Banks must mark to market swap deal losses

Banks will have to mark to market their losses incurred in swap transactions involving conversion of fixed-rate rupee liabilities incurred through tier-I/tier-II bonds into floating rate foreign currency liabilities.

According to market estimates, this puts the losses incurred till date under these structures at Rs 200-250 crore on a total product base of around Rs 1,500 crore.

Marking to market will be done as the Reserve Bank of India (RBI) feels that the product has been used as a cost-reduction strategy and not a hedging tool.

The other option is to account for the losses/gains on an accrual basis as and when the real loss/gain figures, said a source.

The booking of losses arises from the recent circular issued by the RBI restricting banks from using such products and stopping the renewal of swap transactions.

According to the notification, banks have been advised to provide for the losses and treat the gains, if any, as a special reserve through the profit and loss account.

Before the financial year 2005-06, most of the public sector banks floated tier-II bonds and upper tier-II hybrid bonds to meet capital requirements.

However, with liquidity under strain, these banks entered into swaps with foreign banks to cut down the cost of funds, which also helped them show lower cost of funds in their balance sheets.

In the process, foreign banks subscribed to the bonds issued by public sector banks at a rate lower than the market rate, but with the condition that these banks buy dollar-yen options as well.

Under the proposed structure, the fixed-rate liabilities of PSU banks will be serviced by foreign banks and PSU banks will pay the floating interest on yen-rupee swap since the yen interest rate is very low.

While for foreign banks, such products help book lucrative gains because the yen can be accessed cheaper through the banks' local offices in Tokyo, the PSU banks are hit hard.

For PSU banks, things have become worse as the rupee-yen cost has gone up from 37 paise to 42 paise . The yen yield curve has also moved up by 20-25 basis point with the Japanese government proposing an upward revision in interest rates, said a forex dealer.

Similarly, the rupee-dollar exchange rate, which is the basis on which the yen rupee is calculated, has moved up from 43.80 in March to a high of 46 now. Therefore, these banks have been affected both on the interest rate front and on exchange rate movements.