictions on shifting instruments between the regulatory books and treatment of internal risk transfers.
When will the new rules be implemented?
The RBI has sought comments from all the stakeholders and members of the public on these guidelines by April 15, 2023. After this process, the final guidelines will be issued.
Will these be applicable for all banks?
These guidelines will be applicable to all commercial banks (excluding Local Area Banks, Payments Banks, Regional Rural Banks and Small Finance Banks).
“These guidelines are not applicable to Co-operative Banks (i.e., Urban Co-operative Banks, State Co-operative Banks and Central Co-operative Banks).” RBI said in a statement.
Which instruments will be included?
The central bank, in the draft guidelines. said a trading book, for the purpose of capital adequacy, shall consist of all instruments that meet the specifications for trading book instruments such as financial instruments and foreign exchange.
All other instruments shall be included in the banking book.
Financial instruments include primary financial instruments (or cash instruments) and derivative financial instruments.
A financial asset is any asset that is cash, the right to receive cash or another financial asset, or an equity instrument.
“Banks shall only include a financial instrument or instruments on FX in the trading book when there is no legal impediment against selling or fully hedging it,” RBI said.
Do banks have an option to change the instrument?
As per the draft guidelines, banks have the option of deviating from the presumptive list according to the process set out by the central bank.
RBI says that if a bank believes that it needs to deviate from the presumptive list for an instrument, it shall submit a request to the Department of Regulation, RBI, and receive explicit approval.
Further, it said in cases where this approval is not given, the instrument shall be designated as a trading book instrument.
“Banks shall document any deviations from the presumptive list in detail on an on-going basis,” the RBI draft guidelines say.
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