In an effort to lessen the risk of unhedged exposure in the banking sector during periods of excessive volatility in forex markets, the Reserve Bank of India revised some of its rules for banks to manage their foreign currency exposure.
Going forward, banks will be expected to analyse the unhedged foreign currency exposures of all counterparties to whom they have exposure in any currency, according to a statement issued by the RBI on Tuesday.
The rupee has lost over 11 per cent versus the US dollar so far this year, hitting a slew of new lows in recent weeks.
The RBI stated that banks would be able to determine the foreign currency exposure (FCE) of all companies at least yearly, with the updated regulations taking effect on January 1, 2023.
However, the updated regulations broadened the scope of exclusions, allowing banks to also exclude risks from ‘factoring transactions’ in addition to exposures deriving from derivative transactions.
The RBI stated that banks must calculate the probable loss to an entity from unhedged foreign currency exposure (UFCE) using the ten-year annual volatility in the rupee-dollar exchange rate.
“Entities which do not hedge their foreign currency exposures can incur significant losses during the period of heightened volatility in foreign exchange rates,” the RBI said.
“These losses may reduce their capacity to service the loans taken from the banking system and increase their probability of default, thereby affecting the health of the banking system.”
The RBI stated that if the possible loss from an entity’s UFCE is greater than 75 per cent, banks must account for a 25 per centage point increase in the overall risk weight, in addition to the appropriate risk weight for that business.