Foreign banks under RBI scanner over derivatives

The Reserve Bank of India (RBI) scanner on banks with exposures to exotic derivatives has now turned to several high-profile foreign banks.

RBI has called for data from most of the foreign banks active in structured product markets since most of the exotic products have originated from these foreign banks.

Sources said at least eight foreign banks are facing regulatory scrutiny.

Most banks, contacted by Business Standard, refused comment and did not share the details of the products that were offered by them. These banks are also unwilling to disclose the level of their exposure.

Sources close to the development, however, said the books have been audited between December 2007 and March 2008. These inputs will be incorporated in RBI's annual inspection report.

During a high-level meeting, RBI has also asked the foreign banks not to "mis-sell" such highly leveraged products.

The banking regulator had also called for data from systemically important non-deposit-taking non-banking finance corporation (NBFCs), but did not find any substantial exposure to the derivatives segment, said sources.

Leverage allows greater potential returns to the investor than otherwise would have been available. However, the potential for loss is also higher.

This is because even if the investment becomes worthless, the loan principal and all accrued interest on the loans need to be repaid. These risks are again hedged with structured products, which may not have any underlying.

According to banking sources, most private sector banks have bought these structured products from these foreign banks and acted as market makers by selling them to companies.

While a part of the products were sold for hedging the currency risk arising out of a volatile dollar, a major portion is said to be for speculative gains.

Private sector banks with exposure to such exotic derivatives products include ICICI Bank, Kotak Mahindra Bank, HDFC bank, erstwhile Centurion Bank of Punjab, Yes Bank and Axis Bank.

While these banks do not suffer any losses on such products, a risk arises if companies decline to service the pay-ins due on such structures.

Axis Bank and Kotak Mahindra Bank have made provisions for potential losses during the fourth quarter of 2008, while the others did not disclose details.

Centurion Bank of Punjab declined to give any details in response to a faxed query.