'Corporates with large derivative exposure a concern'

Corporates assuming large derivative exposure without adequate prudential accounting and disclosure norms pose a challenge to the banking system, an apex committee on financial sector has said.

"The propensity of some corporate participants to use derivatives to assume excessive leverage coupled with the lack of prudential accounting and disclosure norms remains a significant concern," the Committee on Financial Sector Assessment (CFSA) has said in its report.

"This (banks' large derivative exposure) makes it difficult to gauge the quantum of market and credit risks that banks face in this regard."

Regulators should have a better understanding of the off-balancesheet liabilities of banks and there should be better co-ordination with accounting standards and disclosures, it said.

Off-balancesheet exposure of Indian banks, particularly of private and foreign ones, has increased significantly in the recent years, the CFSA said.

The ratio of off-balancesheet exposure of Indian banks to total assets rose from 57 per cent as at the end of March 2002 to 363 per cent at end March 2008, which amounts to Rs 1,49,69,000 crore (notional principal amount), the report noted.

The exposure of public sector banks to derivatives has shown an increase in the recent years, following the amendment of the respective act, allowing lenders over-the-counter transactions in interest rate derivatives, the report said.

"The derivatives portfolio has undergone change with single currency IRS comprising 57 per cent of total portfolio at end-March 2008 from less than 15 per cent at end-March 2002."

Noting that the existing accounting standards are inadequate to account the loss and profit arising out of derivative transactions, the report said that centralised netting, collateral custody and a clearing system for derivatives will mitigate some of these risks.

The committee, chaired by RBI Deputy Governor Rakesh Mohan, comprises eminent economists and bankers, including Finance Secretary Ashok Chawla and RBI Governor D Subbarao.