In an attempt to shield the banking system from any losses arising out of unhedged forex exposures,the Reserve Bank of India (RBI) is asking banks to make additional provisions on such exposures.
According to RBI draft guidelines,banks will need to make provisions based on the likely loss that could result from a companys unhedged forex exposure,with the provision requirements ranging from 20 basis points to 80 basis points across different buckets based on the estimated loss.
The extent of unhedged foreign currency exposures of corporates continues to be significant and increases the probability of default in an environment of high currency volatility, says RBI.
While RBI does not give the exact quantum of unhedged exposures,the central bank had indicated in the past that nearly half of corporate Indias forex exposures are unhedged. In light of this,banks have been repeatedly advised to check unhedged forex exposures of corporate clients. However many bankers have expressed inability to convince clients to hedge their forex exposures completely,forcing RBI to consider stronger measures to protect the banking system.
RBI is worried about the unhedged exposure of corporates and inturn the banks exposure such cases,so it has been asking for banks to be cautious in this regard. Hedge is a risk mitigation tool and we ask for it when we feel that the corporate needs it, said Pradeep Kumar,DMD (global markets) at SBI. Higher provisioning will obviously hurt banks, he adds.
The draft guidelines suggest that if the likely loss is between 15-30% of the Earnings Before Interest & Depreciation (Ebid),then banks need to set aside an additional 20 basis points in provisions. For a scenario where the likely loss is between 30-50% of Ebid and 50-75% of Ebid,the provisioning requirement stands at 40 and 60 basis points respectively.
In most extreme cases,where the likely loss is more than 75%,RBI has increased the risk weight on such accounts by 25%,along with an additional provision of 80 basis points. If the party suffers,we also suffer. But all in all the exposure would be miniscule and therefore the provisioning impact would also be miniscule, says M Raghavan,ED at Bank of India adding the bank has been trying to ensure that all corporate exposures are hedged.
The RBI has also asked banks to collect information on unhedged foreign currency exposires on a monthly and quarterly basis and share it with credit rating agencies in order to help build in the risk in a companys ratings.
They have been saying this for a long time. Unhedged exposures must be curtailed so this is not unreasonable. But the mechanism to arrive at the likely loss will have to be studied carefully, says Jamal Mecklai of Mecklai Financial. RBI has sought comments on the draft guidelines till August 2 and has set a date of October 1 for implementation of the new framework.