RBI’s clamps on trade to support the rupee have dampened banks’ operations in the segment.
Trading volumes on the country's currency exchanges have fallen by half in the past week. Domestic banks, the dominant players in this trade, have drastically curtailed operations after the Reserve Bank of India (RBI) changed some rules to arrest the rupee’s fall.
Trading in the currency segment of the National Stock Exchange (NSE), MCX Stock Exchange (MCX-SX) and United Stock Exchange (USE) were generating a combined turnover of Rs 40,000 crore just a week before. This is down to around Rs 15,000 crore. While USE's volumes are just a few hundred crores and have been falling after the exit of key officials, turnover on the NSE and MCX-SX are down to around Rs 6,000 crore each.
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As some of the largest banks, also major shareholders of all three currency exchanges, have taken a back seat, officials in the latter are now directly trying to lure corporate houses. "Trading volumes in the currency market are not likely to pick up for some weeks. Banks will not indulge in currency trading the way they did. The change of rules by RBI makes it difficult for bank clients to earn profit," said a top official from one of the currency exchanges.
The trade
Banks are supposed to take positions in currency for the purpose of hedging risk for clients in the import-export business or whose trade is vulnerable to currency fluctuation.
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According to market analysts, currency trading has been growing since corporate clients were creating multiple hedging positions, using a single letter of credit (LC). An LC is used by businessmen in international transactions to ensure payment is received. Banks mainly act on behalf of the buyer (LC holder), by ensuring the supplier isn’t paid till the bank receives confirmation that the goods have been shipped.
Banks can create currency hedging positons for clients based on the LC value. However, many corporate houses had been using a single LC to create hedging positions with more than one bank. For example, a business house with an LC worth Rs 100 crore created Rs 75 crore of heading positions in three-four banks using the same document, and made big profits after squaring off positions. All this ensured excessive speculation and fall in the rupee’s value.
RBI move
To curtail this, RBI made it compulsory for all forward contracts booked under past performance facility by both exporters and importers to be on a fully deliverable basis and also said any gains by such contracts should not be passed on to the customer. But losses can be, which will force corporate houses to abstain from profiting by playing in the currency segment.
Also, banks were using the net overnight open position limit allotted to them aggressively for trading in the segment. For instance, a bank that was allowed to take only Rs 100 crore worth of daily positions had 10 times more intra-day exposure on the pretext that its net positions stood well beyond the permissible limit as it squared off its trades at the end of the day.
Outlook
Market analysts say large banks would suffer a major hit on their bottom line during the next quarter due to the new RBI structure. At least 20 per cent of most large banks’ profits come from treasury operations like currency trades.
"This will ensure banks lobby with the regulator and get some of the rules relaxed. But that can only happen after the rupee recovers some of its lost ground against the dollar," a brokerage analyst said.