Netting

Netting is a financial technique that consolidates multiple obligations between parties into one final balance, rather than settling each item separately. By doing so, it streamlines the settlement process, reduces the number of transactions, and helps lower overall risk.

All amounts owed and receivable are compared, and the differences are combined to determine whether a party is in a net payable or net receivable position.

Forms of Netting:

1. Bilateral netting: Combines obligations between two parties into a single settlement.
2. Multilateral netting: A central entity calculates net positions for a group of participants.
3. Payment netting: Only cash payment obligations are aggregated.
4. Close-out netting: Common in derivatives; if a counterparty defaults, all outstanding contracts are valued and collapsed into one net figure.

Uses: Netting is applied in banking, clearing and settlement systems, corporate treasury operations, and intercompany reconciliations.

Benefits: It cuts settlement risk, reduces the need for liquidity, enhances speed and accuracy of settlements, and lowers operational costs.

Illustration:

If Company A owes ₹1,00,000 to Company B, and Company B owes ₹60,000 to Company A, netting would require only ₹40,000 to be paid by Company A, settling both amounts efficiently.