RBI reviewing derivative positions of banks after IndusInd's forex fiasco
What's the story
The Reserve Bank of India (RBI) has launched an industry-wide review of derivative positions of different banks. The move comes after discrepancies were found in the foreign exchange derivatives accounting at IndusInd Bank. The banking regulator is now assessing the hedging strategies of these banks and collecting information on their respective trades, Moneycontrol reported.
Compliance check
Dual purpose for the review
The RBI's review serves a dual purpose, insider sources said. It seeks to identify any other banks violating the new derivative trades rule, and also evaluate each bank's internal compliance on treasury operations. The detailed evaluation is part of the RBI Master Direction- Classification, Valuation and Operation of Investment Portfolio of Commercial Banks (Directions), 2023.
Portfolio classification
Guidelines for banks' derivatives portfolio
As per the RBI Master Direction, banks must classify their derivatives portfolio into three fair value hierarchies—Level 1, Level 2, and Level 3—and disclose them in their financial statements. The guidelines also bar banks from distributing dividends on the basis of net unrealized gains from the fair valuation of Level 3 derivative assets and liabilities on their balance sheet. These net unrealized gains must be deducted from Common Equity Tier-1 (CET1) capital as per RBI norms.
Risk management
RBI's circular on currency derivatives
The RBI's circular on currency derivatives was issued on January 5, 2024. It required investors to have a valid underlying contracted exposure not hedged with any other derivative contract and be ready to substantiate the same if required. This directive led to a decline in open interest contracts in the currency derivatives market on the National Stock Exchange (NSE).
Discrepancies uncovered
Internal review reveals discrepancies
IndusInd Bank carried out an internal review of its derivative portfolio, which indicated a potential 2.35% impact on its net worth. While the RBI issued directions in September 2023 regarding investment portfolio reviews, the specific reasons for IndusInd Bank's internal review are not detailed. The bank's CEO Sumant Kathpalia admitted some discrepancies in these account balances during a conference call but didn't reveal how these gaps were identified.
Market impact
IndusInd Bank's stock and future plans
After the discrepancies were revealed, IndusInd Bank's stock fell over 27%. Chairman Ashok Hinduja assured investors that he would fully support any capital requirements. Today, the stock ended at ₹685 on the NSE, up 4.4% and breaking a five-day losing streak.