Banks are being told by the regulator to end the decades-long practice of financing stock brokers during the day without collateral.
Intra-day funding, better known as "daylight exposure" in banking parlance, is a crucial facility that enables brokers to tide over a few hours' gap pending receipt of money from stock buyers, or in furnishing derivatives trade margin in the morning or paying for spot trades by institutions in case of mismatches.
The Reserve Bank of India (RBI) has recently communicated to four large private-sector banks that such intra-day credits have to be backed by a minimum margin of 50% in the form of fixed deposits and marketable securities, two senior bankers told ET. Thus, a broker drawing 500 crore as an intra-day fund must give collateral of at least 250 crore to the lending bank.
"Brokers will have to arrange collateral. Some of the smaller ones will find it very difficult." Their cost is expected to rise. They will have to raise funds, create fixed deposits which can be given as collateral, and may, in the process, run a negative carry. "We wonder if there is a strong rationale for this when there is a strong margin system and other checks and balances put in place by stock exchanges and clearing houses," said one of the people.
Till now, such intra-day exposures to market intermediaries-unlike guarantees to a broker or longer-tenor loans to finance proprietary trades-were not considered as "loans" to brokers. It largely remained a grey area as neither banks categorised it as capital market exposure nor the regulator insisted on it. However, this changed with the RBI imposing conditions on banks for having current accounts of firms and companies.
According to the regulation, a bank with less than 10% of the total approved facilities (comprising loans, non-fund businesses like guarantees and overdrafts) to a company cannot have its current accounts, which are sought after by lenders as zero-interest deposits lower a bank's cost of funds. MNC banks, which were hurt by the rule, lobbied with RBI for inclusion of intra-day credit in calculating "total approved facilities". And now, the inclusion of daylight limits (as a loan) in the current account circular is changing the rules on intra-day lines for brokers in a way that most banks did not expect. "RBI, in the course of routine audits of the banks, is telling them separately that there cannot be collateral-free intra-day funding to brokers," said an industry official.
Banks which have received the communication from the central bank also offer custodial services to institutional clients like foreign portfolio investors, mutual funds, and insurance companies.
Banks also take daylight exposure to MFs to enable them to arrange funds for meeting redemption orders from investors. "I don't think RBI is concerned with such intra-day lines to asset management companies, which are pass-through vehicles." But RBI has a risk aversion when it comes to bank exposure to brokers and builders. What if the client doesn't pay? "There have been broker defaults in recent years," said a person who is aware of the regulatory stand. The RBI spokesman could not be contacted for comments.
Significantly, RBI's directive comes about a month before some of the stocks that FPIs invest in can be included in the T+1 (or trade plus one day) settlement cycle that was introduced at the end of February this year. "There is a distinct possibility that hand delivery trades (done by FPIs) could rise with T+1 and this would lead to borrowing more from banks to bridge the payment gap," said an official with a market intermediary. Hand delivery trades arise out of mismatches between contract notes generated by brokers and the confirmation given by global and local custodians of the offshore funds. When a custodian does not confirm, the broker has to settle the trade with the clearing corporation. In such cases where the broker has to put up the money at the time of settlement, it has to borrow from banks, receive the money from the custodian once the latter receives the shares, and then repay the bank by the day-end.
Today, hand delivered trades are miniscule. But in a shorter settlement cycle when there is a time crunch, the chances of errors and mismatches are high if the market regulator and clearing corporations do not fix a timeline that is convenient for banks and FPIs, "said a banker.
So far, stock trades in India have been settled within two days after they take place---a mechanism described as T+2. Keen to quicken the process, Sebi pushed through a change that advanced the settlement cycle by a day to T+1. This allows a stock buyer to receive securities in a demat account while the seller receives funds in a bank account just a day after a trade is executed. India is among the very few markets in the world to have T+1 settlement.