Asset Classification of Derivatives
RBI vide its Circular No. DBOD.No.BP.BC.57/ 21.04.157/2008-09 dated October 13, 2008 on “Prudential Norms for Off-Balance Sheet Exposures of Banks” and Circular No. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/2015-16 dated July 1, 2015 on “Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances” advised the banks including foreign branches of Indian banks as under:
i. The overdue receivables representing positive mark-to-market value of a derivative contract will be treated as a non-performing asset, if these remain unpaid for a period of 90 days from the specified due date for payment.
ii. In case the over dues arising from forward contracts and plain vanilla swaps and options become NPAs, all other funded facilities granted to the client shall also be classified as non-performing asset following the principle of borrower-wise classification as per the existing asset classification norms.
iii. However, any amount, representing positive mark-to-market value of the foreign exchange derivative contracts (other than forward contract and plain vanilla swaps and options) that were entered into during the period April 2007 to June 2008, which has already crystallised or might crystallise in future and is / becomes receivable from the client, should be parked in a separate account maintained in the name of the client /counterparty. This amount, even if overdue for a period of 90 days or more, will not make other funded facilities provided to the client, NPA on account of the principle of borrower-wise asset classification, though such receivable overdue for 90 days or more shall itself be classified as NPA, as per the extant IRAC norms. The classification of all other assets of such clients will, however, continue to be governed by the extant IRAC norms
iv. If the client concerned is also a borrower of the bank enjoying a Cash Credit or Overdraft facility from the bank, the receivables mentioned at item (i) above may be debited to that account on due date and the impact of its non-payment would be reflected in the cash credit/overdraft facility account. The principle of borrower-wise asset classification would be applicable here also, as per extant norms.
v. In cases where the contract provides for settlement of the current mark-to market value of a derivative contract before its maturity, only the current credit exposure (not the potential future exposure) will be classified as a non-performing asset after an overdue period of 90 days.
vi. As the overdue receivables mentioned above would represent unrealised income already booked by the bank on accrual basis, after 90 days of overdue period, the amount already taken to ‘Profit and Loss a/c’ should be reversed.
RBI vide its Circular No. DBOD.No.BP.BC.48 / 21.06.001/2010-11 dated October 1, 2010 on “Prudential Norms for Off-Balance Sheet Exposures of Banks – Bilateral netting of counterparty credit exposures” has decided that since the legal position regarding bilateral netting is not unambiguously clear, bilateral netting of mark-to-market (MTM) values arising on account of such derivative contracts cannot be permitted. Accordingly, banks should count their gross positive MTM value of such contracts for the purposes of capital adequacy as well as for exposure norms.
RBI vide its Circular No. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/ 2015-16 dated July 1, 2015 on “Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances” advised banks that credit exposures computed as per the current marked to market value of the contract, arising on account of the interest rate & foreign exchange derivative transactions, credit default swaps, shall also attract provisioning requirement as applicable to the loan assets in the ‘standard’ category, of the concerned counterparties. All conditions applicable for treatment of the provisions for standard assets would also apply to the aforesaid provisions for derivative exposures. 10.145 RBI vide its circular no. DBOD.BP.BC.28/21.04.157/2011-12 dated August 11, 2011 has further clarified that:
In cases where the derivative contracts provides for more settlements in future, the MTM value will comprise of (a) crystallised receivables and (b) positive or negative MTM in respect of future receivables.
If the derivative contract is not terminated on the overdue receivable remaining unpaid for 90 days, in addition to reversing the crystallised receivable from Profit and Loss Account as stipulated in para 1 of aforementioned circular, the positive MTM pertaining to future receivables may also be reversed from Profit and Loss Account to another accountstyled as ‘Suspense Account – Positive MTM’. The subsequent positive changes in the MTM value may be credited to the ‘Suspense Account – Positive MTM’, not to P&L Account.
The subsequent decline in MTM value may be adjusted against the balance in ‘Suspense Account – Positive MTM’. If the balance in this account is not sufficient, the remaining amount may be debited to the P&L Account.
On payment of the overdues in cash, the balance in the ‘Suspense Account-Crystalised Receivables’ may be transferred to the ‘Profit and Loss Account’, to the extent payment is received.
If the bank has other derivative exposures on the borrower, it follows that the MTMs of other derivative exposures should also be dealt with /accounted for in the manner as described above, subsequent to the crystalised/settlement amount in respect of a particular derivative transaction being treated as NPA.
Since the legal position regarding bilateral netting is not unambiguously clear, receivables and payables from/to the same counterparty including that relating to a single derivative contract should not be netted.
Similarly, in case a fund-based credit facility extended to a borrower isclassified as NPA, the MTMs of all the derivative exposures should be treated in the manner discussed above.
These guidelines are applicable to both outstanding derivatives contracts and the derivatives transactions undertaken from the date of the circular.