Further tightening the prudential norms for banks’ exposure to derivative instruments, the Reserve Bank of India (RBI) today said that non-payment of dues on a derivative contract beyond the stipulated period of 90 days would also turn all other funded facilities extended to a client into a non-performing asset (NPA).
The funded facilities, which include cash credit and overdraft facility, among others, will turn into an NPA even if they are duly serviced, the central bank has said.
These instructions will be applicable to both Indian and foreign offices of Indian banks.
Bankers said these instructions would curb the lending capacity of a bank in India but might prove to be a boon for its foreign offices now since its lending capacity to foreign borrowers would be curbed.
This is because foreign offices of Indian banks are struggling for funds due to tight liquidity and have exposure to derivative instruments as well.
It also means that if a foreign borrower has Indian parentage and its dues become an NPA with an Indian bank, it will also impact the parent.
Explaining the move, a banker said if the amount due to a bank on a particular derivative contract has to be classified as an NPA, it will also impact the total funded exposure limit of the bank to that particular client. In other words, exposure to a client through a derivative instrument will be treated on a par with cash or credit limit to that client.
Derivative contracts are off-balance-sheet items and are not fund-based exposure. These are deals struck by clients with banks to hedge against interest rate and currency risks. It is not mandatory for a client to take a derivative contract from the bank with which it has funded exposure.
Many banks which are not directly linked with a client through funded exposure but take positions through derivative contracts will now have to account for the derivative exposure as funded exposure, bankers say.
In cases where the derivative contract provides for settlement before the maturity of the deal, the bank will mark only current dues and not future exposure as an NPA if the dues remain unsettled after an overdue period of 90 days. After 90 days, the amount provided for in the profit and loss account should be transferred to a suspense account, as is done in the case of overdue advances.
In case where a derivative deal is restructured according to new terms and parameters, the mark-to-market value of the contract on the date of the restructuring should be settled in cash, the RBI has said.
Banks get to trade in rate futures
The Reserve Bank of India on Monday allowed banks to take trading positions in interest rate futures. So far, these lenders were only allowed to use this as a hedging instrument to avoid interest rate volatility and were only buyers of the product.
Bankers said this move would help kick-start the product which failed to take off after being launched by the regulator a few years ago due to lack of market makers.
