RBI norms on unhedged Fx exposure unlikely to impact banks much

In June, the RBI had said that of the outstanding ECBs of $180 billion, 44 per cent was unhedged

The Reserve Bank of India’s (RBI’s) directions over banks’ treatment of unhedged foreign currency exposure have increased regulatory requirements for lenders at a time when the rupee has weakened sharply against the US dollar.

While the RBI has listed out higher provisioning and capital requirements for banks, which face potential losses from unprotected foreign currency exposures, analysts said the central bank’s directions were unlikely to have a major impact on bank profitability now.

For banks, the risk of a weakening rupee plays out in the form of their exposure to corporate clients, which have exposure to overseas currencies through borrowing.

“There was something similar that was communicated by the RBI in 2014 and that was also at a time when the rupee had depreciated sharply. I think it’s more of a precautionary step. It’s an ongoing process to determine what proportion of banks’ clients have foreign exposure which is unhedged,” Prakash Agarwal, director and head, financial institutions, India Ratings and Research said.

“Generally we have seen that for most cases, either they have opted for a hedge or there is a natural hedge. The quantum of completely unhedged exposure would not be very high,” he said.

On Tuesday, the RBI tweaked guidelines for banks on incremental capital and provisioning requirements in relation to unhedged foreign currency exposures.

The revised rules will come into force from January 1. The incremental provisioning requirement for banks is in the range of 20 basis points (bps) to 80 bps based on an estimate of potential loss or hit to earnings before interest and depreciation in a band of 15 per cent to more than 75 per cent.

Banks will also have to put in place a 25 percentage point increase in risk weights if potential losses from unhedged foreign currency exposures account for more than 75 per cent. This is over and above the existing risk weights applicable to the entity.

“They (the RBI) have made it a little more stringent than what it was earlier. What they are saying is instead of 100 per cent risk weight, which you have for unrated exposure or up to triple B minus, you now increase it depending on what is the potential loss,” Federal Bank’s Executive Director Ashutosh Khajuria said.

“Ultimately, because it’s going to hit the profitability of a bank’s constituent, the risk increases as a lender. When that risk increases, banks need to provide more capital because the capital is for unknown losses. Provisions are for known losses. When provisioning is done for any account, an NPA or otherwise, it is for known losses,” he said.

The central bank’s directives come at a time when the volatility in the exchange rate has resulted in greater scrutiny of unhedged foreign currency exposure. So far in 2022, the rupee has depreciated 9.7 per cent versus the US dollar. The weakness in the currency has been accelerated since September 21, which was when the Federal Reserve signalled a longer rate hike cycle. Since then, the rupee has lost 2.9 per cent versus the dollar.

Industry sources, however, said that while the RBI’s new norms had signaled a stricter approach to handling unhedged foreign currency exposures, there were stumbling blocks when it came to the recognition and accounting of such exposures.

Bankers said the process of computing overall unhedged foreign currency exposure of clients was onerous, especially under the prevailing RBI guidelines. There is industry-wide data available for the same at the moment.

The current norms say that to arrive at provisioning and capital requirements, banks will have to determine the potential loss from unhedged exposure using the largest annual volatility in the US dollar/rupee exchange rates over the past 10 years.

Industry sources also flagged issues surrounding information gathering.

“One of the potential loopholes in the framework is the following clause – for computation, the information shall be obtained from entities on a quarterly basis based on statutory audit, internal audit or self-declaration of the concerned entity,” a source said.

“When you look at the capital which is provided by the banks against UFCE, it’s very small. In self-declaration, or in auditor certificates, many entities say that the exposure is small. There are of course some banks which do it very genuinely and do their own estimate,” the source said.

In June, the RBI had said of the outstanding ECBs of $180 billion, 44 per cent was unhedged.  

“The RBI has impressed upon importers, borrowers and bankers the need for exposures to be hedged. Unfortunately, if it is sometimes seen that the depreciation is slow, they do not book forward contracts (hedges) because that increases the cost,” Khajuria said.