RBI asks banks to encourage hedging of agri products

In a first major move to promote the commodity derivatives market with involvement of banks, the Reserve Bank of India asked the latter on Thursday to encourage borrowers of agricultural products to hedge their risk on commodity derivative exchanges.

The circular asks banks to encourage “large agricultural borrowers such as commodity processors, traders, millers, aggregations, etc” to do this on on recognised exchanges.

National Commodity & Derivatives Exchange (NCDEX) is the largest for trading in agri commodity derivatives and also has a platform for forward trading. At present, some banks have tied up with NCDEX or its subsidiary for trading in spot markets for lending against stocks deposited in recognised warehouses and it has been hedged on the exchange’s platform. It is the first time RBI has directly asked banks to encourage hedging by their borrowers, thereby helping them to manage the risk in such loans.

Borrowers who have taken loans for processing can buy the raw material from futures exchange to keep the cost in check if they feel its price would rise in time or sell a processed commodity on the futures platform to ensure realisations if they see prices falling in future.

“Generally, this risk is more pronounced in cases where agri borrowers do not hedge the underlying commodity price risk. Hedging of this risk is beneficial to both borrowers and banks and, hence, it is desirable that a risk management culture is fostered among the stakeholders, including agri-borrowers and banks,” said the RBI circular.

A government official said, “RBI has ultimately recognised the importance of hedging commodity price risk and shown confidence in the commodity derivative system.”

However, experts also say that in many agri commodity derivatives traded on an exchange platform, the liquidity is not enough to accommodate large numbers. In reply, a sector official said, “With banks encouraging their borrowers to hedge the risk of commodity prices, a different kind of players will come on the exchanges, automatically imparting depth to the market.”

The Forward Markets Commission (FMC) has already liberalised the margin structure for hedgers on comexes.

Banks understand the significance of hedging and, hence, many of them have equity holding in comexes. However, they were not coming forward as RBI had not spelt out its mind on allowing banks to take part in commodity derivatives. FMCs chairman Ramesh Abhishek had in the past met RBI seniors for allowing banks to take part in comexes and encourage borrowers to hedge their price risk on exchanges’ platform.

RBI has asked banks to educate borrowers about hedging the price risk of agri commodities, though, it added, "Banks must keep the sophistication, understanding, scale of operation and requirements of their agriborrower in mind while advising on the availability and use of these instruments."