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The Reserve Bank of India (RBI) has proposed new rules requiring banks to keep adequate capital to cover potential losses on certain financial contracts when the financial condition of the other party deteriorates.
The proposed rules will replace RBI's existing Credit Valuation Adjustment (CVA) framework, which was issued in 2011, and bring the regulations in line with updated international banking standards. CVA essentially accounts for the possibility that the value of a financial contract, such as a derivative, may decline because the party on the other side becomes financially weaker and its risk of default increases. The capital requirement is intended to ensure that banks have sufficient funds to absorb such risks. Under the proposed framework, the amount of capital a bank needs to maintain will take into account both the sector and credit quality of the other party. Higher risk is assigned to counterparties with weaker credit quality or those that are not rated. For instance, the prescribed risk weight for financial institutions is 5 per cent for those with stronger credit quality and 12 per cent for those with weaker credit quality or no rating. For companies in sectors including energy, manufacturing, agriculture and mining, the corresponding weights are 3 per cent and 7 per cent. RBI has also proposed a simpler calculation method for banks whose total amount of derivatives not cleared through a central clearing system is Rs 10 lakh crore or less. Such banks may opt to calculate their capital requirement using the alternative method, although RBI can deny the option if it finds that the risk from their derivative positions is significant. Banks will also be allowed to choose between a full and reduced version of the standard calculation method. The reduced version is intended for less sophisticated banks that do not use instruments to protect themselves against CVA risk. The proposed directions will apply to commercial banks but exclude Small Finance Banks, Payments Banks and Local Area Banks. The new framework is proposed to come into effect from April 1, 2027. RBI has invited comments from banks, market participants and other stakeholders until August 28, 2026. (ANI)
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