What changed
RBI replaced the earlier Paragraph E on CDS credit conversion factors in the prudential norms for both deposit-taking and non-deposit-taking NBFCs. The new rules specify that NBFCs can only buy CDS to hedge corporate bonds they hold, with different capital treatment for current-category versus permanent-category bonds. For current-category bonds, only 80% of the hedged exposure gets credit protection recognition, while permanent-category bonds allow full substitution of the exposure to the protection seller.
What it means for you
NBFCs must now apply a 20% capital charge on the hedged portion of current-category corporate bonds, plus a 100% credit conversion factor for counterparty risk on the CDS. For permanent-category bonds, the exposure is fully replaced by the protection seller's risk weight (20% for banks, 100% for others). This tightens capital requirements for current-category hedges and clarifies the treatment for permanent holdings.
What you must do
- Review all CDS hedges on corporate bonds to classify bonds as current or permanent category.
- For current-category bonds hedged with CDS, calculate capital charge as 20% of market value times issuer risk weight, plus counterparty risk charge on CDS.
- For permanent-category bonds hedged with CDS, apply full substitution: use protection seller's risk weight (20% for banks, 100% for others).
- Ensure no mismatches exist between CDS and hedged bond for the above treatments to apply.
- Update internal capital adequacy frameworks and reporting systems to reflect these revised credit conversion factors.
Who it affects
All NBFCs (excluding RNBCs) holding corporate bonds, NBFC treasury and risk management teams, Compliance and capital planning departments of NBFCs
What happens if there is a mismatch between the CDS and the hedged bond?
The circular specifies that the treatment applies only when there is no mismatch between the CDS and the hedged bond. If a mismatch exists, the standard capital rules for unhedged exposures would apply, but this circular does not provide specific guidance for mismatched positions.