Economic Survey 2020: ‘Bilateral Netting’ To Help Release Bank Capital

The Economic Survey 2019-20 has argued in favour of a practice called ‘bilateral netting' as a way to release bank capital.

Bilateral netting allows two parties involved in a swap agreement to net-off their swap positions. Such bilateral netting, which is the global standard, will help reduce the amount of capital you need to set aside for such transactions, the government's Principal Economic Adviser Sanjeev Sanyal told BloombergQuint in an interview.

According to the survey, Indian financial contract laws do not permit bilateral netting, however, they do allow multi-lateral netting where parties can offset claims against each other through a central counterparty. Global regulatory bodies such as the Financial Stability Board and the Basel Committee on Banking Supervision have supported the use of such netting. At present, major jurisdictions such as the U.S., U.K., Australia, Canada, Japan, France, Germany, Singapore and Malaysia have legal provisions in place for netting agreements, the report said.

Without bilateral netting, Indian banks have had to set aside higher capital against their trades in the over-the-counter market, which impacts their ability to participate in the market. Moreover, it also increases the systemic risk during defaults.

“According to RBI estimates, bilateral netting arrangements could have helped 31 major banks participating in India's OTC derivatives market save about Rs 2,258 crore in regulatory capital during FY2017-18,” the report said.

Bilateral netting would also help reduce hedging costs and liquidity needs for banks, primary dealers and other market-makers, thereby encouraging participation in the over-the-counter derivatives market. It would also help develop the corporate default swaps market, which, in turn, would provide support to the development of the corporate bond market, Sanyal said.

A former deputy governor of the RBI, speaking on conditions of anonymity, said that bilateral netting has been an idea suggested by the regulator for many years, since it helps banks in capital conservation. The idea was part of the Financial Resolution and Deposit Insurance (FRDI) Bill, which was eventually pulled back in 2018, owing to concerns over a bail-in clause for distressed banks, the former RBI official said.

The idea, even if implemented, may not have a significant impact on levels of bank capital, added a banking sector consultant, who also spoke on condition of anonymity. The ratio of market trades to the loan book of public sector banks is not high enough to generate significant capital savings from bilateral netting, this consultant said.