finance
In a strategic effort to enhance India's presence in global finance, the International Financial Services Centres Authority (IFSCA) issued a significant circular on July 11, 2024. This circular authorizes IFSC Banking Units (IBUs) in GIFT City to engage in their parent banks’ synthetic securitisation programs. This initiative aims to position India as a hub for innovative risk transfer mechanisms and ensure alignment with international standards, particularly the Basel III framework.
Synthetic securitisation is a financial mechanism through which banks transfer credit risk—not ownership—of loans, maintaining the assets on their balance sheets. For example, a bank with increasing defaults in its SME loan portfolio can use this mechanism to mitigate risk without liquidating the loans.
This approach has gained popularity in regions such as the EU and the U.S., particularly for managing risks associated with mortgages, corporate loans, and credit cards.
Basel III Compliance: The IBU’s home regulator, such as the U.S. Federal Reserve for a U.S. bank’s branch in GIFT City, must have implemented Basel III regulations without prohibiting such transactions.
Prior Notification: IBUs are required to inform IFSCA before incorporating exposures into their parent bank's program.
Regulatory Adherence: Compliance with IFSCA’s Prudential Directions and Banking Handbook is mandatory, encompassing capital adequacy and risk reporting provisions.
Transparency: The IFSCA retains the right to request reports concerning the IBU’s assets involved in the program, which must be submitted to the home regulator.
Risk Diversification: Parent banks can aggregate risks from their international operations, including those from GIFT City IBUs, into consolidated securitisation programs.
Cost Efficiency: Lower capital reserves required for hedged risks can lead to increased liquidity for lending activities.
Competitive Advantage: IBUs in GIFT City can now compete more effectively with financial hubs such as Singapore and Dubai in offering advanced financial products.
Consider Bank Y, a European bank with an IBU operating in GIFT City. Facing rising default risks in its corporate loan portfolio in India, Bank Y can utilize synthetic securitisation by:
Transferring the credit risk of ₹6,000 crore in loans to global investors through credit-linked notes.
Notifying IFSCA and adhering to capital regulations, while its parent bank in Europe hedges its risk exposure.
Outcome: Bank Y’s balance sheet remains intact, Indian borrowers continue to access necessary funds, and investors benefit from exposure to Indian corporate debt.
The circular regarding synthetic securitisation is part of IFSCA’s extensive plan to turn GIFT City into a pivotal global financial center:
On July 10, 2024, the RBI announced remittances under the Liberalised Remittance Scheme (LRS) to IFSCs, facilitating Indian residents’ investments in GIFT City offerings.
On July 15, 2024, IFSCA included additional currencies such as Swedish Krona (SEK), Norwegian Krone (NOK), New Zealand Dollar (NZD), and Danish Krone (DKK) in its permissible currencies list, simplifying foreign exchange transactions.
On July 18, 2024, the IFSCA launched the Board for Payment and Settlement Systems (BPSS) to supervise digital transactions and innovations in fintech.
Cross-Border Compliance: IBUs face the challenge of navigating IFSCA regulations alongside their home regulators’ requirements (such as the U.S. Dodd-Frank Act).
Data Transparency: Frequent reporting to multiple regulators may drain operational resources.
Market Risks: A heavy reliance on derivatives can expose banks to risks related to counterparties during financial crises.
The IFSCA intends to broaden its scope to encompass green securitisation, targeting sustainable projects while leveraging its September 2024 framework for Sovereign Green Bonds. This direction aligns with India’s commitment to achieving net-zero emission goals and meets global trends in Environmental, Social, and Governance (ESG) investing.