Banks may get to hedge in commodity futures

In what could be a game-changing move, banks may be allowed to hedge their risks in the commodity futures market.

According to government sources, the finance ministry has written to the Reserve Bank of India (RBI) to explore ways to allow entry of banks in commodity hedging. RBI is actively considering the matter. Banks give finance against commodity as collateral and hence they take risk on the price of that collateral commodity.

The sources said the move would help improve real hedging and different kinds of risk-takers would come on board.

A committee set up by the central bank had recommended six years ago that banks should be allowed to hedge such risks and should also be allowed to aggregators who aggregate others’ risks and hedge on their behalf in commodity futures.

Despite the enthusiasm of banks, RBI was not allowing it as the Forward Markets Commission (FMC) did not have enough teeth. But that problem is set to be resolved with a parliamentary committee clearing the amendments to the Forward Contract Regulation Act (FCRA) which will strengthen FMC and pave the way for allowing more instruments such as options and index-based trading.

“For allowing banks to enter commodity hedging, RBI also needs to amend banking regulations as the existing provisions do not allow banks to operate on commodity futures exchanges,” said the source.

FMC has been meeting senior RBI officials to allow banks to hedge their commodity risks.

“I had several meetings with RBI on this issue,” B C Khatua, former chairman of the Forward Markets Commission (FMC), said. Even after his retirement, the commodity regulator has been pursuing the matter.

Khatua said banks could act both ways; as a hedger and an investor. The entry of banks would surely bring more depth in the commodity eco system and their track record would also pave the way for other instruments for futures trading, Khatua added.

For example, if options are introduced, a bank which has financed a steel manufacturer can buy a put option of steel (which is kept as collateral) depending upon the loan tenure. If steel prices fall and borrower cannot make good that short margin, banks will make good by increasing in put option price. This is hedging of risk by a bank.

If a farmer mortgages agri-output to banks and gets finance in lieu of it, then it will be in the financing bank’s interest to ensure the quality and quantity of the underlying commodity is maintained.

Hedging of this risk on futures exchange will help banks’ larger risk management.

Once hedging permission is granted to banks, meeting the priority sector lending target would become easier.

“This move will further deepen the commodities market and improve liquidity as banks’ presence will automatically attract big corporates to hedge their risks,” said Naveen Mathur, associate director, Angel Broking.

In addition to the Abhijit Sen Committee, the standing committee on consumer affairs, food and public distribution has also recommended allowing banks and financial institutions to participate in commodity derivatives platforms.