Still for the future

Plan to let banks play commodity futures is misguided

Opening up futures trading in commodities to banks, which may well be a precursor to similar access for other financial institutions, seems a measure whose time has not yet come. Futures trading, reintroduced in 2002 after a nearly four-decade hiatus, is still in its infancy in India. The Forward Markets Commission (FMC), the commodity trade regulator, is weak and toothless; it finds it difficult to ensure fair and distortion-free trading through commodity exchanges even at current volumes. The government itself has been sceptical, whether for the right or the wrong reasons, about the role of futures trading in triggering price increases in commodities. This was clear from the banning of such trading in several key farm goods in 2007. More recently, Finance Minister Pranab Mukherjee said in Parliament that increasing “financialisation” was partly responsible for the spurt in global oil prices. The Reserve Bank, too, is said to have reservations over this move as banks have little expertise in an innately risk-prone and speculative form of trading. The Banking Regulation Act currently does not allow banks to transact any business in commodities. In fact, Section 8 of this legislation specifically states that no bank shall “directly or indirectly deal in the buying or selling or bartering of goods, except in connection with the realisation of security given to or held by it”.

This statute is now proposed to be amended to pave the way for the banks’ entry into commodity futures, on the ground that it would provide them a tool for hedging their risks. It is, indeed, unclear what kind of risks the banks can hedge only through commodity business. If the objective is to allow them to mitigate the scope for default on agricultural loans, this is unlikely to be met unless indebted farmers are also linked to commodity exchanges to shield them against price uncertainties. But that, at this stage, is largely hypothetical, considering that farmers are not familiar with this kind of commerce, nor do they individually have large enough quantities of farm produce to trade on commodity exchange platforms. More importantly, the hedging instrument that actually suits farmers – options trading in commodities – is not allowed under the existing Forward Contracts (Regulation) Act (FCRA), 1952. Indeed, unless this law is amended to introduce options trading in futures and adequately strengthen and legally empower the FMC, perhaps on the lines of the Securities and Exchange Board of India (Sebi), moving to expand commodity futures trading makes little sense. In its present form, the FMC has proved ineffective when it comes to curbing malpractices such as “dabba” trading (parallel illegal trading) in commodities, as also in keeping at bay speculators, who often distort the market and cause abnormal price volatility even in insignificant commodities like guar seed and guar gum.

However, the government, for reasons best known to it, has been in no hurry to amend the FCRA legislation. Though a Bill drafted for this purpose was introduced in Parliament way back in 2006, it was subsequently withdrawn. A fresh draft, too, has been hanging fire for long despite having already been vetted by the relevant parliamentary committee. Getting this statute approved should receive priority over amending the banking law to let banks deal in commodity futures.