The Reserve Bank of India (RBI) mandated banks to make additional provisions if the estimated loss from unhedged exposure exceeds 15% of the company's earnings before tax, interest and depreciation (Ebitda), progressively raising the provision as estimated losses increase.
If the estimated loss is over 75% of Ebitda, banks will have to not just provide 80 basis points more the standard provisioning but also up the risk weight by 25% requiring the bank to set aside more capital.
“The extent of unhedged foreign currency exposures of the entities continues to be significant and this can increase the probability of default in times of high currency volatility,” the RBI said in a release detailing final guidelines.
In early 2013, deputy governor, HR Khan had estimated 60-65% of corporates forex borrowings was unhedged.
A report put out by Crisil in September 2013 estimated total unhedged forex exposure at about $98 billion — this was arrived at after natural hedges were netted off and active hedges taken into account.
However, since the analysis covered just half the total corporate forex debt in the country and did not include several corporate houses with large foreign currency exposures such as Essar, GMR, GVK, JSW, Jaypee and Videocon, the number could be considered to be conservative. The rating agency also pointed out that the forex borrowings were concentrated in a handful of firms, with the top one% accounting for 85% of the debt.
With the rupee losing as much as 20% between May and August last year--the currency hit an all-time low of 68.85/$ in late August---several companies were forced to report mark-to-market losses. While the currency has stabilised at levels of 62 to the dollar, it is nevertheless much weaker than the levels of 45 to the dollar that were ruling in 2012 and also levels of 50 seen in early 2013. By March, 2013, the currency had fallen off to levels of 55 and further to levels of 60 in June.
The RBI wants banks to calculate the estimated loss by considering the biggest yearly swing in the dollar/rupee rate over the last 10 years; this method could bump up banks' provisions since between January 2013 and January 2014, the rupee lost 15%.
Banks will have to calculate the incremental provisioning every quarter and during times of stress every month and the adequacy of banks' risk management will be monitored from time to time. The central bank has asked banks to gather details of unhedged forex exposure of every corporate borrower and estimate the impact of the movement of the exchange rate on such exposures. The guidelines say unhedged forex exposure may exclude items that are naturally hedged wherein cash flows arising out of business offset the risk of the exposure.
The final guidelines come six months after the central bank asked for comments on a draft of the norms. The massive fall of the rupee during May-August in 2013 prompted the central bank to instruct banks to monitor unhedged exposure of companies before giving fresh loans. Short-term debt, payable within the year, is the most vulnerable to currency fluctuations. According to government data as of September 2013, short-term debt stood at a whopping $94.8 billion, 34.2% of the country's forex reserves. However, a large part of this is hedged either through natural hedges or derivatives.