What changed
Previously, investments in paid-up equity of financial entities exempted from capital market exposure (CME) were assigned a 100% risk weight. RBI has now decided that risk weight and capital requirement should be based on risk characteristics, not exemption status. Hence, such investments will now attract a 125% risk weight or the risk weight warranted by external rating (or lack thereof), whichever is higher, as per paragraph 5.13.4 of the Master Circular.
What it means for you
Banks will need to hold more capital against these investments, increasing capital charges. For banking book investments, the capital charge becomes 11.25% of gross equity position; for trading book, it rises to 20.25% or higher (specific risk 11.25% plus general market risk 9%). This aligns treatment with other capital market exposures and removes a regulatory arbitrage.
What you must do
- Reclassify all investments in paid-up equity of financial entities previously exempt from CME to apply 125% risk weight or higher based on external ratings.
- Update internal risk-weighting models and capital adequacy calculations to reflect the new norms from January 1, 2012.
- Review trading book positions to ensure capital charge of 20.25% or higher is applied for specific and general market risk.
- Communicate the change to relevant treasury and risk management teams for compliance.
Who it affects
All Scheduled Commercial Banks (excluding RRBs and LABs), Treasury and risk management departments, Bank investment portfolios holding equity of financial entities
What entities are affected by this change?
This applies to banks' investments in paid-up equity of financial entities that were previously exempt from capital market exposure (CME) norms, such as certain financial institutions.
When does this new rule take effect?
The instruction is applicable from January 1, 2012, as stated in the circular.
How does this impact capital charge for trading book investments?
For trading book, the capital charge is 20.25% or higher: 11.25% for specific risk (or higher based on rating) plus 9% for general market risk on gross equity position.