Debt trade in India faces probe

India’s banking watchdog is examining a lucrative bond trade between banks and insurance companies that swelled in popularity in recent months despite being in a regulatory grey zone. Traders estimate that there are currently about 2 trillion rupees of debt linked to such trades.

Scrutiny from the Reserve Bank of India (RBI) raises the risk that tighter rules may be imminent to regulate the structure. Lenders including Citigroup Inc., Standard Chartered Plc and JPMorgan Chase & Co. have been buying long-tenor sovereign bonds that they then agree to sell to insurers at a specified price after about five years in a forward contract.

Traders argue that the transactions are structured as so-called forward rate agreements, which are permitted by the RBI, allowing them to clear internal compliance checks. However, regulations governing FRAs allow the pricing of the contracts to be based on a benchmark such as MIBOR or Overnight Indexed Swaps.

Banks have been funding these trades by borrowing from the Tri-Party Repo window and then tacking on a fee for the insurance firms, leading to as much as 400 basis points of profit, amounting to about a billion dollars per year profit for the lenders. A consultation paper on the Clearing Corporation of India Ltd. website proposes permitting bond forwards.

The RBI rules don’t specifically say these trades shouldn’t be benchmarked against securities prices and banks are taking advantage of this grey area. The RBI has advised some banks to pause these deals for now, while examining the books of others.