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RBI Initiates Probe into Funding Arrangements Between Private Banks and Stock Brokers

Strategic Insights

— 2 min read

The Reserve Bank of India (RBI) has launched an investigation into the funding arrangements between some private banks and stock brokers, following a dispute over a share-settlement process. The central bank has written to the Securities and Exchange Board of India (Sebi) seeking details about Fixed Deposit Receipts (FDRs), an instrument used by brokers as collateral. Regulators have found instances where brokers borrowed money from banks to create FDRs, only paying a small amount upfront. This arrangement poses a threat to the system, and the RBI has asked Sebi to provide information on partly funded FDRs. Separately, Sebi is also examining the issue, noticing that brokers are using leveraged FDRs as margin for trading in derivatives.

Key Takeaways:

  • The RBI has initiated a probe into funding arrangements between private banks and stock brokers, specifically regarding Fixed Deposit Receipts (FDRs).
  • Regulators have found instances where brokers borrowed money from banks to create FDRs, only paying a small amount upfront, posing a threat to the system.
  • The RBI has written to Sebi seeking details about partly funded FDRs, which are used as collateral by brokers in trades.
  • Sebi is also independently examining the issue, noticing that brokers are using leveraged FDRs as margin for trading in derivatives.
  • The dispute came to light in the IndiaNivesh case, where Edelweiss, a clearing member, was given funded FDRs issued by HDFC Bank as collateral.
  • The matter is currently sub judice, with the Bombay High Court referring it to arbitration and stating that the FDRs cannot be invoked by either party until the process is complete.
  • IndiaNivesh has shut its broking business, but Sebi and exchanges have settled over 95% of the claims of its investors.
  • Sebi has informed stock exchanges and clearing corporations that only the funded portion of the cash collateral is to be considered for margin calculation.
  • Trading members are reporting the full amount of funded fixed deposits (broker deposited plus bank funded) as collateral, which regulators find unacceptable.

Statistics:

  • Over 95% of investor claims have been settled by Sebi and exchanges through IndiaNivesh.
  • The RBI has written to Sebi seeking details about partly funded FDRs.
  • The Bombay High Court has referred the matter to arbitration and has stated that the FDRs cannot be invoked by either party until the process is complete.

Sources:

  • Reuters, RBI initiates probe into funding arrangements between banks and brokers - sources
  • CNBC, RBI probes alleged manipulation of settlement process involving HDFC Bank and Edelweiss
  • Economic Times, RBI, Sebi examine case of HDFC Bank, Edelweiss in relation to IndiaNivesh's FDRs
  • Business Standard, Sebi asks stock exchanges to ensure that FDRs are used as collateral only for approved trades

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