RBI moots extra provisioning for unhedged forex exposure

Scale of risky corporate positions remains significant; poses higher default risk

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The Reserve Bank of India (RBI) has proposed incremental provisioning and capital requirement for banks' exposure to companies with unhedged foreign exchange positions. These steps are expected to help banks deal with the probability of defaults in an environment of high currency volatility. The extent of unhedged foreign currency exposures (UFCE) of companies remain to be significant.

Unhedged exposures are an area of concern for individual companies as well as the entire financial system. At present, banks are monitoring the UFCE on a monthly basis. They also should calculate the incremental provisioning and capital requirements at least on a quarterly basis.

During periods of high rupee-dollar volatility, banks may calculate provisioning requirements on a monthly basis. This framework may be implemented from October 1, RBI said in a communication to banks. Companies that do not hedge their foreign currency exposures can incur significant losses due to exchange-rate movements. These losses may reduce their capacity to service the loans taken from the banking system, thereby affecting the system.

RBI has prescribed norms for estimating loss to companies for un-hedged exposures. UFCE pertains to total unhedged exposure and not limited to unhedged portion of banks' exposure to firms. UFCE in currencies other than the dollar may be converted to the dollar at market rates and the total amount of UFCE may be computed in dollar. The natural hedge available to companies may be excluded from computing UFCE. The amount will represent the portion of foreign currency exposure, which is not hedged using derivatives. It has prescribed norms for estimating the loss to corporates for un-hedged exposures. The loss due to fluctuation in dollar- rupee exchange rate may be calculated using the annualised volatilities. The largest annual volatility seen in the dollar-rupee rates in the last 10 years may be taken as the movement in the adverse direction.

Once the loss figure is calculated, banks may compare it with the annual EBID (earnings before interest and depreciation) according to the latest quarterly results certified by statutory auditors. The loss may be computed as a percentage of EBID. Higher this percentage, higher will be the susceptibility of the corporate to adverse exchange rate movements. Therefore, all exposures would attract incremental capital and provisioning requirements (over and above the present).

Banks can reduce their risk by reducing the exposure to these borrowers or by encouraging these borrowers to reduce their currency mismatches by hedging foreign currency exposures. Banks should also assess their loan pricing policies to ensure that they adequately reflect overall credit risks.