How Serious Is the Issue of Fake Fixed Deposits or Funded Collateral in the Market?
A rather worrying message came to me from a top market intermediary, who said the content is plausible and the source fairly reliable. 
It read (I have not corrected or edited the message): An interesting situation seems to have developed. Specifically for NSE Clearing House. Banks seem to be forced to pay Rs 3 cr per Rs100 cr Bank guarantee if they go above NSE’s counter party limits prescribed with each bank. How NSE can do this no one knows.
To avoid the concentration of Bank Guarantees now, NSE and some Banks seem to have devised a new method. To provide fixed deposit confirmation from broker to NSE clearing house.
It doesn’t require any capital charge for bank because it’s fully backed by FD real money in bank. It also doesn’t add upto BG exposure of bank to NSE. 
I have been told (subject to verification) that many banks and NSE Clearing House put together have a mechanism where bank gives fixed deposit confirmation to NSE clearing house for say Rs 100 crores on behalf of a broker. However, the broker has deposited only Rs 10 crores as FD with bank in reality. Balance 90 crore is only an ‘illusion’ which bank and NSE Clearing house are carrying on. NSE clearing house, in a way is giving 10 times more exposure to the broker than it should have if the real money had been put in by a broker. 
Does it remind of old Harshadmehta BR (Bankers receipt)? Creating money out of thin air and then taking speculative positions against that in speculative stock markets instruments? In Harshadmehta days it was supposed to be Badla. Now, it is future and options on Nifty. 
No one knows how much of bank fixed deposit confirmations issued by banks have real money backing it in NSE clearing house. It might be true for bank guarantee too.
This message has reached many people, including journalists. I brought it to the attention of the top brass at the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI) and the stock exchanges.
While the SEBI chairman did not respond, off-the-record sources in SEBI and the Exchanges said that the market regulator had, indeed, been questioning clearing houses about collateral. 
The RBI governor, however, seems more determined to check whether dubious collateral poses a major systemic risk. It has sought SEBI’s cooperation in conducting a specific reconciliation exercise of the margins in the form of lien-marked fixed deposit receipts, bank guarantees, ‘unfunded fixed deposits’, etc. 
As part of the exercise, SEBI has begun to collect information about the extent of lien-marked fixed deposits receipts (FDRs) that have been submitted to stock exchanges and their clearing entities as margin. 
A report in The Business Line, about the SEBI enquiry referring to fake collateral or ‘non-funded’ fixed deposits being offered as margin, suggests that this is happening across equity and commodity markets. And that clearing corporations (CCs) of stock exchanges, that are primarily responsible for risk management, have been sanctioning trading limits to brokers based on these ‘non-funded’ fixed deposits. 
In response to our query, a source at the National Stock Exchange (NSE) offered an explanation to justify how the Exchange and CC are protected. He says that the Exchange has ‘net worth based criteria’ for how much of bank guarantees (BGs) any bank can issue to its CC. We are told that “post an initial free limit, further limits up to a maximum threshold, based on net worth of the bank, are given against a security deposit by the bank. As far as FDs are concerned, the exchange has received lien-marked FD receipts (FDRs) on behalf of clearing members from banks, along with a confirmation of an effective lien and that there are no other encumbrances. The arrangements that a bank may have with a broker are not visible to the clearing corporation at all.”
Our NSE source seems to suggest that their fake or funded FDRs are within a manageable limit, since it imposes net worth-based limits on the extent of guarantees that a bank itself can issue. However, market sources vehemently disagree. They say, only bank guarantees have limits (there is also a charge on the bank’s capital on issue of bank guarantees or letters of credit), but there is no charge of limit on FDs that can be opened with a bank, because it donotes a cash deposit. We asked NSE for a response to this and have yet to hear from the Exchange. 
This also means that the NSE and the CC would have no idea if the bank makes a false claim that the FDR was ‘without encumbrance’. In practice, the bank could have extended a loan to the broker which is held as a fixed deposit with the bank (so the principal is safe) and only the interest differential to be paid by the broker is at risk. 
This subterfuge gives the broker great leverage to trade in the futures market. Whether NSE’s risk-containment criteria are adequate will be known only when the music stops and there is a payment issue. Even here, isolated blow-ups can be contained but is it good enough when there is a massive market movements? How big is the probability of systemic risk? Does anyone know? What happens when the bank refuses to pay and drags matters into expensive and long-drawn litigation? 
At the moment, one case of a fake or ‘funded’ FDR has already blown up with a brokerage firm closing operations. On 2nd April, IndiaNivesh, a 14-year old firm, suddenly announced a voluntary shutdown of its broking, commodity and portfolio management businesses, citing a ‘liquidity crunch’ caused by the fall in stock markets immediately after the COVID-related lock-down. 
IndiaNivesh, when it closed shop in early April, had issued a statement to say, “During all this turmoil, there has been  mark-to-market losses which have been funded by Edelweiss Custodial Services Limited and Edelweiss Custodial Services Limited was covered with STL, which was available for the credit balances of the clients.” It also asked for all its collaterals and guarantees to be frozen. But this was clearly not true as the matter is now in court. Although the CC has reportedly settled a majority of investor claims (Economic Times – ET —says 95%), the case filed by Edelweiss indicates that there is a serious problem with the security offered by IndiaNivesh.
On 29th April, Edelweiss Custodial Services Limited filed a case in the Bombay High Court to claim outstanding dues by IndiaNivesh Securities Private Limited. HDFC Bank is understood to have issued ‘funded’ FDRs as collateral offered by IndiaNivesh and has refused to pay. The matter is now under arbitration. 
HDFC Bank’s refusal to pay suggests that things are even more complicated and the role of all parties may be suspect. What is the extent of the hole? The claim by Edelweiss Custodial Services Limited on IndiaNivesh may be to the tune of Rs100 crore says a report by
Is this the only brokerage firm in serious trouble and caught up in the fake FDR issue? We don’t know.
While the market regulator has strictly enforced disclosure rules for listed companies and market intermediaries, the same does not seem to apply to SEBI itself or even the NSE and its clearing corporation.
Media reports indicate that SEBI is aware of the problem and has been quietly trying to correct it by asking stock exchanges not to accept ‘funded’ FDRs. According to ET, a SEBI communication to the Exchanges has said, “trading members are showing the full amount of funded fixed deposits (broker deposited plus bank funded) as collateral in their enhanced supervision reporting to the Exchanges.” 
The term ‘funded FDRs’ itself puts a bland spin on what is essentially a fraudulent activity in showing a loan as a deposit in order to get enhanced leverage for speculative trading. 
Hopefully, RBI will ensure a full investigation, if nothing else, to ensure that it is not caught napping like it was in 1992, when the issue of fake banking receipts (BRs) to back ready-forward transactions of banks and financial institutions formed a big component of the securities scam. No governor would want that under his watch, nor should Ajay Tyagi, who is all set to take fresh guard for another 18 months in SEBI. 
Here is the regulatory submission made by IndiaNivesh...

2 years ago
It's a shame that only when investigative journalist like you dig deep that such matters come out. What exactly is the role of the market surveillance teams in the exchanges and SEBI ? SEBI appears to be more of a parking lot for good for nothing Babus. The crores of tax payer's money spent on the so called "State of the Art / Cutting edge " market surveillance system seems to be a dude.
2 years ago
The never ending saga of Banksters & Pranksters !
2 years ago
already NSE has admitted in 2017/18 audited accounts of margin fd/bg missimg worth five crores around or so in NSccl the subsidary of NSE . despoie that sebi has not taken any action against nse or informed about the same to rbi to probe hte connected banks
2 years ago
Sucheta MAm yesterdays latest judgement of supreme court har e krishna mandir trust vs state of maharahastra gives clear cut directions that courts have a statutory duty to issue a writ of mandamus when authorities have a public duty to perform and they fail to do it .
why sebi and rbi are not held jointly responsible along with hdfc bank ,india nivvesh and edelwiss to establsih the truth by way of a mandamus .
Sudhir Mankodi
2 years ago
The mechanism branded by you as \"Fraud\" may not be fraud in real sense. At the time of assessment of credit facilities to be sanctioned or renewed to a borrower, two types of Limits are sanctioned. 1. Fund Based and 2. Non Fundbased. The latter is a contingent liability and normally a margin of 10% to 25% is mandated for availing of credit. The margin is prescribed/stipulated on the basis of the risk perception by the bank taking exposure on the borrower for both - the Fund Based and Non Fund Based facilities. If the regulator invokes the guarantee for any default on the part of the market operator, the bank issuing such guaranteehas to pay it to the regulator and that Non Fund Based liability of the borrower gets converted into Fund Based Liability requiring the borrower to mobilise his cash resources to meet the liability. Generally, only in 10% of cases, such guarantees are required to be invoked as more the invocation of guarantees, the more vitiated the business environment.

So we cannot generalise such issue of guarantees by the bank (if done with proper appraisal of various risks and keeping the interest of the bank uppermost in the mind), such business can be considered as bank\'s normal business without attributing any motives. The business history of the company and its reputation to honour timely commitments of its financial obligations weigh heavily while sanctioning such non fund based facilities. I hope this clarification from a senior retired banker will help in modifying your perception of \"Fraud\"
Replied to Sudhir Mankodi comment 2 years ago
Ms Dalal is correct. Sudhirji there is a fundamental issue here: if the FDs were the property of India Nivesh then who iS HDFC Bank to decide whether they should be liquidated or not? The case should be between Edelweiss and India Nivesh. And if India Nivesh has pedged the FDs and Edelweiss has invoked them, then why should HDFC Bank stop them from being liquidated and paid to Edelweiss?

Here is the quote from a LiveMint article updated on 18 Aug:

"The problem started when HDFC Bank declined to honour the FDRs issued by it as IndiaNivesh’s collateral pledged with Edelweiss, which was acting as the clearing member.

Edelweiss claimed that the FDRs issued by HDFC Bank were pledged by IndiaNivesh as collateral for the entire trade, while HDFC Bank claimed that these were meant only as margin and not for mark-to-market or M2M losses."

Why should HDFC Bank interfere? These FDs belong to India Nivesh. Here is the answer: HDFC Bank is interfering because they have lent this money to India Nivesh to deposit back into HDFC Bank and use as collateral. So effectively HDFC Bank is taking the invoking risk. Now that the business has gone bust, HDFC Bank is saying: "All FDs are not equal. FDs funded by us are our property." And this claim is rubbish.
Replied to Sudhir Mankodi comment 2 years ago
There is no generalisation. No idea what you are defending. First, a FD is a deposit - it denotes cash in the bank. Anything else will need to have a different name and cannot pretend to be a deposit by adding a pre-fix like "funded". Secondly, not only am I not generalising, but saying there is ALREADY a problem. If things were as simple as you make them out to be, HDFC Bank would have honoured the deposit and the matter would not be in court. The hole is Rs100 crore -- as an investor I want answers from SEBI about whether there is a risk. There are no answers. Is this the amount in dispute? Both HDFC Bank and Edelweiss are hiding behind "sub judice" to avoid details . Sub-judice does not mean hide information. It only means that a commentator cannot pre-judge the issue. As for the regulator - the rules of disclosure are ignored by it, even when in public interest. If all this seems completely clean and normal to you - there must be some other reasons for your thinking. best
Replied to sucheta comment 2 years ago
I fully agree with what Mr.Sudhir is stating in his message. This is the way Bank operate. He is not defending anything. He is just stating things the way bank works. If HDFC does not pay, then they should be hauled to court or it could have been fraudulent Gtee or Gtee. Do you know that RBI penalised Catholic Syrian Bank for not paying the Gtee on the due date.
Banks will grant credit facility to their broker. This is the way they make money. Banks can issue gtee or a confirmation that they hold FD and this is good eneough for clearing house. In case the broker defaults, NSE will claim from the bank and the bank will then claim against the broker.
I am sure you know this .
Fully endorse what Mr.Sudhir is saying.
Statement such as "No idea what you are defending" or "there must be some other reasons for your thinking" is not warranted from a person like you. You should be able to accept criticism however stupid it is and not reply like this.
Replied to sucheta comment 2 years ago
what an apt reply Sucheta Ji
Replied to ca.navinsaraf comment 2 years ago
Sir in which way sucheta ji reply is apt. What sudhir said is absolutely true. This is the way banking works. This also shows that sucheta ji is little short of knowledge of working of a bank and its credit process.
When PNB issued fraudulent bank guarantees to Nirav Modi, did you know that though it was fraudulent, it was the Bank's responsbility because it was issued by the bank and based on this guarantee others granted facility to Nirav Modi. As pr sucheta ji, if HDFC does not pay, then they should be dragged to court and RBI will pull their pants down. Do you also know that a guarntee is unconditional and if invoked it should be paid up within a pre determined time.
Sucheta ji lacks the ability to accept criticism. Mr.Sudhir just explained in detail how a bank issues facilities.
Just because Sucheta ji writes something, it does not mean that it is cast in stone and for you to say "apt reply".
Replied to cjninan comment 11 months ago
Even if a bank does work like that, the established banking system is clearly not working cleanly and transparently and should anyways be changed for the better. No one can claim that this is how the banking system works and I love it.
Replied to araash.mehta.ashish comment 11 months ago
@cjninan Would also like you to give a reply to prime’s reply above
2 years ago
It has been a long time when a Chennai Based IT Co. Helios & Matheson cheated a lot of Retail FD investors But no action till date.
Sucheta Ji! Please look into the case.
2 years ago
HDFC Bank is always a favourite bank of NSE. I don't think much can happen as the bank will drag the matter to the courts. And finally settle for 50% after 5 years.
2 years ago
I have to say that contention in the below (blue font) paragraph from that article about the “principal being safe” is not sound. The FD being under lien will be liquidated when it’s invoked on default and paid out to the CC.

The banks loan to fund the FD will no longer be covered by that FD !!

“In practice, the bank could have extended a loan to the broker which is held as a fixed deposit with the bank (so the principal is safe) and only the interest differential to be paid by the broker is at risk.”

It’s likely that the loan is also secured by mortgage of property or other illiquid assets. So in case of FD gets invoked the property is the fall back.

Such arrangements are routine - gold jewellers mortgage property for getting LC and CC limits. The borrowing from CC are placed as FDs for margining the LC for import of gold.

It’s a process of transformation of illiquid assets like property into liquid cash loans .
2 years ago
Could this be another Ponzi scheme?
2 years ago
An eye opener article as always from Sucheta Dalal..Maybe another Harshad Mehta type scamster is operating..!
2 years ago
How are we going to find out the extent of fake FDR's?
Nobody seems to care about the real issues cropping up at regular intervals.
2 years ago
A fraud is now due in stock markets
It happens every now and then Be prepared
2 years ago
why the role of aditya puri the md of hdfc bank is not being probed in funded fdrs
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