RBI asks banks to evaluate risk of unhedged forex

To prevent adverse impact of volatile forex market movement on corporates and their lenders, the Reserve Bank of India (RBI) has directed banks to evaluate risks from unhedged foreign currency exposure of companies while extending them credit facilities.

"In view of the importance of prudent management of foreign exchange risk, it has been decided that banks, while extending fund based and non-fund based credit facilities to corporates, should rigorously evaluate the risks arising out of unhedged foreign currency exposure of the corporates and price them in the credit risk premium," the RBI said in a circular today.

It also directed lenders to fix a limit on unhedged exposure of corporates on the basis of bank's board approved policy.

"Recent events relating to derivative trades have shown that excessive risk taking by corporates could lead to severe distress to them and large potential credit loss to their bankers in the event of sharp adverse movements in currencies," it said.

The circular comes a few months after the apex bank had, in its second quarter review of monetary policy in October 2011, warned against unhedged forex exposure of corporates.

"Unhedged forex exposure of corporates is a source of risk to corporates and a source of credit risk to financing banks. If the unhedged position is large, it can have serious consequences for the solvency of corporates in the event of large depreciation of the home currency and can result in large credit losses to the financing banks," the policy review has said.

According to RBI, the recent volatility in rupee exchange rate has underlined the importance of prudent management of foreign exchange risk.

The rupee depreciated by over 15% against the US dollar between August and December 2011. In mid-December, the rupee had weakened to an all-time low of Rs 53.72/73 to a US dollar.

However, it has since then strengthened and is currently trading at around Rs 49 a dollar.