Foreign banks lead off-balance sheet exposure
REPORT ON TREND AND PROGRESS OF BANKING IN INDIA 2005-06
| OBS exposures essentially take the form of contingent liabilities and derivatives. Contingent liabilities are the more traditional off-balance sheet exposures, while derivatives, except for traditional forward exchange contracts, have come into prominence recently. |
| The combined share of the 15 banks in total OBS exposures has steadily increased from 73.8 per cent in March 2002 to 82.3 per cent in March 2006. OBS exposures of the banking system rose sharply by 50.9 per cent in 2005-06 over and above the increase of 58 per cent in 2004-05. |
| The OBS exposure of banks has been growing significantly in the last five years, with the total notional principal amount of OBS exposures increasing from Rs 8,41,884 crore at end-March 2002 to Rs 43,99,908 crore at end-March 2006. The share of OBS exposures in total assets rose sharply to 152.5 per cent from 57.7 per cent over the same period. |
| The growth in OBS exposures reflects the impact of deregulation of interest rates, risk management operations, squeeze on margin on conventional balance sheet items, greater competition and new opportunities thrown up by advances in information technology, especially derivatives. The growth in derivatives segment has fuelled growth in OBS exposures in India. |
| Between end-March 2002 and end-March 2006, contingent liabilities of the banking system recorded an annual compound growth rate of 23.6 per cent, while contracts and derivatives increased at an annual compound growth rate of 55.5 per cent. |
| Consequently, the share of contracts and derivatives (notional principal) in total OBS exposures of the banking system increased from 82.5 per cent to 92.7 per cent during the same period. |
| While the notional amount of OBS exposures, including derivatives, has grown exponentially, the number of banks which are actively involved in these activities in India are only 15, most of which are foreign banks. |
| The proliferation of derivatives exposures poses a challenge to financial stability on account of the immense downside risks associated with them. |
| High concentration risk owing to a limited number of counterparties, both banks and corporates, is an important source of vulnerability in the Indian derviatives market. |
| The concentration of activity and knowledge among a small number of players raises the potential risk of systemic market crisis due to default by a few counterparties. |
| Thus, both market participants and policymakers need to be aware of the risk management challenges associated with the use of derivatives to transfer risk, both within and outside the banking system. |
| While the notional amount is a proxy for the amount of derivatives activity, it does not measure the risk of the activity. |
| A measure of assessing the risk is the credit equivalent, which is the monetary value of the credit risk exposure, and is the potential cost of replacing the contract's expected net cash flows in the event of default by the counterparty. |
| At the system's level, total credit equivalent of outstanding derivatives constituted 1.9 per cent of notional principal at end-March 2006. |