Banks review foreign derivatives deals

Indian banks are in the process of reviewing their exposures to derivatives contracts entered into with foreign banks as counter-parties.

Both the public and private sector banks are pruning their prudential exposure limits as they fear that a contagion effect of foreign banks following the sub-prime crisis may impact them seriously.

According to bankers, the review is mainly in exposure to foreign exchange derivatives contracts entered into for hedging as well as trading, both on behalf of their clients and on their own books.

The bankers, none of them wanted to be named, said RBI was also continuously reviewing the derivatives positions of Indian banks to try and avoid any contagion effect of the subprime losses.

The world's biggest banks and securities firms, including Citigroup and Merrill Lynch, have reported $45 billion of combined write-downs for bad debts in sub-prime mortgages and the losses are estimated to at least double. The sub-prime mortgage collapse has snapped the careers of Citigroup's Chuck Prince, Merrill's Stan O'Neal and UBS's Peter Wuffli.

Bankers said that the review of the exposure was not for short-term products like call market or short-term foreign exchange. It was mainly for the long-term derivative products and term-loan commitments.

Usually Indian banks maintain counter-party exposure in the money and foreign exchange markets. In the foreign exchange market, these limits pertain to spot and forward market transactions in the short term and derivatives in the long-term segment.

Bankers explained that the review in the limits was to slow down the dealings with the foreign banks till the time the losses on account of the sub-prime lending completely unfolds, hopefully by the beginning of the next calendar year.

"Though there has been no written communication (to review exposures to foreign banks), the managements of various banks have given verbal directions to this effect (to functional heads)," said a private sector bank official.

Several bankers said foreign banks might not be affected through these sub-prime losses going by their balance sheet size. However, most of the Indian banks have smaller balance sheet, which may get badly affected if any deal goes haywire.

The foreign banks are also going slow on their operations since the US sub-prime mortgage crisis first emerged in late July.

According to bankers close to the development, there has been a sort of "internal embargo" at foreign banks on fresh exposures till the time their parents get a clearer picture on the losses arising out of the sub-prime collapse.

Foreign banks in India have also been increasing their committed lines of credit from Indian banks to remain cash surplus. These lines of credit are over and above the stand-by credit, which is usually maintained by foreign banks with the Indian banks.

"This line of credit is for future and not immediate term, depending on the crunch overseas," said a foreign banker.