Regulatory caps on bank guarantees boost demand for fixed deposit receipts

Arrangements between brokers and banks have come under Sebi, RBI lens over potential risks

Regulatory caps on bank guarantees have spurred the demand for fixed deposit receipts (FDRs) — both fully and partially funded — as the go-to instrument for clearing members (CMs) to place as collateral with clearing corporations (CCs) for obtaining trading limits.
 

At present, CCs accept cash, FDRs, bank guarantees (BGs) and select securities as assets for providing margins. Until a few years ago, BGs were popular instruments. However, the exchanges imposed strict caps, limiting their use. The cap in case of some brokers is just Rs 50 crore. Also, banks have limits on issuance of BGs tied to their networth — roughly Rs 10 per CM for Rs 1,000 crore of networth.
 

Industry players said the use of FDRs have shot up because of the limits on BG use. And this increased reliance on FDRs, particularly the partially-funded ones, has come under the lens of both the Securities and Exchange Board of India (Sebi) and Reserve Bank of India (RBI). Sources said both have sought reports from CCs on the amount of outstanding non-funded FDRs to assess if there is any systemic risk.

 

FDRs gained prominence because of the dispute between IndiaNivesh and Edelweiss, where the former had placed FDRs issued by HDFC Bank as collateral. Edelweiss has dragged IndiaNivesh, which shut its broking operations in April, to the Bombay High Court over settlement of outstanding dues. HDFC Bank is said to have rejected Edelweiss’ plea to encash the FDRs.
 

“Experts have stumbled upon various instances where brokers have borrowed money from banks for creating FDRs and simultaneously furnished that as collateral as was highlighted in the IndiaNivesh case. With partly-funded FDRs, brokers can save money upfront, but this is indicative of a systemic issue with far-reaching threat,” said Sonam Chandwani, managing partner at KS Legal & Associates.
 

Market players said the rising demand for FDRs has prompted banks to tweak the instrument.
 

“Partially-funded FDRs are when a broker obtains collateral receipts worth say Rs 100 crore for only Rs 40 crore placed with a bank. The non-funded portion is technically a loan given by the bank to the broker to obtain higher margin from the clearing corporation. Until now, this arrangement worked smoothly as there were hardly any defaults by brokers. However, the recent turbulence in the broking industry has brought to the fore the risks in these arrangements,” said a broker. Private banks are believed to be major players offering non-funded services to their clients. The RBI is said to have written to Sebi seeking details of banks that have issued such receipts.
 

Earlier, CCs tagged FDRs as low-risk collaterals. However, now they have been tagged as moderate-risk because of concerns over the non-funded portion.
 

Experts say more curbs are likely to be imposed on the use of these instruments once the probe is completed.
 

Recently, Sebi alerted CCs and exchanges that only funded portion of the FDRs should be considered for calculating margins.

In the past few months, brokers and banks have found themselves at odds on a number of occasions. Beside the FDR issue, banks were caught on the wrong foot after providing loans against shares to brokers who had pledged shares belonging to their clients as collateral.