India’s Cenbank changes rules for banks to manage foreign currency exposure

MUMBAI, Oct 11 (Reuters) – The Reserve Bank of India has amended some of its guidelines for banks to manage their currency exposure, in a bid to reduce the risk of unhedged exposure to the banking system in times of extreme volatility in the foreign exchange markets.

Banks would be required to assess the unhedged currency exposures of all counterparties to which they are exposed in any currency, going forward, the RBI said in a statement on Tuesday.

The rupee has lost almost 11% against the dollar so far this year and has hit a string of record highs in recent weeks.

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Banks will have to check the foreign currency exposure (FCE) of all entities at least once a year, the RBI said, adding that the revised rules will come into effect on January 1, 2023.

The revised rules, however, widened the scope of the exemptions, allowing banks to now exclude exposures arising from “factoring transactions”, with the exception of exposures arising from derivatives transactions.

Banks should determine an entity’s potential loss from unhedged currency exposure (UFCE) using the highest annual volatility in the rupee-dollar exchange rate over the past ten years, the RBI said.

“Entities that do not hedge their foreign currency exposures may suffer significant losses during the period of heightened exchange rate volatility,” the RBI said.

“These losses can reduce their ability to service loans taken from the banking system and increase their likelihood of default, thereby affecting the health of the banking system.”

The RBI said that if the potential loss of an entity’s UFCE is greater than 75%, banks should provide for a 25 percentage point increase in the total risk weight, in addition to the risk weight applicable to this entity.

“This is because exposures falling into the same bucket will have an equal increase in their risk rating, regardless of the applicable initial risk weighting,” the apex bank said.

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Reporting by Swati Bhat; Editing by Savio D’Souza

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