RBI panel proposes norms for Interest Rate Option

Reserve Bank panel today proposed introduction of Interest Rate Option up to Rs 5 crore without documentation relating to exposure, a move aimed at providing more flexibility for hedging with regard to interest rate.
Currently, the only interest rate derivatives permitted in India are Interest Rate Swap (IRS) and Forward Rate Agreement (FRA) in the OTC segment and Interest Rate Futures (IRF) on the exchanges.
The panel headed P G Apte in the report said interest rate options may be permitted both on the currency and derivatives segment of stock exchanges as well as in the OTC market.
"To begin with, simple call and put Options, caps, floors, collars and swap options may be permitted," RBI said while releasing working group report on introducing Interest Rate Option.

Complex structures may be introduced subsequently, it said.
All domestic entities with an underlying interest rate risk may be allowed to trade these "interest rate options," the report said.

The RBI called for comments on its report by February 26 and will issue final guidelines by end-March.
Futures are a financial contract obligating the buyer to purchase an asset at a pre-determined future date and price while options are contract that has right, but not the obligation, to buy (for a call option) or sell (for a put option) during a specified period of time.
While banks, PDs and other regulated entities having sound financials and prudent risk management may be allowed as market makers subject to the approval of concerned regulator, all domestic entities having underlying interest rate risk may be permitted as users, it said.

"While no documentation relating to underlying exposure may be required for exposures up to Rs 5 crore, large corporates may also be allowed to take hedging positions for their anticipated interest rate exposures," it said.