Banks violated forex derivative norms: RBI.

Mumbai: Even as the Supreme Court is scheduled to start hearing on a case involving losses suffered by companies in the foreign exchange derivative transactions in 2007-08 in the next few days, a Reserve Bank of India (RBI) report has said there were irregularities and deviations by banks in complying with the provisions of the Foreign Exchange Management Act and the Reserve Bank of India guidelines. It was also equally critical of corporates for using forex derivatives “as profit management tools” rather than risk mitigants.

“These violations related to the failure to verify the underlying of derivative transaction, offering structures resulting in increase in risk and receipt of net premium by corporates, booking of contracts under past performance route beyond the eligible limit and offering products,” the RBI said in its report to the Central Bureau of Investigation. However, the RBI which held discussions with the CEOs of 22 banks that were active in the business came to the conclusion that “this is not a systemic issue”.

The RBI report also castigated customers (companies) for having undertaken “hedge transactions in excess of their exposures, despite the FEMA provisions, by making false declaration under the past performance route or the underlying route.” This further compounded their losses, the RBI said. “While as on December 2008, the gross MTM (marked to market) gains (losses to the customers) of 22 banks active in the derivative business was Rs 31,719 crore, the crystallised losses (unrealised dues to the banks) were Rs 755.45 crore. Most of the derivative contacts have been executed for long maturities and the MTM profile of such contracts would undergo changes till the maturity of the contracts,” it said.

Listing the deviations by banks while complying with the guidelines, the RBI said leverage had also been used in many derivative structures by banks and their customers. In such a structure, the customer buys and sells options to reduce his cost. “The notional principal amount on the sold option had been observed to be a multiple of the value of the underlying — which too compounded the MTM losses of the customers. Banks also did not verify the underlying/ insufficient underlying exposures.”

The RBI said the banks did not obtain “written acknowledgement from clients for understanding the risks involved”. Periodical audit reports were not obtained from the concerned users, it said. They were also found “offering structures that were in violation of extant regulations —

Source : financialexpress.com