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Saturday, December 18, 2010

Why does'Net Owned Funds' exclude investments in similar companies?

RBI guidelines for ARC's(http://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=5847) exclude investments in other ARC's for the purpose of equity('Net Owned Funds'). And this is true even for banking capital calculations by RBI.

One may feel why is this so? Why ignore credit rating, sectoral stability etc? The rationale in this case maybe to reduce systemic risks because when one bank collapses, the other banks should be, as far as possible, stable.

Another reason maybe double counting. Imagine the case where 2 FI's(banks/ARC's) have investments in each other, both counted as equity. Effectively, the net investment is zero but the regulatory may get a false perception of capital when it is not really so.

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