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    RBI Circular Addresses Measurement of Capital Charge for Market Risk

    August 06, 2020

    RBI issued a circular that addresses the treatment of debt mutual funds/exchange-traded funds (ETFs) while computing capital charge for market risk under the Basel III capital regulations. According to Para 8.4.1 of the Master Circular on Basel III capital regulations, capital charge for equities is applicable to units of mutual funds. This recent circular details the RBI decision on computation of capital charge for market risk for the banks investing in a debt mutual fund/ETF with underlying comprising the Central, State, and Foreign Central Governments’ bonds; bank bonds; and corporate bonds (other than bank bonds).

    Under the Basel III capital rules in the Master Circular, the minimum capital requirement is expressed in terms of two separately calculated charges. One is the "specific risk" charge for each security, which is designed to protect against an adverse movement in the price of an individual security owing to factors related to the individual issuer, both for short (short position is not allowed in India except in derivatives and Central Government Securities) and long positions. The other is the "general market risk" charge toward interest rate risk in the portfolio, where long and short positions (which is not allowed in India except in derivatives and Central Government Securities) in different securities or instruments can be offset. The circular covers the following points with respect to the computation of capital charge for market risk:

    • Investment in debt mutual fund/ETF, for which full constituent debt details are available, shall attract general market risk charge of 9%, as hitherto. Additionally, the Annex to this recent circular details the application of specific risk capital charge for exposures to securities issued by Indian and foreign sovereigns, bonds issued by banks, and corporate bonds (other than bank bonds).
    • In case of debt mutual fund/ETF, which contains a mix of the debt instruments, the specific risk capital charge shall be computed based on the lowest rated debt instrument or instrument attracting the highest specific risk capital charge in the fund.
    • Debt mutual fund/ETF, for which constituent debt details are not available, at least as of each month-end, shall continue to be treated on par with equity for computation of capital charge for market risk, as prescribed in Para 8.4.1 of the Master Circular on Basel III capital regulations.

    Keywords: Asia Pacific, India, Banking, Basel, Regulatory Capital, Market Risk, Mutual Funds, ETF, RBI

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