1. Basel III makes hedging unviable for firms, banks

Basel III makes hedging unviable for firms, banks

A bank extending forex loan to client and providing to hedge the loan through a derivative contract...

By: | Mumbai | Updated: November 13, 2014 8:55 AM
According to regional head of global markets at Standard Chartered Bank, a bank has to set aside higher capital if its client hedges a long-term forex loan using derivatives.

According to regional head of global markets at Standard Chartered Bank, a bank has to set aside higher capital if its client hedges a long-term forex loan using derivatives.

At a time when the Reserve Bank of India (RBI) has been issuing caution over the risks to corporate unhedged forex exposure, the rules of Basel-III governing transactions in derivatives are putting a hitch in banks’ efforts to urge their clients to hedge.

According to regional head of global markets at Standard Chartered Bank Ananth Narayan G, a bank has to set aside higher capital if its client hedges a long-term forex loan using derivatives.

“We realised this when we actually did a transaction. We have requested RBI to look into the matter,” he told FE in an interview. The Basel-III norms state that banks have to set aside capital for counterparty credit risk (CCR) and also maintain an additional charge towards credit valuation adjustments (CVA) which is an upfront charge to safeguard against the mark-to-market risks associated with the derivative transaction.

Therefore, a bank extending forex loan to its client and providing to hedge the loan through a derivative contract will have to set aside capital for both the transactions as well as the CVA for the derivative.

“If the client remains unhedged, the bank is supposed to attribute a higher risk weight to that unhedged loan portion. Ironically, if the client hedges the exposure, the total risk weight is far higher than the penal one in case of unhedged exposure,” said Narayan.

Given the higher capital requirement, it is unviable for banks to urge their clients to hedge their exposure as such a move puts the bank’s capital at risk. “The hedging cost for users has gone up because the banks that provide the hedging instruments have to set aside higher capital,” said a treasury official at a US-based bank. In January, RBI had mandated banks to keep aside capital for unhedged exposures of their borrowers. For those borrowers whose unhedged exposure is more than 75%, banks had to assign a risk weight of 25% for provisioning.

Last month, putting the aggregate hedge ratio of Indian companies at a mere 15%, RBI deputy governor HR Khan had warned of the risks that companies are exposed to.

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