Liquidity Risk Management Policy

Last updated on: 28th November 2023

Preamble:

In order to strengthen and raise the standard of the Asset Liability Management (“ALM”) framework applicable to NBFCs, RBI has revised the extant guidelines on liquidity risk management for NBFCs. All non-deposit-taking NBFCs with asset size of ₹ 100 crore and above, systemically important Core Investment Companies, and all deposit-taking NBFCs irrespective of their asset size, shall adhere to the set of liquidity risk management guidelines given below.

RBI has accordingly provided guidelines on the Liquidity Risk Management Framework for NBFCs for adherence by regulated entities vide Circular RBI/2019-20/88 DOR.NBFC (PD) CC. No.102/03.10.001/2019-20 dated November 4, 2019. The Framework kicked in effective from December 1, 2020. The Company initiated requisite steps for ensuring adherence to the Framework.

RBI has since issued consolidated Master Direction – Reserve Bank of India (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023 which are being updated from time to time and the Company has been recognised in the category of Middle Layer for the purpose of regulation and supervision by RBI.

The LRM policy has been framed taking into account the RBI guidelines and reflects the business model requirements of the Company and is placed for the approval of the Board, pursuant to the recommendation of the Risk Management Committee of the Company (“RMC”).

Policy Components:

Liquidity Risk Management Policy, Strategies, and Practices
Management Information System (MIS)
Internal Controls
Maturity profiling
Liquidity Risk Measurement – Stock Approach
Managing Interest Rate Risk
Liquidity Risk Monitoring Tools –
Liquidity Coverage Ratio
High-Quality Liquid Assets

Liquidity Risk Management Policy, Strategies and Practices

In order to ensure a sound and robust liquidity risk management system, the Board of the Company framed a liquidity risk management policy to ensure that it maintains, sufficient liquidity, including a cushion of unencumbered high-quality liquid assets (HQLA) to withstand a range of stress events, including those involving the loss or impairment of both unsecured and secured lending. Key elements of the liquidity risk management framework are as under:
- Governance of Liquidity Risk Management
  
  The RMC, aided by ALCO, shall be involved in the process of identification, measurement, and mitigation of liquidity risks. The Board of Directors of the Company shall have the overall responsibility for the management of liquidity risk.
- Liquidity Risk Tolerance
  
  A strategy to manage liquidity risk in accordance with risk tolerance and ensure that the Company maintains sufficient liquidity has been put in place. A sound process for identifying, measuring, monitoring, and controlling liquidity risk has also been developed.
- Liquidity Costs, Benefits, and Risks in the Internal Pricing
  
  The Company endeavours to develop a process to quantify liquidity costs and benefits so that the same may be incorporated in the internal product pricing, performance measurement and new product approval process for all material business lines, products and activities.
- Off-balance Sheet Exposures and Contingent Liabilities
  
  The process of identifying, measuring, monitoring and controlling liquidity risk includes a robust framework for comprehensively projecting cash flows arising from assets, liabilities and off-balance sheet items over an appropriate set of time horizons.
- Funding Strategy – Diversified Funding
  
  There shall not be over-dependency on a single source of funding and thus the Company with the approval of the Board shall establish a funding strategy that provides effective diversification in the sources and tenor of funding. It should maintain an ongoing presence in its chosen funding markets taking benefit of strong relationships with fund providers to promote effective diversification of funding sources and regularly gauge its capacity to raise funds quickly from each source.
- Collateral Position Management
  
  Collateral positions, differentiating between encumbered and unencumbered assets shall be managed by the Company. It shall monitor the legal entity and physical location where the collateral is held and how it may be mobilized in a timely manner. The Company shall have sufficient collateral to meet expected and unexpected borrowing needs and potential increases in margin requirements over different timeframes.
- Stress Testing
  
  Stress testing shall form an integral part of the overall governance and liquidity risk management culture in the Company. In designing liquidity stress scenarios, the nature of The Company’s business, activities, and vulnerabilities shall be taken into consideration so that the scenarios incorporate the major funding and market liquidity risks to which the Company is exposed if the maturity mismatch is above the RBI prescribed tolerance limits.
  
  The Company shall conduct stress tests on a quarterly basis for a variety of short-term and protracted Company-specific and market-wide stress scenarios (individually and in combination), if the maturity mismatch is above the RBI-prescribed tolerance limits.
- Contingency Funding Plan
  
  A contingency funding plan (CFP) shall be formulated for responding to likely severe disruptions which might affect the Company’s ability to fund some or all of its activities from market borrowings in a timely manner and at a reasonable cost. Contingency plans should contain details of available/ potential contingency funding sources and the amount/ estimated amount which can be drawn from these sources, clear escalation/ prioritization procedures detailing when and how each of the actions can and should be activated, and the lead time needed to tap additional funds from each of the contingency sources.
- Public disclosure
  
  To enable market participants to make an informed judgment about the soundness of its liquidity risk management framework and liquidity position, the Company (since it is a closely held private limited entity and that it has no plans to raise borrowings from the public) shall publicly disclose information in the annual financial statement and provide to other stakeholders on a need-to-know basis as and when required.
- Intra Group transfers
  
  With a view to recognizing the likely increased risk arising due to Intra-Group transactions and exposures (ITEs), the Company with the approval of its Board of Directors shall develop and maintain liquidity management processes and Rsource Planning Policy for its funding programmes that are consistent with the complexity, risk profile, and scope of operations of the companies in the Group. The liquidity risk management processes and funding programmes are expected to take into account lending, investment, and other activities, and ensure that adequate liquidity is maintained. Processes and programmes should fully incorporate real and potential constraints, including legal and regulatory restrictions, on the transfer of funds from and to the parent Company.

Management Information System (MIS)

The Company shall have a reliable MIS designed to provide timely and forward-looking information on the liquidity position of the Company to the Board and RMC, both under normal and stress situations. It shall capture all sources of liquidity risk, including contingent risks and those arising from new activities, and have the ability to furnish more granular and time-sensitive information during stress events. The following shall be hygiene MIS components:

1	Cumulative Gap Analysis of the following: Total inflows (Cash, advances, trade receivables and others) vs Total outflows (Borrowings repayment, capital reserves and surplus and others)
2	Capital Adequacy Tier1/Tier 2
3	Leverage Ratio

Internal Controls

The Company shall have appropriate internal controls, systems, and procedures to ensure adherence to liquidity risk management policies and procedures. RMC should ensure that an independent party regularly reviews and evaluates the various components of the Company’s liquidity risk management process.
Maturity Profiling
- For measuring and managing net funding requirements, the use of a maturity ladder and calculation of cumulative surplus or deficit of funds at selected maturity dates is adopted as a standard tool. The Maturity Profile shall be used for measuring the future cash flows of the Company in different time buckets. The time buckets shall be distributed as under
  - 1 day to 7 days
  - 8 day to 14 days
  - 15 days to 30/31 days (One month)
  - Over one month and upto 2 months
  - Over two months and upto 3 months
  - Over 3 months and upto 6 months
  - Over 6 months and upto 1 year
  - Over 1 year and upto 3 years
  - Over 3 years and upto 5 years
  - Over 5 years
- Within each time bucket, there could be mismatches depending on cash inflows and outflows. While the mismatches up to one year would be relevant since these provide early warning signals of impending liquidity problems, the main focus shall be on the short-term mismatches, viz., 1-30/31 days. The net cumulative negative mismatches in the Statement of Structural Liquidity in the maturity buckets 1-7 days, 8-14 days, and 15-30 days shall not exceed 10%, 10% and 20% of the cumulative cash outflows in the respective time buckets. The Company, however, shall monitor its cumulative mismatches (running total) across all other time buckets upto 1 year by establishing internal prudential limits with the approval of the Board. The Company shall also adopt the above cumulative mismatch limits for their structural liquidity statement for consolidated operations.
- The Statement of Structural Liquidity shall be prepared by placing all cash inflows and outflows in the maturity ladder according to the expected timing of cash flows. A maturing liability shall be a cash outflow while a maturing asset shall be a cash inflow.
- In order to monitor its short-term liquidity on a dynamic basis over a time horizon spanning from 1 day to 6 months, the Company shall estimate its short-term liquidity profiles on the basis of business projections and other commitments for planning purposes.

Liquidity Risk Measurement – Stock Approach

The Company shall adopt a “stock” approach to liquidity risk measurement and monitor certain critical ratios in this regard by putting in place internally defined limits as approved by its Board, pursuant to the recommendation of the RMC. An indicative list of certain critical ratios to monitor in the initial phase are:

Sr.	Ratio	Purpose
1	Short term liability/Total Assets	To gauge the asset-liability mismatch in the Company.
2	Short term liabilities/Long term assets	To gauge the asset-liability mismatch in the Company.
3	Commercial Papers/Total Assets	To gauge the dependence on the type of borrowing.
4	Non-convertible debentures/total Assets	To gauge the dependence on the type of borrowing.
5	Short term liabilities/Total liabilities	To gauge the percentage of obligations to be met within 1 year so that the ability to meet these requirements can be addressed.
6	Long term assets/Total assets	To gauge the percentage of assets to materialize after 1 year which indicates the ability to service any debts/borrowings.
7	Liquidity Coverage Ratio	The Company shall maintain adequate stock of unencumbered high-quality liquid assets that can be easily and immediately converted in financial markets, at no or little loss of value.
8	Net Stable Funding Ratio	The Company shall maintain a stable funding profile in relation to its off-balance sheet assets and activities. The goal is to reduce the probability that shocks, affecting the Company’s usual funding sources, might erode its liquidity position, increasing its risk of bankruptcy

Managing Interest Rate Risk (IRR)

Being a lending entity, the Company shall hedge, if required, the interest rate risk as one of its essential operational activities.
- As per RBI mandate, the Gap or Mismatch risk shall be measured by calculating Gaps over different time intervals as at a given date. Gap analysis measures mismatches between rate sensitive liabilities and rate sensitive assets (including off-balance sheet positions). An asset or liability is normally classified as rate sensitive if:
  - within the time interval under consideration, there is a cash flow;
  - the interest rate resets/reprices contractually during the interval;
  - dependent on RBI changes in the interest rates/Bank Rate;
  - it is contractually pre-payable or withdrawal before the stated maturities.
- The Gap Report shall be generated by grouping rate sensitive liabilities, assets and off-balance sheet positions into time buckets according to residual maturity or next repricing period, whichever is earlier. All investments, advances, borrowings, purchased funds, etc. that mature/reprice within a specified timeframe are interest rate sensitive. Similarly, any principal repayment of loan is also rate sensitive if the Company expects to receive it within the time horizon. This includes final principal payment and interim instalments. Certain assets and liabilities to receive/pay rates vary with a reference rate.
- The Gaps shall be identified in the following time buckets:
  - 1-30/31 days (One month)
  - Over one month to 2 months
  - Over two months to 3 months
  - Over 3 months to 6 months
  - Over 6 months to 1 year
  - Over 1 year to 3 years
  - Over 3 years to 5 years
  - Over 5 years
  - Non-sensitive
  The Gap is the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) for each time bucket. The positive Gap indicates that it has more RSAs than RSLs whereas the negative Gap indicates that it has more RSLs than RSAs. The Gap reports indicate whether the institution is in a position to benefit from rising interest rates by having a positive Gap (RSA > RSL) or whether it is in a position to benefit from declining interest rates by a negative Gap (RSL > RSA). The Gap can, therefore, be used as a measure of interest rate sensitivity.
- Over and above the RBI mandated interest rate risk assessment tool, the RMC shall actively seek, if required, to hedge interest rate risk with instruments like interest rate swap.
Liquidity Risk Monitoring Tools

The Statement of Structural Liquidity is currently one of the prescribed monitoring tools. In addition to this, the following tools shall be adopted by the Company for internal monitoring of liquidity requirements:
- Concentration of Funding
  
  This metric is meant to identify those significant market sources of funding, withdrawal of which could trigger liquidity problems. The metric thus encourages diversification of funding sources and monitoring of each of the significant counterparty, significant product / instrument and significant currency.
- Available Unencumbered Assets
  
  This metric provides significant information on available unencumbered assets, which have the potential to be used as collateral to raise additional secured funding in secondary markets. It shall capture the details of the amount, type and location of available unencumbered assets that could serve as collateral for secured borrowing in secondary markets.
- Market-related Monitoring Tools
  - This includes high frequency market data that can serve as early warning indicators in monitoring potential liquidity difficulties at the Company.
  - The RMC shall monitor on a quarterly basis, the movements in their book-to-equity ratio and the coupon at which long-term and short-term debts are raised by them. This also includes information on breach/penalty in respect of regulatory liquidity requirements, if any.
Liquidity Coverage Ratio (LCR)
- The Company shall maintain an adequate level of unencumbered High Quality Liquid Assets, when market borrowings are raised, that can be converted into cash to meet its liquidity needs for a 30 calendar-day time horizon under a significantly severe liquidity stress scenario, as specified in these guidelines.
- LCR shall be maintained as at below on an ongoing basis to help monitor and control liquidity risk.
- The LCR requirement shall be binding on the Company when market borrowings are raised, effective from December 1, 2020, with the minimum LCR to be 50%, progressively increasing, till it reaches the required level of 100%, by December 1, 2024, as per the time-line given below:
- The LCR shall continue to be minimum 100% (i.e., the stock of HQLA shall at least equal total net cash outflows) on an ongoing basis with effect from December 1, 2024, i.e., at the end of the phase-in period.
  
  Provided that Si Creva shall have the option to use their stock of HQLA, thereby allowing LCR to fall below 100% during a period of financial stress.
  
  Provided further that Si Creva shall immediately report to RBI (Department of Regulation and Department of Supervision) such use of stock of HQLA during a period of financial stress along with reasons for such usage and corrective steps initiated to rectify the situation.
- The stress scenario for LCR shall cover a combined idiosyncratic and market-wide shock that would result in:
  - a partial loss of unsecured wholesale funding capacity;
  - a partial loss of secured, short-term financing with certain collateral and counterparties;
  - additional contractual outflows that would arise from a downgrade in the Company’s credit rating, if obtained, including collateral posting requirements;
  - increases in market volatilities that impact the quality of collateral or potential future exposure of derivative positions and thus require larger collateral haircuts or additional collateral, or lead to other liquidity needs;
  - unscheduled draws on committed but unused credit and liquidity facilities if the Company has provided to its clients; and,
  - the potential need for the Company to buy back debt, if debt instruments are used for raising borrowings, or honour non-contractual obligations in the interest of mitigating reputational risk.
High Quality Liquid Assets (as per regulations)
- Liquid assets comprise of high-quality liquid assets (HQLA) that can be readily sold or used as collateral to obtain funds in a range of stress scenarios. They shall be unencumbered. Assets are considered to be high quality liquid assets if they can be easily and immediately converted into cash at little or no loss of value. The liquidity of an asset depends on the underlying stress scenario, the volume to be monetized and the timeframe considered. Nevertheless, there are certain assets that are more likely to generate funds without incurring large discounts due to fire-sales even in times of stress.
- The fundamental characteristics of HQLAs include low credit and market risk; ease and certainty of valuation; low correlation with risky assets and listing on a developed and recognized exchange market. The market related characteristics of HQLAs include active and sizeable market; presence of committed market makers; low market concentration and flight to quality (tendencies to move into these types of assets in a systemic crisis).
- Assets to be included in the computation of HQLAs shall be those that the Company shall be holding on the first day of the stress period. Such assets shall be valued at an amount no greater than their current market value for the purpose of computing the LCR. Depending upon the nature of assets, different haircuts as prescribed under the regulations shall be applied while calculating the HQLA for the purpose of calculation of LCR.
- All assets in the stock of liquid assets must be managed as part of that pool by the Company and shall be subject to the following operational requirements:
  - must be available at all times to be converted into cash;
  - shall be unencumbered;
  - shall not be co-mingled/ used as hedges on trading position; designated as collateral or credit enhancement in structured transactions or designated to cover operational costs;
  - shall be managed with sole intent for use as a source of contingent funds; and,
  - shall be under the control of specific function/s charged with managing liquidity risk of the bank, e.g., RMC.
Role of Aseet Liability Management Committee (ALCO)

The ALCO will, apart from reviewing the liquidity returns being submitted to RBI, consider all the aspects of the Framework and update RMC at its ensuring meeting held after the end of quarter, on any of the adverse features of the operations of the Company alongwith the mitigation plans.

Revision of Policy:

The RMC shall review the Policy annually or earlier if considered necessary and shall recommend to the Board for adoption.”