RBI wants derivatives deals on bank books

The Reserve Bank of India (RBI) plans to bring all derivative transactions of banks on their balance sheets against the current practice of showing them as 'off-balance sheet' items.

The RBI proposes to route all valuation gains and losses on derivatives either through the profit and loss account (for less than 90 days) and or through a new account titled 'unrealised gains/losses on derivatives' (for 90 days and more), somewhat similar to the norms for the part of investment portfolio classified as available for sale (AFS).

The central bank is concerned at the tendency of participants in the derivatives markets to assume excessive leverage and also at the lack of prudential accounting guidelines on derivatives.

"One of the features of in the Indian derivative market relates to concentration risk in respect of both the market makers (banks) and corporates. The combined share of top 15 banks has steadily grown from around 74 per cent in March 2002 to 82 per cent of the total OBS (off-balance sheet) exposures of the banking system in March 2006, of which 62 per cent is accounted for by foreign banks," the RBI deputy governor, Shyamala Gopinath, today said.

Concentration of knowledge is another risk which results in the concentration of derivative activity among few players, she stressed at the FICCI-IBA seminar on "Global Banking: Paradigm Shift".

"To address all issues related to derivatives in a comprehensive manner, we are now in the process of harmonizing the regulatory prescriptions based on generic principles rather than approving specific products," she added.

Gopinath said RBI was stressing on the need to carry out due diligence regarding customer appropriateness and suitability of products before offering derivative products to their customers.

There is need to use risk mitigation techniques such as collaterals and netting to reduce systemic risks and evolve appropriate accounting guidelines.

RBI has also issued two separate draft guidelines, one for valuation/accounting of investment portfolio in general and the second relating to derivatives.

The proposed guidelines attempt to put in place fair value accounting norms for derivatives broadly in line with IAS 39, the international accounting standard for valuation and accounting for financial instruments.

For investments, the proposed framework envisages a symmetrical treatment for unrealised gains and losses, with gains for HFT being reflected in the profit and loss account. For AFS, however, a gain or loss on subsequent measurement shall be reflected in 'Unrealised gain/ loss on AFS portfolio'.

"What has developed incrementally over the years is now being consolidated and once the regulations, infrastructure and appropriate accounting standards stabilise, several other initiatives like credit derivatives could be considered," the RBI deputy governor said.