RBI warns banks on rising exposure to large cos; may lower cap

Flagging the potential threat of contagion to the banking system in case a large corporate fails, the Reserve Bank has hinted at bringing down the single entity and group exposure limits for lenders.
"A review of the extant single and group borrower exposure limits would considerably enhance the stability of the banking sector," RBI said in its half-yearly Financial Stability Report released earlier this week.
The existing exposure norms, which have evolved in the context of growth and developmental needs, are higher than the international standards as well, making a case for lowering the caps, it said.
Currently, the single entity exposure limit is pegged at 25 per cent of the total incremental assets of a bank in any given year. The cap for a group can even top 50 per cent of the total capital of a bank. Against this, the total average is only 25 per cent globally.

Though large banks such as SBI and ICICI often cross this limit, they normally they bring it down to the prescribed limit by the end of the given fiscal. Currently, SBI has crossed the cap in two large government-run firms -- Bharat Heavy Electricals and Indian Oil Corporation.
"Total loss to the banking system from the failure of the corporate/group will typically be distributed across banks in proportion to their individual exposures to the corporate/ group. If, in the case of one or more banks, the loss is large enough to cause distress to the bank, then there will be further losses to the banking system due to the contagion caused by the distressed bank/banks," said the report.

"Depending on the importance of the distressed bank/banks in the network of interbank exposures, the contagion losses may be substantial," it added.

The report also makes an analysis of possible scenarios saying that in several cases the contagion losses are significant and could exceed the direct losses caused by the failure of the corporate group.
"The failure of a large corporate group could result in a total loss of over 60 per cent of the banking system's capital when the LGD (loss given default) is 100 per cent and over 50 per cent of the banking system's capital when the LGD is 60 per cent," it said.

The report further said that "such risks posed by a large corporate or corporate group are sought to be minimised by large exposure limits prescribed by regulators".
The RBI report also quoted from a study conducted by the IMF and the World Bank in FY12 which said exposure norms in the country were high.
"The large exposure limit of 40 per cent, which can exceptionally be brought to 50 per cent for infrastructure exposures - for a group borrower, is significantly higher than the large exposure limits of 25 percent which is considered good international practice... This limit has the potential to allow the default of one particular consolidated borrower to cause a serious loss of capital in a banking company," the FSR said, quoting from the study.