Finance minister Nirmala Sitharaman said the Bilateral Netting of Qualified Financial Contracts Bill would have a huge bearing on the stability of the financial sector and would release large amounts of locked up capital in the banking system for onward lending.
Bilateral netting refers to offsetting the claims arising from dealings between two parties to determine the net amount payable or receivable from one party to the other.
Under existing laws, banks have to make higher provisions for such bilateral contracts which are outside the Clearing Corporation of India’s framework since calculations are done on a gross basis rather than a net basis, Sitharaman said in Rajya Sabha on Wednesday. “This bilateral netting legislation will help us in evaluating risks far more in real-time basis and actual risk assessment will happen rather than a notional risk assessment based on the gross figures,” the minister said urging the House to pass the bill. The upper house of Parliament later passed the bill with no opposition.
Based on the data collected by 31 private, public and foreign banks, the amount of bank capital that went unutilised due the absence of this bill, from FY17-FY20 stood at Rs 2.14 lakh crore, Sitharaman said.
On the issue of stability of the financial sector, the minister said the bill would bring much needed regulation to derivative markets based on lessons learnt from the financial crisis of 2008, which raised questions on how non-centrally cleared derivative contracts accentuated risks.
“The derivatives markets can facilitate excessive and opaque risk taking which may lead to a lot of systemic risks,” Sitharaman said. The bill covers trades that are negotiated bilaterally including cross-currency or interest rate or commodity swaps, currency or interest rate futures or options and spot, future or forward foreign exchange transactions. These include credit derivatives such as the credit default swaps and commodity derivatives such as electricity derivatives, oil derivatives, coal derivatives or gas derivatives.
“It will reduce the price of derivative products on account of optimal utilisation of all the (bank) capital…corporate bond markets will be greatly energised because the credit default swap markets will be better functioning now,” she said.
Provisions of the bill would apply to individuals only if the counterparty to such transactions are entities regulated by an authority mentioned in the bill.