Netting law to help banks unlock capital and spur lending, says FM Nirmala Sitharaman

The Bilateral Netting of Qualified Financial Contracts Bill, which would help banks release a portion of their capital locked in transactions in the over-the-counter (OTC ) derivatives market and spur lending, was passed by the Rajya Sabha on Wednesday.

Stressing that the Bill is “absolutely critical” for the country’s financial stability, finance minister Nirmala Sitharaman said the absence of a bilateral netting law prevented banks from onlending as much as Rs 2.14 lakh crore during the FY17-20 period, as they were forced to lock up higher capital against trades in the OTC market.

A bilateral netting agreement typically allows two counterparties in a financial contract to offset claims against each other to determine a single net payment obligation due from one counterparty to the other.

Since the Bill has already been cleared by the Lok Sabha, it will be made into a law with the Presidential assent.

While India allows multilateral netting of over-the-counter derivative financial contracts through the Clearing Corporation of India, bilateral netting isn’t permitted.

“It is just the bilateral contracts which do not have any firm legal basis. Value of bi-lateral derivative contracts is estimated by the Clearing Corporation of India to be Rs 56,33,257 crore as of March 2018,” the minister said. Such bilateral contracts make up for about 40% of total financial contracts.

The Bill is cleared at a time when the government is exhorting banks to spur lending, as the economy needs a massive credit push to get back on its feet.

According to the RBI data, non-food bank credit growth (year-on-year) stood at just 6.7% in July, the same as in June but sharply lower than a 11.4% rise in July 2019. Loans for agriculture and allied activities rose 5.4% in July, against 6.8% a year before. However, credit to industry grew just 0.8% in July, compared with 6.1% a year earlier.

The minister said if the bilateral netting law were made available in FY17, banks would have been able to onlend Rs 42,194 crore more. Similarly, additional credit of as much as Rs 45,956 crore was blocked in FY18, Rs 67,792 crore in FY19 and Rs 58,308 crore in FY20 in the absence of the bi-lateral netting law.

Countries like the US, UK, Australia, Canada, Japan, France, Germany, Singapore and Malaysia have legal provisions in place for bilateral netting agreements.

Pitching for a bilateral netting law, the Economic Survey for FY20 had said: “…establishing a legal framework for bilateral close-out netting in India would help: (a) reduce credit risk and regulatory capital burden for banks, freeing up capital for other productive uses; (b) reduce hedging costs and liquidity needs for banks, primary dealers and other market-makers, thereby encouraging participation in the OTC derivatives market to hedge against risk….”