Banks asked to unwind guarantees to FIIs

Foreign institutional investors (FIIs) from now on cannot avail of guarantees (irrevocable payment commitments) from banks for their payment obligations at the stock exchanges.

In a circular to banks on capital market exposure, the Reserve Bank of India (RBI) has said entities such as FIIs are not permitted to avail of fund or non-fund based facilities such as irrevocable payment commitments (IPCs) from banks, under the provisions of the Foreign Exchange Management Act (FEMA).

Banks have been asked to unwind all such guarantees given on behalf of FIIs within six months starting today.

RBI said the annual financial Inspection reports of certain banks and an analysis of the consolidated prudential return (CPR) of some banks have revealed that these banks have extended large loans to various mutual funds and have also issued IPCs to stock exchanges on behalf of mutual funds and FIIs.

These exposures have, however, not been included by the banks for computation of their capital market exposure, which is capped at 40 per cent of every bank's net worth.

Industry sources said large foreign banks were involved in providing IPCs on behalf of some large FIIs as it helped in confirming trades entered into by investors resident outside India.

The RBI's regulations under FEMA state that the payment for buying shares by persons resident outside India has to be made through inward remittances, with non-resident Indians (NRIs) having the option of paying through debits in their bank accounts in India.

The sources said the RBI directive is unlikely to have a major impact as only a few large FIIs were actually availing of bank guarantees.

Foreign banks providing custodian services would benefit from this restriction as FIIs would now ensure they have enough cash balances in their accounts with the custodians to support their level of trading activity.

The banking regulator said IPCs issued by banks to stock exchanges on behalf of mutual funds would have to be included for calculation of their capital market exposures.

Similarly, loans given by banks to mutual funds would also have to be included in the capital market exposures.

An official with a private sector bank, which was already including loans to mutual funds as capital market exposure, said this would have a marginal impact as only a few banks had not included loans to mutual funds in their capital market exposures.