Non-banking financial companies (NBFCs) have urged the finance ministry to ease liquidity coverage ratio (LCR) norms by introducing graded haircuts for corporate bond investments, instead of the current flat structure.
The finance ministry has asked the Reserve Bank of India (RBI) to examine the proposal, according to people familiar with the matter. The Department of Financial Services (DFS) also discussed the issue with NBFC representatives earlier this month.
Industry participants said a graded haircut system could encourage investments in more liquid and relatively safer assets, especially during periods of market stress.
At present, NBFCs face a 15% haircut on bonds rated between ‘AAA’ and ‘AA-’, while bonds rated ‘A’ and below attract a steep 50% haircut.
“If a further graded system is introduced, NBFCs which invest in lower rated papers will be benefitted,” said a chief financial officer at a large non-bank lender. He added that there is currently no LCR advantage in investing in ‘A’-rated instruments over riskier assets. “A graded haircut system will create incentive to invest in instruments with lower risk,” he said.
A haircut, in LCR terms, refers to the regulatory reduction in the market value of high-quality liquid assets to account for potential price volatility during stressed conditions.
However, experts caution that changes may not be straightforward. Vinod Kothari, an independent financial consultant, noted that corporate bonds already qualify as high-quality liquid assets with a 50% haircut for ‘A-’ to ‘BBB-’ rated bonds, in line with global standards.
“Corporate bonds count as part of high quality liquid assets, subject to 50% haircuts for ‘A-’ to ‘BBB-’ rated bonds. The same haircut is applicable to banks. The same is also prescribed by Basel III norms. Therefore, RBI may not deviate from a settled global norm on a matter which has international congruence,” he said.
The LCR is a key requirement under the Basel III framework, mandating banks and non-banks, including housing finance companies, to maintain sufficient liquidity buffers. These buffers, held in high-quality liquid assets, must be adequate to meet expected net cash outflows over a 30-day stress period.
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