Policy

Bilateral Netting law becomes operational from October 1

KR Srivats New Delhi | Updated on October 03, 2020 Published on October 03, 2020

The new law is to boost financial market stability

From October 1, The Centre has operationalised all the provisions of the Bilateral Netting of Qualified Financial Contracts Act.

This law, which was enacted in the third week of September, is expected to help banks optimally utilise capital and increase credit limits so as to enhance liquidity in the economy, sources said.

The law now provides an unambiguous legal framework for enforceability of netting of a qualified financial contract.

Prior to this legislation, India did not have a legal framework for bilateral netting.

 

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.

Besides aiding the stability of the financial markets, this bilateral netting 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, experts said.

Now that this bilateral netting law has been made operational, economy is expected to get greater lubrication to move rather than sit and wait for the locked up assets to get released.

This will also help reduce the price of the derivative products on account of the optimal utilisation of all the capital that will be available for banks and increased credit limits for borrowers.

This law is expected to also energise the corporate bond markets because the credit default swap market will be better functioning now.

Business exits will also see better recovery as there will be improved recovery mechanism for financial contracts. To a limited extent, this legislation will supersede Insolvency and Bankruptcy Code (IBC).

How much credit would have been available

Finance Ministry had computed 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.

It assessed 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 unproductive way because of regulatory capital requirements. 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 few years back.

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 computation was based on actual data from 31 public, private and foreign banks, Finance Minister Nirmala Sitharaman had recently said in Parliament.

Netting explained

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 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 -- before this law enacted--everybody was locking more money for facing risk.

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Published on October 03, 2020
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