Why in News:

• RBI has put up the draft circular, Liquidity Risk Management Framework for Non-Banking Financial Companies and Core Investment Companies.

Background: / What are the new rules?

• LCR – Non-Banking Financial Companies (NBFCs) should maintain a liquidity coverage ratio (LCR) in line with banks.
• The LCR requires banks to hold enough high-quality liquid assets (HQLA) that can be sold to fund banks during a stress scenario.
• The LCR requirement shall be binding on NBFCs from April 01, 2020. The liquidity rules were proposed for all NBFCs.
• But for NBFCs with assets above Rs 5,000 crore and deposit-taking NBFCs, the LCR is mandatory. HQLA – RBI has asked the firms to have sufficient High-Quality Liquid Asset (HQLA) that would keep them liquid for at least 30 days.
• HQLAs are generally cash or government securities that can be quickly sold in the market to raise cash. The minimum HQLAs to be held from April 1, 2020 will be 60% of the LCR.
• But by April 1, 2024, large and deposit-taking NBFCs should have HQLAs of a minimum of 100% of net cash outflows over the next 30 calendar days.
• Collaterals – An NBFC must actively manage its collateral positions, differentiating between encumbered and unencumbered (free of liabilities) assets.
• NBFCs should monitor such assets so that they can be mobilised in a timely manner.
• All NBFCs must have contingency funding plans for responding to severe disruptions.
• Liquidity position – Firms are to measure their liquidity in a granular manner, measuring as minutely as 1-7 days’, 8-14 days’, and 15-30 days’ period.
• Asset-liability mismatches should not exceed 10-20% in the timeframes running up to a year. Liquidity position has to be reported to the RBI, along with the interest rate sensitivity statement. Liquidity positions should also be disclosed to the public for investors.
• Earlier, the RBI also asked large NBFCs to introduce chief risk officers to manage asset- liability mismatches on the books. In addition to the structural and dynamic liquidity needs, a stock approach will also have to be maintained to gauge liquidity needs.
• NBFCs were thus asked to maintain tools that would generate early warning on risk situations.

What is the Rationale?

• Since the IL&FS crisis, there has been notable uncertainty in the NBFC market.
• Over the past few months, many NBFCs have not been able to borrow from markets, including banks. In this backdrop, the regulatory norms are good for the long-term sustainability of the NBFC sector. With the RBI bringing in the guidelines to manage asset- liability mismatches, lenders will get more confidence.
• It ensures that an NBFC has sufficient collateral to meet expected and unexpected borrowing needs.