- Executive Summary This Master Circular outlines the prudential guidelines for Urban Co-operative Banks (UCBs) regarding non-fund-based credit facilities such as Guarantees, Co-acceptances, and Letters of Credit (LCs).
- It mandates strict volume caps (e.g., total guarantees limited to 10% of owned resources), emphasizes the issuance of financial over performance guarantees, and enforces rigorous safeguards to prevent accommodation bill financing.
- The circular underlines the critical obligation of UCBs to honor commitments immediately upon invocation to maintain financial system credibility and details specific exposure norms to mitigate systemic risks.
- Guarantees Issuance Guidelines UCBs are advised to primarily issue financial guarantees.
- Scheduled banks may issue performance guarantees but must exercise due caution.
Executive Summary
This Master Circular outlines the prudential guidelines for Urban Co-operative Banks (UCBs) regarding non-fund-based credit facilities such as Guarantees, Co-acceptances, and Letters of Credit (LCs). It mandates strict volume caps (e.g., total guarantees limited to 10% of owned resources), emphasizes the issuance of financial over performance guarantees, and enforces rigorous safeguards to prevent accommodation bill financing. The circular underlines the critical obligation of UCBs to honor commitments immediately upon invocation to maintain financial system credibility and details specific exposure norms to mitigate systemic risks.
1. Guarantees
Issuance Guidelines
UCBs are advised to primarily issue financial guarantees. Scheduled banks may issue performance guarantees but must exercise due caution. The maturity of guarantees should be kept relatively short-term and must not exceed 10 years in any scenario.
Volume and Exposure Limits
To ensure financial stability, UCBs must adhere to strict quantitative limits on their guarantee business:
| Metric | Limit / Guideline |
|---|---|
| Total Guarantee Obligations | Max 10% of Total Owned Resources (Paid-up Capital + Reserves + Deposits) |
| Unsecured Guarantees | Max 25% of Owned Funds OR 25% of Total Guarantees (whichever is less) |
Secured vs. Unsecured Guarantees
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Secured: Preferred. Defined as guarantees backed by assets (including cash margin) covering the full contingent liability, or counter-guarantees from Government/PSUs.
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Unsecured: Banks must avoid concentration risk to specific groups/trades. Boards must fix reasonable proportion limits for individual constituents.
Deferred Payment Guarantees
These should be backed by tangible security or counter-guarantees. Proposals must be appraised with the same rigor as term loans, ensuring the project’s cash flows can meet repayment installments.
Operational Safeguards
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Selective Credit Controls: Guarantees for essential commodity import duties require a cash margin of at least 50%.
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Documentation: Guarantees must be issued in serially numbered security forms.
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Authorization: Guarantees above a cut-off limit require two authorized signatures.
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Non-Borrowers: Issuing guarantees for customers maintaining only current accounts requires thorough financial scrutiny and verification with their existing bankers.
Payment Discipline
UCBs must honor guarantee claims immediately upon invocation. The Supreme Court has ruled that courts should not interfere with guarantee encashment except in exceptional cases of fraud or irretrievable injustice.
2. Co-acceptance of Bills
Risk Mitigation
Co-acceptance often hides accommodation bills (bills without genuine trade) drawn by group concerns. UCBs must guard against this by ensuring:
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Genuine Trade: Co-acceptance is restricted to genuine trade bills where goods receipt can be verified.
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Valuation: Invoice values must be verified to prevent over-valuation.
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Prohibition: Co-acceptance of house bills or accommodation bills is strictly prohibited.
Administrative Controls
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Limits must be sanctioned only for customers with existing credit facilities.
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Powers to co-accept beyond a specific limit must be exercised jointly by two officials.
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Periodical returns must be submitted to controlling offices to monitor overdue bills.
3. Letters of Credit (LCs)
Granting Facilities
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Assessment: LCs should not be issued for amounts disproportionate to the borrower’s requirements.
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Capital Goods: LCs for capital acquisition must ensure long-term funds are tied up; working capital limits cannot be used for retiring such bills.
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Non-Constituents: UCBs should generally avoid opening LCs for parties who are not regular borrowers. If necessary, prior concurrence from the existing banker is mandatory.
Restrictions & Safeguards
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Inland LCs: Prohibited from having clauses that allow other banks to discount usance bills.
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Negotiation: UCBs can negotiate restricted LCs for non-borrowers only if proceeds are remitted to the beneficiary’s regular banker.
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Settlement: Claims under LCs must be settled immediately to preserve the bank’s reputation and the integrity of the payment mechanism.
4. Common Guidelines & Prudential Norms
Exposure Norms
UCBs must strictly observe statutory and regulatory exposure limits for all non-fund-based limits (Guarantees, LCs, Co-acceptances).
Asset Classification
If a UCB has to pay for a devolved LC or invoked guarantee:
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The amount should be debited to the borrower’s principal operating account.
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Parking these dues in a separate account is discouraged as it hides the true asset quality.
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For NPA classification, the outstanding balance in the separate account must be clubbed with the principal operating account.
Asset-Liability Management (ALM)
UCBs must adopt effective ALM systems to manage liquidity and interest rate risks arising from these off-balance sheet commitments.
We have made the summary of the circular for the convenience of readers. We have taken all due care to get the List of the notification but to get the exact text for the notification and it’s implication we recommend readers to visit the RBI website https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=12819