The RBI draft guidelines on IRS and FRAs, released on Tuesday, allows commercial banks, primary dealers and financial institutions to undertake FRAs and IRS as products for their own balance sheet management and also offer them to corporates. However, while dealing with corporates, banks and institutions must ensure that companies are undertaking FRAs and IRS only for hedging their own rupee balance sheet exposures, the central bank said.

The central bank will announce the guidelines on IRS and FRAs on July 5 after taking into account suggestions from the market.

RBI governor Bimal Jalan announced the introduction of IRA and FRAs in the April credit policy. The objective is to facilitate hedging of interest rate risks and ensuring orderly development of the derivative market.

RBI has allowed the banks andinstitutions to use any domestic money or debt market rate as benchmark rate for entering into FRAs and IRS provided the methodolog of computing the rate is objective, transparent and acceptable to counterparties, the draft guidelines said. The participants should undertake FRAs and IRS only for hedging underlying genuine exposure, the central bank pointed out.

The RBI has stated that there will be no restriction on the type, size and tenor of FRAs and IRS. "Apart from plain vanilla type of products, swaps can also have caps, floors and collars. The norms on size will emerge with the development of the products," it said.

The central bank has said that before undertaking FRAs or IRS, participants will have to set up appropriate infrastructure and risk management system such as ability to price the product and mark to market their positions, monitor and limit exposures on ongoing basis.

The draft guidelines have also stipulated the norms for computation of risk weighted assets on account of FRAs and IRSby banks, financial institutions and primary dealers. For bank and instituions, the notional principal amount of each instrument for a maturity period below one year should be multiplied by the conversion factor pegged at 0.5 per cent, for a maturity period above one year and less than two years with 1 per cent and 1 per cent for each additional year.

At the second stage, the adjusted value obtained should be multiplied by the risk weightage alloted to the relevant counterparty. For banks and financial institutions, the risk weightage is 20 per cent and for corporates it is pegged at 100 per cent.

According to the RBI release, primary dealers undertaking forward rate agreements and interest rate swaps will be required to maintain minimum net owned funds as defined in the primary dealers' guidelines. Besides, the PDs will be required to maintain an additional capital at 12 per cent of risk weighted assets (RWA) towards credit risk on interest rate contracts.

RBI has said that transactions for hedgingand market making purposes should be recorded separately. "With transactions for market-making purposes should be marked to market, those for hedging could be accounted for on accural basis," it said.

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