Why NBFCs need ICAAP

Why in news?

RBI has stated that the Upper and Middle Layer NBFCs will have to follow Internal Capital Adequacy Assessment Process (ICAAP).

What is ICAAP?

• ICCAP is Internal Capital Adequacy Assessment Process (ICAAP).
• The ICAAP will inform NBFC about
  • Risks associated with assets.
  • The way management intends to mitigate those risks
  • Amount of current and future capital necessary.
• The objective is to ensure that NBFCs hold adequate capital to support the relevant risks in their business.

Why RBI proposes ICAAP?

• Size and nature of NBFC - The RBI is concerned about the growing size of NBFCs and their interconnectedness with other segments of the financial system.
• Some larger NBFCs are equivalent to smaller, new generation private banks in terms of size and complexity of business.
• The risk-management of these NBFCs is similar to commercial banks counterparts.
• The impact of pandemic – Pandemic has led to substantial reduction in consumption demand which have resulted in slowdown in credit growth.
• The impact is visible on asset quality, profitability, and capital position of NBFCs.
• The profitability of NBFC has dipped in 2021.
• Deterioration in credit quality - This deterioration in credit quality in the MSME portfolio of NBFCs has drawn regulatory attention.
• The concern is about Asset Liability Management (ALM) and credit risk for these NBFCs.

What are the key elements of ICAAP?

• The key elements of ICAAP policy are:
  1. Risk Appetite Statement – It provides the aggregate level and types of risk associated with a financial institution.
  2. Risk Profile Analysis - It will indicate the ability to accept or reject risks.
  3. Capital Management.
  4. Capital Strategy and Targets
  5. ICAAP reporting and Independent Review.

What NBFC needs to do?

• NBFCs has to
  • establish a board-approved policy and framework of ICAAP
  • assess their existing and future capital requirements based on credit, market, operational and other residual risks.
• The risk appetite defined by the board has to be reviewed periodically to take into cognizance the changing business perspective of the environment and hence of the NBFC.
• An assessment of the current and desired risk profile has to be made.
• The assessment states
  • The level of risk the NBFC is willing to take.
  • The action plan to achieve it.

What are the measures taken by RBI to regulate NBFCs?

• The ICAAP policy and framework laid down by the NBFCs will be subject to regulatory oversight.
• RBI has permitted restructuring of temporarily impaired MSME loans up to 25 crore.
• It has been further boosted by Emergency Credit Line Guarantee Scheme (ECLGS) disbursements to eligible categories.
• RBI has now put in place a PCA framework for NBFCs as an early supervisory intervention which will be effective from March 31, 2022.

Reference

1. https://www.financialexpress.com/opinion/why-nbfcs-need-icaap/2402035/