'Waterfall Payment'

What is a 'Waterfall Payment'

Definition-1

A waterfall payment is a type of payment scheme in which higher-tiered creditors receive interest and principal payments, while the lower-tiered creditors receive only interest payments. When the higher tiered creditors have received all interest and principal payments in full, the next tier of creditors begins to receive interest and principal payments.

Definition-2

A contractual loan repayment plan established by a debtor organization that prioritizes payments to multiple creditors based on the size or expense of the loan. Debtors will cascade their loans in a way that eliminates the more expensive loans with larger principal payments while making minimum interest payments to the less expensive loans.

Definition-3

A waterfall payment is a repayment system by which senior lenders receive principal and interest payments from a borrower first, and subordinate lenders receive principal and interest payments after.

How it works (Example):

Imagine the cash generated by a company as a waterfall that flows from senior lenders down to subordinate lenders.

For example, let's assume that ABC Company has borrowed Rs.100 million from Lender A and Lender B. Lender A is "senior" and Lender B is "subordinate." If ABC Company is required to make waterfall payments, Lender A must be paid all its obligations before Lender B gets anything. 

Assume that ABC Company must pay Lender A Rs 5 million in interest and Rs10 million in principal, and ABC Company must also pay Lender B Rs 4 million in interest and Rs 9 million in principal each year.

Assuming that ABC Company is able to generate at least Rs 31 million in cash with which it pays its lenders, there is no problem. But if ABC Company only makes Rs25 million one year, it must pay Lender A all Rs15 million in interest and principal, leaving only Rs10 million for Lender B. Because Lender B is farther down the waterfall, its loan is at greater risk of not getting paid in full. The "water," i.e. the cash, will get diverted to Lender A until ABC Company's obligations are fulfilled.

Why it Matters:

Waterfall payments are common for borrowers with several tranches of debt. It protects lenders who are higher up in the debt structure.

The waterfall concept can also be used in the personal finance world as well. The idea is that a person should repay the most expensive debt first.

For example, let's assume that Ram has three credit cards: Card A, Card B and Card C. The interest rates on the cards are 20%, 12% and 10%, respectively. Ram wants to get out of credit card debt, so he decides to pay down the highest interest-rate card first. The minimum monthly payments on the cards are Rs15000, Rs10000 and Rs7500, respectively. Ram makes waterfall payments. First, he pays the minimum on each card (Rs32500 total) every month, and then sends Card A an extra Rs80000. When Card A is finally paid off, he cuts it up and then applies the extra Rs 80000 per month, plus the Rs15000 monthly payment he used to send to Card A (Rs95000 in total) to Card B. When Card B is paid off, Ram applies the Rs80000 in extra payments plus the Rs25000 minimum payment he used to send to Cards A and B (Rs105,000 in total) to Card C until it is paid off.

Basel III Capital Regulations - Revision

Master Circular – Basel III Capital Regulations - Revision

Please refer to Master Circular DBR.No.BP.BC.1/21.06.201/2015-16 dated July 1, 2015 on ‘Basel III Capital Regulations’. The treatment of certain balance sheet items, as per the extant regulations on banks’ capital, differs from what is prescribed by the Basel Committee on Banking Supervision (BCBS). It has also been represented to the Reserve Bank that the current framework places on the banks in India the need to raise more capital than would be required had the Basel rules been applied as they are. The Reserve Bank has reviewed the position in this regard and it has been decided to align, to some extent, the current regulations on treatment of these balance sheet items, for the purpose of regulatory capital, with the BCBS guidelines. Accordingly it has been decided as detailed herein below:

2.1 Treatment of revaluation reserves

Revaluation reserves arising out of change in the carrying amount of a bank’s property consequent upon its revaluation may, at the discretion of banks, be reckoned as CET1 capital at a discount of 55%, instead of as Tier 2 capital under extant regulations, subject to meeting the following conditions:

bank is able to sell the property readily at its own will and there is no legal impediment in selling the property;

the revaluation reserves are shown under Schedule 2: Reserves & Surplus in the Balance Sheet of the bank;

revaluations are realistic, in accordance with Indian Accounting Standards.

valuations are obtained, from two independent valuers, at least once in every 3 years; where the value of the property has been substantially impaired by any event, these are to be immediately revalued and appropriately factored into capital adequacy computations;

the external auditors of the bank have not expressed a qualified opinion on the revaluation of the property;the instructions on valuation of properties and other specific requirements as mentioned in the circular DBOD.BP.BC.No.50/21.04.018/2006-07 January 4, 2007 on ‘Valuation of Properties - Empanelment of Valuers’ are strictly adhered to.

2.2 Treatment of foreign currency translation reserve (FCTR)

Banks may, at their discretion, reckon foreign currency translation reserve arising due to translation of financial statements of their foreign operations in terms of Accounting Standard (AS) 11 as CET1 capital at a discount of 25% subject to meeting the following conditions: 

the FCTR are shown under Schedule 2: Reserves & Surplus in the Balance Sheet of the bank;the external auditors of the bank have not expressed a qualified opinion on the FCTR.

2.3 Treatment of deferred tax assets (DTAs)

(i) Deferred tax assets (DTAs) associated with accumulated losses and other such assets should be deducted in full from CET1 capital.

(ii) DTAs which relate to timing differences (other than those related to accumulated losses) may, instead of full deduction from CET1 capital, be recognised in the CET1 capital up to 10% of a bank’s CET1 capital, at the discretion of banks [after the application of all regulatory adjustments mentioned from paragraphs 4.4.1 to 4.4.9(C)(ii) of the Master Circular].

(iii) Further, the limited recognition of DTAs as at (ii) above along with limited recognition of significant investments in the common shares of unconsolidated financial (i.e. banking, financial and insurance) entities in terms of paragraph 4.4.9.2(C) (iii) of the Master Circular taken together must not exceed 15% of the CET1 capital, calculated after all regulatory adjustments set out from paragraphs 4.4.1 to 4.4.9 of the Master Circular. Please refer to the Annex of this circular clarifying this applicable limited recognition. However, banks shall ensure that the CET1 capital arrived at after application of 15% limit should in no case result in recognising any item more than the 10% limit applicable individually.

(iv) The amount of DTAs which are to be deducted from CET1 capital may be netted with associated deferred tax liabilities (DTLs) provided that:

both the DTAs and DTLs relate to taxes levied by the same taxation authority and offsetting is permitted by the relevant taxation authority;the DTLs permitted to be netted against DTAs must exclude amounts that have been netted against the deduction of goodwill, intangibles and defined benefit pension assets; and the DTLs must be allocated on a pro rata basis between DTAs subject to deduction from CET1 capital as at (i) and (ii) above.

(v) The amount of DTAs which is not deducted from CET1 capital (in terms of para (ii) above) will be risk weighted at 250% as in the case of significant investments in common shares not deducted from bank’s CET1 capital as indicated in paragraph 4.4.9 (C)(iii) of the Master Circular.

3. These instructions are applicable with immediate effect.