Loved by banks, bond trade worth Rs 2 trn faces scrutiny from RBI

India’s banking watchdog is examining a lucrative bond trade between banks and insurance companies that’s swelled in popularity in recent months despite being in a regulatory grey zone, according to people with knowledge of the matter.

Lenders including Citigroup Inc., Standard Chartered Plc and JPMorgan Chase & Co. have been buying long-tenor sovereign bonds that they then agree to sell to insurers at a specified price after about five years in a forward contract, the people said, declining to be named as they aren’t allowed to speak with the media.

Traders estimate that there are currently about 2 trillion rupees ($26 billion) of debt linked to such trades. Scrutiny from the Reserve Bank of India raises the risk that tighter rules may be in the offing to regulate the structure, though it’s unclear what action, if any, the RBI will eventually take.

The growing popularity of the trade has allowed banks to boost earnings without taking on mark-to-market risks, while insurers can lock in costs and promise returns to policyholders at a time when volatility has surged. The structures are similar to what are known as bond forwards, which aren’t uncommon abroad, but are not allowed by the Indian regulator.

Traders argue that the transactions are structured as so-called forward rate agreements, which are permitted by the RBI, allowing them to clear internal compliance checks. Regulations governing FRAs, however, allow the pricing of the contracts to be based on a benchmark such as MIBOR or Overnight Indexed Swaps. 

The RBI rules don’t specifically say these trades shouldn’t be benchmarked against securities prices and banks are taking advantage of this grey area, the people said. 

HSBC Holdings Plc., Bank of America Corp. and Barclays Plc. are among other lenders offering the deal, they said. The RBI has advised some banks to pause these deals for now, while examining the books of others, two of the people said, without providing details. An email to the RBI wasn’t immediately answered.

A Barclays spokesperson said the bank’s transactions comply with regulations and it isn’t aware of any regulatory assessment regarding such trades. In response to an email seeking comment, a representative for JPMorgan said Bloomberg’s statement was “factually incorrect and misleading.” All products offered to clients, including insurance companies, comply with RBI guidelines and the bank isn’t aware of any RBI examination, the lender said. 

Representatives for Citigroup, StanChart, HSBC, and Bofa declined to comment.

Banks have been funding these trades by borrowing from the Tri-Party Repo window and then tacking on a fee for the insurance firms, leading to as much as 400 basis points of profit, the people said. That would amount to profits of about a billion dollars per year for the lenders put together, they said.

A consultation paper on the Clearing Corporation of India Ltd. website proposes permitting bond forwards.

The proposed structure also involves clearing corporation as the central counterparty to ensure transparency and avoid settlement risk. That’s in contrast to the current contracts, which carry a risk due to the long duration between the trade and settlement.

--With assistance from Anup Roy.