What changed
Earlier, all bills discounted under LC were treated as exposure on the borrower, attracting a 100% risk weight. Now, clean negotiations (not 'under reserve') are treated as exposure on the LC issuing bank, with inter-bank risk weight. Negotiations 'under reserve' remain borrower-exposure.
What it means for you
Banks discounting clean LC bills can now assign lower capital charge (inter-bank risk weight) instead of 100% on borrower. This improves capital efficiency for such transactions. However, 'under reserve' negotiations still require full borrower risk weight, so banks must carefully classify each negotiation.
What you must do
- Update internal systems to classify LC bill discounting as exposure on LC issuing bank for clean negotiations.
- Ensure 'under reserve' negotiations are flagged and treated as borrower exposure with 100% risk weight.
- Review existing LC discounting portfolios to reallocate capital as per new norms.
- Train trade finance teams on the distinction between clean and 'under reserve' negotiations.
Who it affects
Scheduled commercial banks (excluding RRBs/LABs), Trade finance departments, Risk management teams, Capital adequacy planners
What is a 'clean negotiation' under LC?
A clean negotiation is when the bank pays the beneficiary without any reservation or recourse, meaning it does not hold the beneficiary liable if the LC issuing bank fails to pay.
Does this circular change exposure norms for all LC transactions?
No, only clean negotiations are affected. Negotiations 'under reserve' still count as exposure on the borrower with 100% risk weight.
When did this circular take effect?
It came into immediate effect from March 24, 2006.