RBI rule on novation for derivatives

Transferee bank is also required to carry out necessary due diligence independently as required by RBI

To deepen the derivatives market, the Reserve Bank of India (RBI) has issued an operational guidance on novation.

Novation is the legal term for replacing an obligation to perform with a new one or replacing a party to an agreement with a new one.

RBI says a bank can novate a derivative contract only after this has been held by the lender for at least six months if the original maturity was up to a year. Or, at least nine months for a contracts with an original maturity of more than a year.

The condition is not to apply where the transferor bank is winding up the business. And, the other party must be a constituent borrower. The latter is to do an independent examination (“due diligence”) in a required manner.