Master Circular on Prudential Norms for Capital Adequacy (2007)

RBI/2007-2008/26 DBOD No. BP.BC. 4/21.01.002 / 2007-08 July 2, 2007 All Commercial Banks (excluding  RRBs) Dear Sir, Master Circular- Prudential Norms on Capital Adequacy Please refer to the Master Circular No. DBOD. BP. BC. 13/ 21.01.002/ 2006-2007 dated July 1, 2006 consolidating instructions/ guidelines issued to banks till June 30, 2006 on matters relating to prudential norms on capital adequacy. The Master Circular has been suitably updated by incorporating instructions issued up to 30th June 2007 and has also been placed on the RBI web-site (http: // www.rbi.org.in ). 2. It may be noted that all relevant instructions on the above subject contained in the circulars listed in the Appendix have been consolidated. These instructions are applicable to all banks till March 30, 2008. However, for banks migrating to Basle II norms with effect from March 31, 2008, instructions contained in our circular DBOD. No. BP. BC.90 /20.06.001/2006-07 dated April 27, 2007 on "Implementation of the New Capital Adequacy Framework" will be applicable. For banks, which will not be migrating to Basle II, the instructions contained in this circular will continue to be applicable. Yours faithfully, (Prashant Saran) Chief General Manager-in-Charge Master Circular on ‘Prudential Norms on Capital Adequacy’ Purpose The Reserve Bank of India decided in April 1992 to introduce a risk asset ratio system for banks (including foreign banks) in India as a capital adequacy measure in line with the Capital Adequacy Norms prescribed by Basel Committee.  This circular prescribes the risk weights for the balance sheet assets, non-funded items and other off-balance sheet exposures and the minimum capital funds to be maintained as ratio to the aggregate of the risk weighted assets and other exposures, as also, capital requirements in the trading book, on an ongoing basis. Previous instructions This master circular consolidates and updates the instructions on the above subject contained in the circulars listed in Annex 11. Application To all the commercial banks, excluding Regional Rural Banks Structure 1. Introduction 1.1. Capital 1.2. Credit Risk 1.3. Market Risk 2. Guidelines 2.1. Components of Capital 2.2. Capital charge for Market risk 2.3. Capital adequacy for Subsidiaries 2.4. Procedure for computation of CRAR 3. Annex 4. Glossary 1. INTRODUCTION This master circular covers instructions regarding the components of capital and capital charge required to be provided for by the banks for credit and market risks. It deals with providing explicit capital charge for credit and market risk and addresses the issues involved in computing capital charges for interest rate related instruments in the trading book, equities in the trading book and foreign exchange risk (including gold and other precious metals) in both trading and banking books. Trading book for the purpose of these guidelines includes securities included under the Held for Trading category, securities included under the available for sale category, open gold position limits, open foreign exchange position limits, trading positions in derivatives, and derivatives entered into for hedging trading book exposures. 1.1. Capital The basic approach of capital adequacy framework is that a bank should have sufficient capital to provide a stable resource to absorb any losses arising from the risks in its business. Capital is divided into tiers according to the characteristics/qualities of each qualifying instrument. For supervisory purposes capital is split into two categories: Tier I and Tier II. These categories represent different instruments’ quality as capital. Tier I capital consists mainly of share capital and disclosed reserves and it is a bank’s highest quality capital because it is fully available to cover losses. Tier II capital on the other hand consists of certain reserves and certain types of subordinated debt. The loss absorption capacity of Tier II capital is lower than that of Tier I capital. 1.2. Credit Risk Credit risk is most simply defined as the potential that a bank’s borrower or counterparty may fail to meet its obligations in accordance with agreed terms. It is the possibility of losses associated with diminution in the credit quality of borrowers or counterparties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a customer or a counterparty to meet commitments in relation to lending, trading, settlement and other financial transactions. Alternatively, losses result from reduction in portfolio arising from actual or perceived deterioration in credit quality. For most banks, loans are the largest and the most obvious source of credit risk; however, other sources of credit risk exist throughout the activities of a bank, including in the banking book and in the trading book, and both on and off balance sheet. Banks increasingly face credit risk (or counterparty risk) in various financial instruments other than loans, including acceptances, inter-bank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options and in guarantees and settlement of transactions. The goal of credit risk management is to maximize a bank’s risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio, as well as, the risk in the individual credits or transactions. Banks should have a keen awareness of the need to identify measure, monitor and control credit risk, as well as, to determine that they hold adequate capital against these risks and they are adequately compensated for risks incurred. 1.3. Market Risk Market risk refers to the risk to a bank resulting from movements in market prices in particular changes in interest rates, foreign exchange rates and equity and commodity prices. In simpler terms, it may be defined as the possibility of loss to a bank caused by changes in the market variables.  The Bank for International Settlements (BIS) defines market risk as “the risk that the value of ‘on’ or ‘off’ balance sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates and commodity prices”. Thus, Market Risk is the risk to the bank’s earnings and capital due to changes in the market level of interest rates or prices of securities, foreign exchange and equities, as well as, the volatilities of those changes.  2. GUIDELINES 2.1. Components of Capital Capital funds: The capital funds for the banks are being discussed under two heads i.e. the capital funds of Indian banks and the capital funds of foreign banks operating in India. 2.1.1. Capital funds of Indian banks:For Indian banks, 'capital funds' would include the components Tier I capital and Tier II capital. 2.1.1.1. Elements of Tier I capital: The elements of Tier I capital include i) Paid-up capital (ordinary shares), statutory reserves, and other disclosed free reserves, if any. ii) Innovative Perpetual Debt Instruments (IPDI) eligible for inclusion as Tier I capital iii) Perpetual non-cumulative preference shares eligible for inclusion as Tier I capital - subject to laws in force from time to time; iv) Capital reserves representing surplus arising out of sale proceeds of assets. The guidelines governing the Innovative Perpetual Debt Instruments eligible for inclusion as Tier I capital indicating the minimum regulatory requirements are furnished in Annex 1 2.1.1.2.  Elements of Tier II capital: The elements of Tier II capital include undisclosed reserves, revaluation reserves, general provisions and loss reserves, hybrid capital instruments, subordinated debt, deferred revenue expenditure under VRS and investment reserve account. a. Undisclosed reserves They can be included in capital, if they represent accumulations of post-tax profits and are not encumbered by any known liability and should not be routinely used for absorbing normal loss or operating losses. . b. Revaluation reserves It would be prudent to consider revaluation reserves at a discount of 55 percent while determining their value for inclusion in Tier II capital. Such reserves will have to be reflected on the face of the Balance Sheet as revaluation reserves. c. General provisions and loss reserves Such reserves can be included in Tier II capital if they are not attributable to the actual diminution in value or identifiable potential loss in any specific asset and are available to meet unexpected losses. Adequate care must be taken to see that sufficient provisions have been made to meet all known losses and foreseeable potential losses before considering general provisions and loss reserves to be part of Tier II capital. General provisions/loss reserves will be admitted up to a maximum of 1.25 percent of total risk weighted assets.  'Floating Provisions' held by the banks, which is general in nature and not made against any identified assets, may be treated as a part of Tier II capital within the overall ceiling of 1.25 percent of total risk weighted assets, if such provisions are not netted off from gross NPAs to arrive at disclosure of net NPAs d. Hybrid debt capital instruments Those instruments  which have close similarities to equity, in particular when they are able to support losses on an ongoing basis without triggering liquidation, they may be included in Tier II capital. At present following instruments have been recognized and placed under this category.  i. Debt capital instruments eligible for inclusion as Upper Tier II capital; and ii. Redeemable cumulative preference shares eligible for inclusion as Tier II capital - subject to laws in force from time to time. The guidelines governing the instruments at (i) above, indicating the minimum regulatory requirements are furnished in Annex 2 .  e. Subordinated debt i. To be eligible for inclusion in Tier II capital, the instrument   should be fully paid-up, unsecured, subordinated to the claims of other creditors, free of restrictive clauses, and should not be redeemable at the initiative of the holder or without the consent of the Reserve Bank of India. They often carry a fixed maturity, and as they approach maturity, they should be subjected to progressive discount, for inclusion in Tier II capital. Instruments with an initial maturity of less than 5 years or with a remaining maturity of one year should not be included as part of Tier II capital. The quantum of subordinated debt instruments eligible to be reckoned as Tier II capital will be limited to 50 percent of Tier I capital. ii. Banks can raise, with the approval of their Boards, rupee-subordinated debt as Tier II capital, subject to the terms and conditions given in the Annex 3 . iii. Banks should indicate the amount of subordinated debt raised as Tier II capital by way of explanatory notes/ remarks in the Balance Sheet as well as in Schedule 5 to the Balance Sheet under ‘Other Liabilities & Provisions'. f. Deferred Revenue Expenditure under VRS In the case of public sector banks, the bonds issued to the VRS employees as a part of the compensation package, net of the unamortised VRS Deferred Revenue Expenditure, could be treated as Tier II capital, subject to compliance with the terms and conditions stipulated in para 2.1.1.2 (e)(ii). g. Investment Reserve Account In the event  of provisions created on account of depreciation in the ‘Available for Sale’ or ‘Held for Trading’ categories being found to be in excess of the required amount in any year, the excess should be credited to the Profit & Loss  account  and  an equivalent amount (net of taxes, if any and net of transfer to Statutory Reserves as applicable to such excess provision) should be appropriated to an Investment Reserve Account in Schedule 2 –“Reserves & Surplus” under the head “Revenue and other Reserves” and would be eligible for inclusion under Tier II within the overall ceiling of 1.25 per cent of total Risk Weighted Assets prescribed for General Provisions/ Loss Reserves. h. Banks are allowed to include the ‘General Provisions on Standard Assets’ and ‘provisions held for country exposures’ in Tier II capital. However, the provisions on ‘standard assets’ together with other ‘general provisions/ loss reserves’ and ‘provisions held for country exposures’ will be admitted as Tier II capital up to a maximum of 1.25 per cent of the total risk-weighted assets. 2.1.2. Capital funds of foreign banks operating in India For the foreign banks operating in India, 'capital funds' would include the two components i.e. Tier I capital and Tier II capital. 2.1.2.1. Elements of Tier I capital: The elements of Tier I capital include i) Interest-free funds from Head Office kept in a separate account in Indian books specifically for the purpose of meeting the capital adequacy norms. ii) Innovative Instruments  eligible for  inclusion as Tier I capital  iii) Statutory reserves kept in Indian books. iv) Remittable surplus retained in Indian books which is not repatriable so long as the bank functions in India. 2.1.2.2. Elements of Tier II capital: The elements of Tier II capital include the following elements. a) Elements of Tier II capital as applicable to Indian banks. b)  Head Office (HO) borrowings  raised in foreign currency (for inclusion in Upper Tier II Capital) subject to the  terms and conditions as mentioned at para 7 of Annex 2 to this circular. Foreign banks also would not require prior approval of RBI for raising subordinated debt in foreign currency through borrowings from Head Office for inclusion in Tier II capital. 2.1.2.3. Regarding the capital of foreign banks they are also required to follow the following instructions. a) The foreign banks are required to furnish to Reserve Bank, (if not already done), an undertaking to the effect that the banks will not remit abroad the remittable surplus retained in India and included in Tier I capital as long as the banks function in India. b) These funds may be retained in a separate account titled as 'Amount Retained in India for Meeting Capital to Risk-weighted Asset Ratio (CRAR) Requirements' under 'Capital Funds'. c) An auditor's certificate to the effect that these funds represent surplus remittable to Head Office once tax assessments are completed or tax appeals are decided and do not include funds in the nature of provisions towards tax or for any other contingency may also be furnished to Reserve Bank. d) Foreign banks operating in India are permitted to hedge their entire Tier I capital held by them in Indian books subject to the following conditions: (i) The forward contract should be for tenor of one year or more and may be rolled over on maturity. Rebooking of cancelled hedge will require prior approval of Reserve Bank (ii) The capital funds should be available in India to meet local regulatory and CRAR requirements. Therefore, foreign currency funds accruing out of hedging should not be parked in nostro accounts but should remain swapped with banks in India at all times. (iii) Capital reserve representing surplus arising out of sale of assets in India held in a separate account and which is not eligible for repatriation so long as the bank functions in India. (iv) Interest-free funds remitted from abroad for the purpose of acquisition of property and held in a separate account in Indian books. (v) The net credit balance, if any, in the inter-office account with Head Office/overseas branches will not be reckoned as capital funds. However, any debit balance in Head Office account will have to be set-off against the capital. (vi) Foreign banks in India may raise Head Office (HO) borrowings in foreign currency for inclusion as Tier I /Tier II capital subject to the same terms and conditions as  indicated at  para 7 of Annex 1 & 2.  e) Foreign banks operating in India are also required to comply with the instructions on limits for Tier II elements and norms on cross holdings as applicable to Indian banks. The elements of Tier I & Tier II capital do not include foreign currency loans granted to Indian parties. The foreign banks are also required to follow the guidelines given at Annex 4 on the subordinated debt-head office borrowings in foreign currency raised by foreign banks operating in India for inclusion in Tier II capital 2.1.3 Deductions from computation of Capital funds: 2.1.3.1 Tier I capital: The following deductions should be made from Tier I capital a) Equity investments in subsidiaries, intangible assets and losses in the current period and those brought forward from previous periods should be deducted from Tier I capital. b) In the case of public sector banks which have introduced Voluntary Retirement Scheme (VRS), in view of the extra-ordinary nature of the event, the VRS related Deferred Revenue Expenditure would not be reduced from Tier I capital. However, it will attract 100% risk weight for capital adequacy purpose. c) Creation of deferred tax asset (DTA) results in an increase in Tier I capital of a bank without any tangible asset being added to the banks’ balance sheet. Therefore, DTA, which is an intangible asset, should be deducted from Tier I capital. 2.1.3.2 Tier I & Tier II Capital Credit Enhancements pertaining to Securitization of Standard Assets a) Treatment of First Loss Facility The first loss credit enhancement provided by the originator shall be reduced from capital funds and the deduction shall be capped at the amount of capital that the bank would have been required to hold for the full value of the assets, had they not been securitised. The deduction shall be made at 50% from Tier I and 50% from Tier II capital. b) Treatment of Second Loss Facility The second loss credit enhancement provided by the originator shall be reduced from capital funds to the full extent. The deduction shall be made 50% from Tier I and 50% from Tier II capital.  c) Treatment of credit enhancements provided by third party In case, the bank is acting as a third party service provider, the first loss credit enhancement provided by it shall be reduced from capital to the full extent as indicated at para (a) above. d) Underwriting by an originator Securities issued by the SPVs  and devolved / held by the banks in excess of 10 per cent of the original amount of issue, including secondary market purchases,  shall be deducted 50% from Tier I capital and 50% from Tier II capital. e) Underwriting by third party service providers If the bank has underwritten securities issued by SPVs devolved and held by banks which are below investment grade will be deducted from capital at 50% from Tier I and 50% from Tier II. 2.1.4. Limit for Tier II elements Tier II elements should be limited to a maximum of 100 percent of total Tier I elements for the purpose of compliance with the norms. 2.1.5. Norms on cross holdings (i) A bank’s / FI’s investments in all types of instruments listed at 2.1.5 (ii) below, which are issued by other banks / FIs and are eligible for capital status for the investee bank / FI, will be limited to 10 per cent of the investing bank's capital funds (Tier I plus Tier II capital).  (ii) Banks' / FIs' investment in the following instruments will be included in the prudential limit of 10 per cent referred to at 2.1.5(i) above. a. Equity shares; b. Innovative Perpetual Debt Instruments eligible as Tier I capital; c. Preference shares eligible for capital status; d. Subordinated debt instruments; e. Debt capital Instruments qualifying for Upper Tier II status ; and f. Any other instrument approved as in the nature of capital. (iii) Banks / FIs should not acquire any fresh stake in a bank's equity shares, if by such acquisition, the investing bank's / FI's holding exceeds 5 per cent of the investee bank's equity capital. (iv) Banks’ / FIs’ investments in the equity capital of subsidiaries are at present deducted from their Tier I capital for capital adequacy purposes. Investments in the instruments issued by banks / FIs which are listed at paragraph 2.1.5(ii) above, which are not deducted from Tier I capital of the investing bank/ FI, will attract 100 per cent risk weight for credit risk for capital adequacy purposes. Note: Following investments are excluded from the purview of the ceiling of 10 percent prudential norm prescribed above: a) Investments in equity shares of other banks /FIs in India held under the provisions of a statute. b) Strategic investments in equity shares of other banks/FIs incorporated outside India as romoters/significant shareholders (i.e. Foreign Subsidiaries / Joint Ventures / Associates). c) Equity holdings outside India in other banks / FIs incorporated outside India. 2.1.6. Swap Transactions Banks are advised not to enter into swap transactions involving conversion of fixed rate rupee liabilities in respect of Innovative Tier I/Tier II bonds into floating rate foreign currency liabilities. 2.1.7. Minimum requirement of capital funds Banks are required to maintain a minimum CRAR of 9 percent on an ongoing basis. 2.2. Capital charge for Market risk 2.2.1. As an initial step towards prescribing capital requirement for market risk, banks were advised to: i) assign an additional risk weight of 2.5 per cent on the entire investment portfolio; ii) assign a risk weight of 100 per cent on the open position limits on foreign exchange and gold; and iii) build up Investment Fluctuation Reserve up to a minimum of five per cent of the investments held in Held for Trading and Available for Sale categories in the investment portfolio. 2.2.2. Subsequently, keeping in view the ability of the banks to identify and measure market risk, it was decided to assign explicit capital charge for market risk. Thus banks are required to maintain capital charge for market risk on securities included in the Held for Trading and Available for Sale categories, open gold position, open forex position, trading positions in derivatives and derivatives entered into for hedging trading book exposures. Consequently, the additional risk weight of 2.5% towards market risk on the investment included under Held for Trading and Available for Sale categories is not required. 2.2.3. To begin with, capital charge for market risks is applicable to banks on a global basis. At a later stage, this would be extended to all groups where the controlling entity is a bank. 2.2.4. Banks are required to manage the market risks in their books on an ongoing basis and ensure that the capital requirements for market risks are being maintained on a continuous basis, i.e. at the close of each business day. Banks are also required to maintain strict risk management systems to monitor and control intra-day exposures to market risks. 2.2.5. Capital charge for interest rate risk : The capital charge for interest rate related instruments and equities would apply to current market value of these items in bank’s trading book. The current market value will be determined as per extant RBI guidelines on valuation of investments. The minimum capital requirement is expressed in terms of two separate capital charges i.e. S pecific risk charge for each security both for short and long positions and G eneral market risk charge towards interest rate risk in the portfolio where long and short positions in different securities or instruments can be offset. In India short position is not allowed except in case of derivatives and Central Government Securities. The  banks  have to  provide the  capital charge for interest rate risk in the trading book other than derivatives as per the guidelines given below  for   both specific risk   and general risk after measuring the risk of holding or taking positions in debt securities and other interest rate related instruments in the trading book. 2.2.5.1. Specific risk : This refers to risk of loss caused by an adverse price movement of a security principally due to factors related to the issuer. The specific risk charge is designed to protect against an adverse movement in the price of an individual security owing to factors related to the individual issuer. The specific risk charge is graduated for various exposures under three heads i.e. claims on Government, claims on banks, claims on others and is given in Annex 5 2.2.5.2. General Market Risk: The capital requirements for general market risk are designed to capture the risk of loss arising from changes in market interest rates. The capital charge is the sum of four components: the net short (short position is not allowed in India except in derivatives and Central Government Securities) or long position in the whole trading book; a small proportion of the matched positions in each time-band (the “vertical disallowance”); a larger proportion of the matched positions across different time-bands (the “horizontal disallowance”), and a net charge for positions in options, where appropriate. 2.2.5.3. Computation of capital charge for market risk: The Basel Committee has suggested two broad methodologies for computation of capital charge for market risks i.e. the Standardised method and the banks’ Internal Risk Management models (IRM) method. As banks in India are still in a nascent stage of developing internal risk management models, it has been decided that, to start with, banks may adopt the standardised method. Under the standardised method there are two principal methods of measuring market risk, a “maturity” method and a “duration” method. As “duration” method is a more accurate method of measuring interest rate risk, it has been decided to adopt Standardised Duration method to arrive at the capital charge. Accordingly, banks are required to measure the general market risk charge by calculating the price sensitivity (modified duration) of each position separately.  Under this method, the mechanics are as follows: first calculate the price sensitivity (modified duration) of each instrument; next apply the assumed change in yield to the modified duration of each instrument between 0.6 and 1.0 percentage points depending on the maturity of the instrument as given in  Annex 6 slot the resulting  capital charge measures into a maturity ladder with the fifteen time bands as set out in Annex 6; subject long and short positions (short position is not allowed in India except in derivatives and Central Government Securities) in each time band to a 5 per cent vertical disallowance designed to capture basis risk; and carry forward the net positions in each time-band for horizontal offsetting subject to the disallowances set out in Annex  7 . 2.2.5.4. Capital charge for interest rate derivatives: The measurement of capital charge for market risks should include all interest rate derivatives and off-balance sheet instruments in the trading book and derivatives entered into for hedging trading book exposures which would react to changes in the interest rates, like FRAs, interest rate positions, etc. The details of measurement of capital charge for interest rate derivatives and options are furnished below. 2.2.5.5. Interest rate derivatives The measurement system should include all interest rate derivatives and off-balance-sheet instruments in the trading book, which react to changes in interest rates, (e.g. forward rate agreements (FRAs), other forward contracts, bond futures, interest rate and cross-currency swaps and forward foreign exchange positions). Options can be treated in a variety of ways as described at para 2.2.5.5.2 below. A summary of the rules for dealing with interest rate derivatives is set out at the end of this section. a) Calculation of positions The derivatives should be converted into positions in the relevant underlying and be subjected to specific and general market risk charges as described in the guidelines. In order to calculate the capital charge, the amounts reported should be the market value of the principal amount of the underlying or of the notional underlying. For instruments where the apparent notional amount differs from the effective notional amount, banks must use the effective notional amount. i. Futures and forward contracts, including Forward Rate Agreements (FRA) These instruments are treated as a combination of a long and a short position in a notional government security. The maturity of a future or a FRA will be the period until delivery or exercise of the contract, plus - where applicable - the life of the underlying instrument. For example, a long position in a June three-month interest rate future (taken in April) is to be reported as a long position in a government security with a maturity of five months and a short position in a government security with a maturity of two months. Where a range of deliverable instruments may be delivered to fulfill the contract, the bank has flexibility to elect which deliverable security goes into the duration ladder but should take account of any conversion factor defined by the exchange. ii. Swaps Swaps will be treated as two notional positions in government securities with relevant maturities. For example, an interest rate swap under which a bank is receiving floating rate interest and paying fixed will be treated as a long position in a floating rate instrument of maturity equivalent to the period until the next interest fixing and a short position in a fixed-rate instrument of maturity equivalent to the residual life of the swap. For swaps that pay or receive a fixed or floating interest rate against some other reference price, e.g. a stock index, the interest rate component should be slotted into the appropriate re-pricing maturity category, with the equity component being included in the equity framework. Separate legs of cross-currency swaps are to be reported in the relevant maturity ladders for the currencies concerned. b) Calculation of capital charges for derivatives under the standardised methodology: i.  Allowable offsetting of matched positions Banks may exclude the following from the interest rate maturity framework altogether (for both specific and general market risk); Long and short positions (both actual and notional) in identical instruments with exactly the same issuer, coupon, currency and maturity. A matched position in a future or forward and its corresponding underlying may also be fully offset (the leg representing the time to expiry of the future should however be reported) and thus excluded from the calculation. When the future or the forward comprises a range of deliverable instruments, offsetting of positions in the future or forward contract and its underlying is only permissible in cases where there is a readily identifiable underlying security which is most profitable for the trader with a short position to deliver. The price of this security, sometimes called the "cheapest-to-deliver", and the price of the future or forward contract should in such cases move in close alignment. No offsetting will be allowed between positions in different currencies; the separate legs of cross-currency swaps or forward foreign exchange deals are to be treated as notional positions in the relevant instruments and included in the appropriate calculation for each currency. In addition, opposite positions in the same category of instruments can in certain circumstances be regarded as matched and allowed to offset fully. To qualify for this treatment the positions must relate to the same underlying instruments, be of the same nominal value and be denominated in the same currency. In addition: for futures: offsetting positions in the notional or underlying instruments to which the futures contract relates must be for identical products and mature within seven days of each other; for swaps and FRAs: the reference rate (for floating rate positions) must be identical and the coupon closely matched (i.e. within 15 basis points); and for swaps, FRAs and forwards: the next interest fixing date or, for fixed coupon positions or forwards, the residual maturity must correspond within the following limits: less than one month hence: same day; between one month and one year hence: within seven days; over one year hence: within thirty days. Banks with large swap books may use alternative formulae for these swaps to calculate the positions to be included in the duration ladder. The method would be to calculate the sensitivity of the net present value implied by the change in yield used in the duration method and allocate these sensitivities into the time-bands set out in Table 1 in Section 2.3.5.4.2( a) ii. Specific risk iii. Interest rate and currency swaps, FRAs, forward foreign exchange contracts and interest rate futures will not be subject to a specific risk charge. This exemption also applies to futures on an interest rate index (e.g. LIBOR). However, in the case of futures contracts where the underlying is a debt security, or an index representing a basket of debt securities, a specific risk charge will apply according to the credit risk of the issuer as set out in paragraphs above. General market risk General market risk applies to positions in all derivative products in the same manner as for cash positions, subject only to an exemption for fully or very closely matched positions in identical instruments as defined in paragraphs above. The various categories of instruments should be slotted into the maturity ladder and treated according to the rules identified earlier. Table - Summary of treatment of interest rate derivatives Instrument

Reproduced for reference with acknowledgment — Source: Reserve Bank of India · RBI/2007-2008/26 · issued 02 Jul 2007. The plain-English explanation above is BankPulse’s own independent summary.

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