Bilateral netting

The Economic Survey 2020 advocated introducing Bilateral netting for financial sector in India and government is planning to introduce Bilateral Netting of Qualified Financial Contracts Bill, 2020. According to the Survey, “A bilateral netting agreement enables 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.”

Context

  • As of now, BN for financial contracts is not allowed in India. Instead, we practice ‘ gross netting ‘.
  • Under gross netting method, banks measure credit exposure to the counterparty for Over the counter derivatives based on the gross market to market exposure. This increase credit risk for financial sector participants, especially in the case of insolvency, which then raises the systemic risk.
  • The current system requires banks to divert greater capital towards collateral requirements.
  • This has a negative impact on banks and other financial market participants.

Benefits of Enabling BN for Financial Contracts in India.

  • Reduce credit risk and regulatory capital burden for banks, freeing up capital for other productive uses. Reduce hedging costs and liquidity needs for banks, primary dealers and other market-makers, thereby encouraging participation in the Over-the-counter (OTC) derivatives market to hedge against risk.
  • Increased market participation in the Credit default swap market would also provide an impetus for corporate bond market development.
  • Establish an efficient recovery mechanism for financial contracts under instances of default by a counter party .
  • Adhere to India’s G20 and FSB commitment to implement global regulatory reforms in the OTC derivatives market.
Most of the advance economies settlements are carried out in bilateral netting, which generally give rise to strong derivatives market and it provides the most accurate picture of a company’s financial position, solvency and risk. Adoption of bilateral netting is in accordance with international practice and is needed reform.

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