RBI's CMI norms set to impact private banks more due to higher exposure

A ban on bank funding for proprietary trading, stricter collateral rules and higher haircuts are expected to hurt pvt banks' exposure and fee income, while shifting brokers toward CP, NBFC borrowing

With the Reserve Bank of India (RBI) tightening norms for bank finance to capital market intermediaries (CMIs), which include ban on loan for proprietary trading, private sector banks are likely to be impacted more as they have more exposure in this segment, banking industry sources said. 

Some of the private banks have around 2 per cent of their fund and non-fund-based exposures to CMIs. 

Last month, the regulator issued new norms barring bank finance for proprietary trading by brokers. 

Proprietary trading involves financial institutions like stock brokers using their own funds to trade and earn profits. The RBI has said banks should not provide finance to a CMI for acquisition of securities on its own account. 

The new norms also require that all credit facilities to CMIs be fully secured, meaning banks must have 100 per cent collateral against the loan. In addition, the haircut on equity collateral has been increased to at least 40 per cent, compared to 25 per cent earlier. This means that for ₹100 worth of collateral, a bank can lend only ₹60. 

Ban on bank funding for proprietary trade is seen as a big blow for the segment as brokers used to rely on bank guarantees (BGs) as they would get double leverage. 

“Ban on funding for prop trading would reduce leverage (by 50 per cent) available to proprietary traders, who typically contribute a large share of derivatives and equity volumes (30-50 per cent); restricting bank support makes proprietary positions more expensive or capital-intensive,” IIFL Capital said in a note released after the RBI issued the final norms last month. 

Sources said the regulator was worried about systemic risk buildup in bank books, which led to the tightening of norms. 

While bank loans will be scarce for brokers, this will, in turn, reduce fee income for the lenders as they earned a fee for those guarantees. “Banks were also earning fee income from bank guarantees that they were issuing. This used to be a profitable proposition for the banks, given the fact that the brokers and the intermediaries used to place a reasonable amount of collaterals. If the quantum of BG issuances goes down because of this, then it will definitely hurt the banks’ fee income,” said a source. 

The Association of NSE Members of India (ANMI) estimated ₹1.2 trillion BGs across exchanges, with the segment’s non-performing asset (NPA) level remaining almost zero in the past two decades. While requesting that the norms be kept in abeyance for at least six months, the industry body said NSE Clearing Limited (NCL) currently has ₹9 trillion of total collateral, of which about ₹90,000 crore collateral is in the form of BGs.

 

“An estimated ₹45,000 crore of this relates to proprietary trading firms, which have already furnished around ₹22,500 crore as cash collateral. Increasing the BG collateral requirement from 50 per cent to 100 per cent would, therefore, reduce overall collateral by only about ₹22,500 crore — roughly 2.5 per cent of total collateral,” ANMI said.

 

While the banks’ exposure to CMIs will be impacted — a negative for them in the near term — the decision is seen as positive over the medium term. This is because the expected credit loss (ECL) norms, which are proposed to come into effect from April 1, 2027, mandate provision requirement for non-fund exposure like BGs. If banks cut down their exposure from non-fund facilities, they will have to set aside lesser capital once the ECL norms come into effect.

 

For financing to brokers for margin trading facility (MTF), the new norms said the facility shall be fully secured by collateral of cash, cash-equivalents, and government securities, out of which a minimum 50 per cent shall be cash.

 

Commenting that the cost of capital will increase, the chief executive officer (CEO) of a broking firm said, “In margin trading, one has to figure out one’s own capital and deploy more of it. On the MTF side, brokers currently using bank lines may have to move towards commercial papers (CPs). Bank funding will not completely dry up, but it may not make sense in many cases.”

 

Citing broking firm Angel One, JM Financial said the company will need to borrow through CPs/non-convertible debentures (NCDs). JM said Angel One has been borrowing through CPs for the last few years. Now it may first move to non-banking financial companies (NBFCs) for funding and expand further into NCD offerings.

 

In a recent interaction with the media, RBI Governor Sanjay Malhotra had said the banking regulator is not contemplating changes to its new norms tightening bank lending for proprietary trading. The new norms of bank finance to CMIs come into effect from April 1.

 

What changes?

• RBI tightens norms to ensure no unsecured funding to brokers
• Bans proprietary trading 
• Stricter norms set to hit banks’ fee income from bank guarantees
• Cutting down exposure from non-fund facilities means banks will have to set aside lesser capital once ECL norms come into effect