Derivative Dilemma

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assets will have to be marked to market and ICICI Bank has already mentioned of a Rs 260 crore loss on this account. There are others like SBI, BoI and Axis Bank which too will have an impact, albeit a lower one.

Normally, banks would have no reason to worry about corporate derivative exposure going bad. They have risk management systems and regulations in place that require them to have a square position in the market, to take care of any movement in the market.

However, now the corporates have started taking an aggressive stance against banks alleging that the banks have duped them into buying exotic derivatives, something that they did not understand. Banks could then get into a big legal mess. “The market risk could also turn into a credit risk if there are defaults. And this is more dangerous,” says Nevgi.

And then there is the overall impact of falling capital markets. Banks have been gaining on account of their exposure to the capital markets. For some private sector banks, this accounts for 10-20% of their profit before tax. With the capital markets tanking, this could be curbed in the fourth quarter. And with the inflation raising its ugly head, the bond portfolio will also see substantial erosion. The effect of which, however, will not be felt in FY08. The banking sector is one which will remain tensed in the current year, reckon analysts.

What now

There are chances that the ICAI ruling will be reworked. “After all, the government would not want a major embarrassment in the election year. There will be some intervention,” says a chartered accountant.

Then there are chances that not many would work out some arrangement with banks and restructure their obligations.

“Banks also don’t want bad books at this stage”, he adds.

“I think that there will be a lot of companies reporting derivative losses this quarter.

They will bank on the fact that there is a gloomy sentiment all around and the impact of reporting these losses might not be as bad,” says Harihar. Many would just want to get over this and move on, he adds.

Investors now have to be extremely careful now. There could be some good companies that have been trapped in this derivative tangle and while there could be losses, the long-term prospects remain bright. It would be unwise to shun such companies off the portfolio, reckon advisors.