Banks levy margin on OTC market forward contracts

Volatility in exchange rates and heightened risk of defaults have forced Indian banks to start charging margins for booking forward contracts in the over-the-counter (OTC) currency derivatives market.

The range of these margins varies from 5 per cent to 15 per cent, depending on the client’s capacity to pay the specified amount in a future date.

While margining is common on exchanges, sources familiar with the development said that exporters trading in the OTC market too have to pay margins to their bankers now.
 

RISK FACTOR

* OTC currency derivatives market’s daily turnover is around $34 billion

* Clients enter into forward contract deals to hedge currency rate risks

* So far, there was no margin system in the OTC market

* Banks have now started levying margins up to 15%

* Margins taken in the form of collaterals and FDs

* Move prompted by rising fluctuations in currency rates and risk of defaults

“Banks have started charging margins in the OTC market as they fear that the party may fail to pay the agreed amount due on a future date if his export contract gets cancelled or delayed due to increased fluctuations in currency rates,” the sources added.

Forward contract, usually with maturities ranging from a month to a year, is an agreement between a corporation and a commercial bank to exchange a specified amount of a currency at a specified rate (called the forward rate) on a specified future date. When a company anticipates a future need for a future receipt of foreign currency, it can set up forward contracts to lock in the rate at which they can purchase or sell a particular currency on the agreed future date. It is used to mitigate exposure to currency rate risks.

So far, only exchanges charge margins from members to trade in currency derivatives in order to avoid counter-party risks. “Given the surge in volatility of currency rates, banks too have started charging margins from their clients to book forward contracts. This may encourage more players to trade in the exchange-traded currency market where risks are covered to a larger extent,” said the head of a large domestic exchange that trades in currency futures.