The financial sector may now get far more resilient, with Parliament on Wednesday passing the Bilateral Netting of Qualified Financial Contracts Bill 2020, which seeks to help banks optimally utilise capital and increase credit limits to enhance liquidity in the economy.

The Bill primarily aims to provide an unambiguous legal framework for enforceability of netting of a qualified financial contract. Prior to this, India did not have a legal framework for bilateral netting.

While the Rajya Sabha passed the Bill on Wednesday, the lower house had passed this Bill on Sunday night.

Netting enables two counter parties in a bilateral financial contract to offset claims against each other to determine a single net payment obligation due from one counter party to others in event of default.

Evaluating risks

Replying to the discussion on the Bill in the Rajya Sabha, Finance Minister Nirmala Sitharaman said this piece of legislation is necessary for the stability of the financial markets. “This will help in evaluating risks in far more real time basis and actual risk assessment will happen rather than notional assessment based on gross figure,” she added.

“Otherwise each bank was locking up money and that money was not available for economic activities. At the end of the day, locked money remains locked up and the economy is starved of funds. If this law is passed, the economy will get greater lubrication to move rather than sit and wait for the locked-up assets to get released,” she said.

The legislation will also help reduce the price of derivative products on account of the optimal utilisation of capital that will be available for banks and increased credit limits for borrowers. The passage of this Bill will also energise the corporate bond markets because the credit default swap market will be better functioning now, Sitharaman said.

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Sitharaman also highlighted that business exits will also see better recovery as there will be improved recovery mechanism for financial contracts. To a limited extent, this piece of legislation will supersede the Insolvency and Bankruptcy Code (IBC), she added.

How much was lost

Sitharaman reeled out data to show how much additional resources would have been available to the banks to extend credit if there had been legal backing for Bilateral Netting of qualified financial contracts.

“We went back to assess how much of money would have been available with the banks in case this Act was available for onward lending without keeping it aside in an unproductive way because of regulatory capital requirements. Even in 2017, ₹42,194 crore would have been available for banks for onward lending. Because this Act was not available, this amount was kept locked up. This wouldn’t have been necessary if bilateral netting had happened,” she said.

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In 2018, as much as ₹45,956 crore would have been available for credit lending. In 2019, ₹67,792 crore would have been available and in March 2020, ₹58,308 crore are locked due to absence of law on bilateral netting. This is based on actual data from 31 public, private and foreign banks.

Explaining in simple terms as to what netting means, Sitharaman said that if two parties are engaging in a bilateral contract and one has to pay the other ₹100 and the other had to pay ₹210, then at the end of the day only ₹110 would have to be exchanged after netting. Now, each keeps aside a portion for the ₹100 and ₹210 respectively, thereby both calculating risk on what they are facing rather than netting to see the risk the financial markets are facing, “ At the end of the day, everybody is locking up more money for facing risk,” she added.

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